<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) January 27, 1999
----------------
PHILIP MORRIS COMPANIES INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 1-8940 13-3260245
- --------------------------------------------------------------------------------
(State or other (Commission (IRS Employer
jurisdiction File Number) Identification No.)
of incorporation)
120 Park Avenue, New York, New York 10017-5592
- --------------------------------------------------------------------------------
(Address of principal
executive offices) (Zip Code)
Registrant's telephone number, including area code (917) 663-5000
--------------
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
Item 5. Other Events.
Filed as part of this Current Report on Form 8-K are the
consolidated balance sheets of Philip Morris Companies Inc. and subsidiaries
(the "Company") as of December 31, 1998 and 1997, and the related consolidated
statements of earnings, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998 (the "Financial Statements"),
the independent accountants' report thereon and the statement regarding
computation of ratios of earnings to fixed charges. The Financial Statements,
the independent accountants' report and the statement regarding computation of
ratios of earnings to fixed charges will be incorporated by reference in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
Item 7. Financial Statements and Exhibits.
The Financial Statements, together with the independent
accountants' report thereon, are included herein.
(c) Exhibits
12. Statement regarding computation of ratios of earnings to
fixed charges.
23. Consent of independent accountants.
27. Financial Data Schedule.
99. Financial Statements.
2
<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 hereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
BY /s/ LOUIS C. CAMILLERI
Senior Vice President and
Chief Financial Officer
DATE January 27, 1999
3
<PAGE>
EXHIBIT INDEX
EXHIBIT NO.
12. Statement regarding computation of ratios of earnings
to fixed charges.
23. Consent of independent accountants.
27. Financial Data Schedule.
99. Financial Statements.
<PAGE>
EXHIBIT 12
PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(dollars in millions)
---------------------
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Earnings before
income taxes and
cumulative effect
of accounting changes $ 9,087 $10,611 $10,683 $ 9,347 $ 8,216
Add (Deduct):
Equity in net earnings of
less than 50% owned
affiliates (195) (207) (227) (246) (184)
Dividends from less than
50% owned affiliates 70 138 160 202 165
Fixed charges 1,386 1,438 1,421 1,495 1,537
Interest capitalized, net
of amortization (5) (16) 13 2 (1)
------- ------- ------- ------- -------
Earnings available for
fixed charges $10,343 $11,964 $12,050 $10,800 $ 9,733
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Fixed charges:
Interest incurred:
Consumer products $ 1,166 $ 1,224 $ 1,197 $ 1,281 $ 1,317
Financial services and
real estate 77 67 81 84 78
------- ------- ------- ------- -------
$ 1,243 $ 1,291 $ 1,278 $ 1,365 $ 1,395
Portion of rent expense
deemed to represent
interest factor 143 147 143 130 142
------- ------- ------- ------- -------
Fixed charges $ 1,386 $ 1,438 $ 1,421 $ 1,495 $ 1,537
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Ratio of earnings to
fixed charges 7.5 8.3 8.5 7.2 6.3
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in Post-Effective Amendment No.
13 to the registration statement of Philip Morris Companies Inc. (the
"Company") on Form S-14 (File No. 2-96149) and in the Company's registration
statements on Form S-3 (File No. 333-35143) and Form S-8 (File Nos. 333-28631,
333-20747, 333-16127, 33-1479, 33-1480, 33-10218, 33-13210, 33-14561,
33-17870, 33-37115, 33-38781, 33-39162, 33-40110, 33-48781, 33-59109, 33-63975
and 33-63977), of our report dated January 25, 1999 (included herein), on our
audits of the consolidated financial statements of the Company, which is
included in this Current Report on Form 8-K dated January 27, 1999, as
indicated in Item 7 herein.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
January 27, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Pages 2-3 of
the Company's consolidated financial statements for the year ended December 31,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,081
<SECURITIES> 0
<RECEIVABLES> 4,873
<ALLOWANCES> 182
<INVENTORY> 9,445
<CURRENT-ASSETS> 20,230
<PP&E> 21,234
<DEPRECIATION> 8,899
<TOTAL-ASSETS> 59,920
<CURRENT-LIABILITIES> 16,379
<BONDS> 12,615
0
0
<COMMON> 935
<OTHER-SE> 15,262
<TOTAL-LIABILITY-AND-EQUITY> 59,920
<SALES> 74,391
<TOTAL-REVENUES> 74,391
<CGS> 26,820
<TOTAL-COSTS> 43,398
<OTHER-EXPENSES> 21,016
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 890
<INCOME-PRETAX> 9,087
<INCOME-TAX> 3,715
<INCOME-CONTINUING> 5,372
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,372
<EPS-PRIMARY> 2.21
<EPS-DILUTED> 2.20
</TABLE>
<PAGE>
Exhibit 99
PHILIP MORRIS COMPANIES INC.
and SUBSIDIARIES
Consolidated Financial Statements as of
December 31, 1998 and 1997 and for Each of the
Three Years in the Period Ended December 31, 1998
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
January 25, 1999
To the Board of Directors and Stockholders of
Philip Morris Companies Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, stockholders' equity and cash flows present
fairly, in all material respects, the consolidated financial position of Philip
Morris Companies Inc. and its subsidiaries at December 31, 1998 and 1997, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
<PAGE>
PHILIP MORRIS COMPANIES INC.
and Subsidiaries
CONSOLIDATED BALANCE SHEETS, at December 31,
(in millions of dollars, except per share data)
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
ASSETS
CONSUMER PRODUCTS
Cash and cash equivalents $ 4,081 $ 2,282
Receivables, net 4,691 4,294
Inventories:
Leaf tobacco 4,729 4,348
Other raw materials 1,728 1,689
Finished product 2,988 3,002
------- -------
9,445 9,039
Other current assets 2,013 1,825
------- -------
Total current assets 20,230 17,440
Property, plant and equipment, at cost:
Land and land improvements 655 666
Buildings and building equipment 5,386 5,114
Machinery and equipment 13,771 12,667
Construction in progress 1,422 1,555
------- -------
21,234 20,002
Less accumulated depreciation 8,899 8,381
------- -------
12,335 11,621
Goodwill and other intangible assets
(less accumulated amortization of
$5,436 and $4,814) 17,566 17,789
Other assets 3,309 3,211
------- -------
TOTAL CONSUMER PRODUCTS ASSETS 53,440 50,061
FINANCIAL SERVICES
Finance assets, net 6,324 5,712
Other assets 156 174
------- -------
TOTAL FINANCIAL SERVICES ASSETS 6,480 5,886
------- -------
TOTAL ASSETS $59,920 $55,947
------- -------
------- -------
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
LIABILITIES
CONSUMER PRODUCTS
Short-term borrowings $ 225 $ 157
Current portion of long-term debt 1,822 1,516
Accounts payable 3,359 3,318
Accrued liabilities:
Marketing 2,637 2,149
Taxes, except income taxes 1,408 1,234
Employment costs 968 1,083
Settlement charges 1,135 886
Other 2,608 2,894
Income taxes 1,144 862
Dividends payable 1,073 972
-------- --------
Total current liabilities 16,379 15,071
Long-term debt 11,906 11,585
Deferred income taxes 929 889
Accrued postretirement health care costs 2,543 2,432
Other liabilities 7,019 6,218
-------- --------
TOTAL CONSUMER PRODUCTS LIABILITIES 38,776 36,195
FINANCIAL SERVICES
Long-term debt 709 845
Deferred income taxes 4,151 3,877
Other liabilities 87 110
-------- --------
TOTAL FINANCIAL SERVICES LIABILITIES 4,947 4,832
-------- --------
Total liabilities 43,723 41,027
-------- --------
Contingencies (Note 16)
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 26,261 24,924
Accumulated other comprehensive earnings
(including currency translation of $1,081
and $1,109) (1,106) (1,109)
Cost of repurchased stock
(375,426,742 and 380,474,028 shares) (9,893) (9,830)
-------- --------
Total stockholders' equity 16,197 14,920
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 59,920 $ 55,947
-------- --------
-------- --------
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS of EARNINGS
for the years ended December 31,
(in millions of dollars, except per share data)
----------
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Operating revenues $74,391 $72,055 $69,204
Cost of sales 26,820 26,689 26,560
Excise taxes on products 16,578 15,941 14,651
------- ------- -------
Gross profit 30,993 29,425 27,993
Marketing, administration and research costs 17,051 15,720 15,630
Settlement charges (Note 16) 3,381 1,457
Amortization of goodwill 584 585 594
------- ------- -------
Operating income 9,977 11,663 11,769
Interest and other debt expense, net 890 1,052 1,086
------- ------- -------
Earnings before income taxes 9,087 10,611 10,683
Provision for income taxes 3,715 4,301 4,380
------- ------- -------
Net earnings $ 5,372 $ 6,310 $ 6,303
------- ------- -------
------- ------- -------
Per share data:
Basic earnings per share $ 2.21 $ 2.61 $ 2.57
------- ------- -------
------- ------- -------
Diluted earnings per share $ 2.20 $ 2.58 $ 2.54
------- ------- -------
------- ------- -------
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
CONSOLIDATED STATEMENTS of STOCKHOLDERS' EQUITY
(in millions of dollars, except per share data)
----------
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Earnings
--------------------------------
Earnings Currency Cost of Total
Common Reinvested in Translation Repurchased Stockholders'
Stock the Business Adjustments Other Total Stock Equity
-------- ------------ ----------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1996 $ 935 $ 19,811 $ 467 $ (32) $ 435 $ (7,196) $ 13,985
Comprehensive earnings:
Net earnings 6,303 6,303
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments (275) (275) (275)
Net unrealized appreciation on
securities 30 30 30
--------
Total other comprehensive earnings (245)
--------
Total comprehensive earnings 6,058
--------
Exercise of stock options and issuance
of other stock awards (28) 609 581
Cash dividends declared ($1.47 per share) (3,606) (3,606)
Stock repurchased (2,800) (2,800)
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1996 935 22,480 192 (2) 190 (9,387) 14,218
Comprehensive earnings:
Net earnings 6,310 6,310
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments (1,301) (1,301) (1,301)
Net unrealized appreciation
on securities 2 2 2
--------
Total other comprehensive earnings (1,299)
--------
Total comprehensive earnings 5,011
--------
Exercise of stock options and issuance
of other stock awards 14 300 314
Cash dividends declared ($1.60 per share) (3,880) (3,880)
Stock repurchased (743) (743)
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1997 935 24,924 (1,109) (1,109) (9,830) 14,920
Comprehensive earnings:
Net earnings 5,372 5,372
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments 28 28 28
Additional minimum pension liability (25) (25) (25)
--------
Total other comprehensive earnings 3
--------
Total comprehensive earnings 5,375
--------
Exercise of stock options and issuance
of other stock awards 50 287 337
Cash dividends declared ($1.68 per share) (4,085) (4,085)
Stock repurchased (350) (350)
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1998 $ 935 $ 26,261 $ (1,081) $ (25) $ (1,106) $ (9,893) $ 16,197
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
CONSOLIDATED STATEMENTS of CASH FLOWS
for the years ended December 31,
(in millions of dollars)
----------
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 5,255 $ 6,152 $ 6,180
- Financial services 117 158 123
------- ------- -------
Net earnings 5,372 6,310 6,303
Adjustments to reconcile net earnings to operating cash flows:
CONSUMER PRODUCTS
Depreciation and amortization 1,690 1,629 1,631
International food realignment 630
Deferred income tax provision (benefit) 11 (188) 163
Gain on sale of Brazilian ice cream businesses (774)
Gains on sales of other businesses (196) (320)
Cash effects of changes, net of the effects from acquired and
divested companies:
Receivables, net (352) (168) 35
Inventories (192) (531) (952)
Accounts payable (150) 37 60
Income taxes 565 48 373
Accrued liabilities and other current assets 254 726 (448)
Other 671 653 527
FINANCIAL SERVICES
Deferred income tax provision 265 257 224
Gain on sale of business (103)
Other (14) 10 38
------- ------- -------
Net cash provided by operating activities 8,120 8,340 7,634
------- ------- -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
CONSUMER PRODUCTS
Capital expenditures (1,804) (1,874) (1,782)
Purchase of businesses, net of acquired cash (17) (630) (616)
Proceeds from sales of businesses 16 1,784 612
Other (154) 42 (47)
FINANCIAL SERVICES
Investments in finance assets (736) (652) (439)
Proceeds from finance assets 141 287 217
Proceeds from sale of business 424
------- ------- -------
Net cash used in investing activities (2,554) (619) (2,055)
------- ------- -------
</TABLE>
See notes to consolidated financial statements.
Continued
5
<PAGE>
CONSOLIDATED STATEMENTS of CASH FLOWS (Continued)
for the years ended December 31,
(in millions of dollars)
----------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
CONSUMER PRODUCTS
Net issuance (repayment) of short-term borrowings $ 61 $(1,482) $(1,119)
Long-term debt proceeds 2,065 2,893 2,699
Long-term debt repaid (1,616) (1,987) (1,979)
FINANCIAL SERVICES
Net repayment of short-term borrowings (173) (498)
Long-term debt proceeds 174 363
Long-term debt repaid (178) (387)
Repurchase of common stock (307) (805) (2,770)
Dividends paid (3,984) (3,885) (3,462)
Issuance of common stock 265 205 448
Other (200) (74) (88)
------- ------- -------
Net cash used in financing activities (3,894) (5,521) (6,406)
------- ------- -------
Effect of exchange rate changes on cash and cash equivalents 127 (158) (71)
------- ------- -------
Cash and cash equivalents:
Increase (decrease) 1,799 2,042 (898)
Balance at beginning of year 2,282 240 1,138
------- ------- -------
Balance at end of year $ 4,081 $ 2,282 $ 240
------- ------- -------
------- ------- -------
Cash paid: Interest - Consumer products $ 1,141 $ 1,219 $ 1,244
------- ------- -------
------- ------- -------
- Financial services $ 79 $ 79 $ 95
------- ------- -------
------- ------- -------
Income taxes $ 2,644 $ 3,794 $ 3,424
------- ------- -------
------- ------- -------
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
-------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of presentation:
The consolidated financial statements include all significant
subsidiaries. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and
liabilities at the dates of the financial statements and the reported
amounts of operating revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
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 assets and
liabilities are unclassified, in accordance with respective industry
practices.
Certain prior years' amounts have been reclassified to conform with the
current year's presentation.
Cash and cash equivalents:
Cash equivalents include demand deposits with banks and all highly
liquid investments with original maturities of three months or less.
Inventories:
Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method is used to cost substantially all domestic
inventories. The cost of other inventories is determined by the average
cost or first-in, first-out methods. It is a generally recognized
industry practice to classify leaf tobacco inventory as a current asset
although part of such inventory, because of the duration of the aging
process, ordinarily would not be utilized within one year.
Impairment of long-lived assets:
The Company reviews long-lived assets for impairment whenever events or
changes in business circumstances indicate that the carrying amount of
the assets may not be fully recoverable. The Company performs
undiscounted cash flow analyses to determine if an impairment exists.
If an impairment is determined to exist, any related impairment loss is
calculated based on fair value. Impairment losses on assets to be
disposed, if any, are based on the estimated proceeds to be received,
less costs of disposal.
Depreciation, amortization and goodwill valuation:
Depreciation is recorded by the straight-line method. Goodwill and
other intangible assets substantially comprises brand names purchased
through acquisitions, which are amortized on the straight-line method
over 40 years. The Company periodically evaluates the recoverability of
its intangible assets and measures any impairment by comparison to
estimated undiscounted cash flows from future operations.
Advertising costs:
Advertising costs are expensed as incurred.
Continued
7
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
Revenue recognition:
The Company recognizes operating revenues upon shipment of goods to
customers.
Hedging instruments:
The Company utilizes certain financial instruments to manage its
foreign currency, commodity and interest rate exposures. The Company
does not engage in trading or other speculative use of these financial
instruments. To qualify as a hedge, the Company must be exposed to
price, currency or interest rate risk and the financial instrument must
reduce the exposure and be designated as a hedge. Additionally, for
hedges of anticipated transactions, the significant characteristics and
expected terms of the anticipated transaction must be identified and it
must be probable that the anticipated transaction will occur. Financial
instruments qualifying for hedge accounting must maintain a high
correlation between the hedging instrument and the item being hedged,
both at inception and throughout the hedged period.
The Company uses forward contracts, options and swap agreements to
mitigate its foreign currency exposure. The corresponding gains and
losses on those contracts are deferred and included in the basis of the
underlying hedged transactions when settled. Options are used to hedge
anticipated transactions. Option premiums are recorded generally as
other current assets on the consolidated balance sheets and amortized
to interest and other debt expense, net over the lives of the related
options. The value of options, excluding their time values, are
recognized as adjustments to the related hedged items. If anticipated
transactions were not to occur, any gains or losses would be recognized
in earnings currently. Foreign currency and related interest rate swap
agreements are used to hedge certain foreign currency net investments.
Realized and unrealized gains and losses on foreign currency swap
agreements that are effective as hedges of net assets in foreign
subsidiaries are offset against currency translation adjustments as a
component of stockholders' equity. The interest differential to be paid
or received under the currency and related interest rate swap
agreements is recognized over the life of the related debt and is
included in interest and other debt expense, net. Gains and losses on
terminated foreign currency swap agreements, if any, are recorded as
currency translation adjustments, which is a component of stockholders'
equity.
Commodity futures and forward contracts are used by the Company to
procure raw materials, primarily coffee, cocoa, sugar, wheat and corn.
Commodity futures and options are also used to hedge the price of
certain commodities, primarily coffee and cocoa. Realized gains and
losses on commodity futures, forward contracts and options are deferred
as a component of inventories and are recognized when related raw
material costs are charged to cost of sales. If the anticipated
transaction were not to occur, the gains and losses would be recognized
in earnings currently.
Interest rate swap agreements are accounted for on an accrual basis
with the net receivable or payable recognized as an adjustment to
interest expense. Gains and losses on terminated interest rate swaps,
if any, are recognized over the remaining life of the arrangement, or
immediately, if the hedged items do not remain outstanding. The fair
value of the interest rate swap agreements and changes in these fair
values as a result of changes in market interest rates are not
recognized in the consolidated financial statements.
Continued
8
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
During 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which must be adopted
by the Company by January 1, 2000. SFAS No. 133 requires that all
derivative financial instruments be recorded on the consolidated
balance sheets at their fair value. Changes in the fair value of
derivatives will be recorded each period in earnings or other
comprehensive earnings, depending on whether a derivative is designated
as part of a hedge transaction and, if it is, the type of hedge
transaction. Gains and losses on derivative instruments reported in
other comprehensive earnings will be reclassified as earnings in the
periods in which earnings are affected by the hedged item. The Company
has not yet determined the impact that adoption or subsequent
application of SFAS No. 133 will have on its financial position or
results of operations.
Stock-based compensation:
The Company accounts for employee stock compensation plans in
accordance with the intrinsic value-based method permitted by SFAS No.
123, "Accounting for Stock-Based Compensation," which generally does
not result in compensation cost.
Software costs:
The Company capitalizes certain computer software and software
development costs incurred in connection with developing or obtaining
computer software for internal use in accordance with Statement of
Position No. 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," which was adopted by
the Company as of January 1, 1998. The adoption of SOP 98-1 had no
material effect on the Company's financial position or results of
operations.
Capitalized costs are amortized on a straight-line basis over the
estimated useful lives of the software.
NOTE 2. DIVESTITURES:
During 1997, the Company sold several domestic and international food
businesses, including its Brazilian ice cream businesses and its North
American maple-flavored syrup businesses, for total proceeds of $1.5
billion and net pre-tax gains of $958 million. In addition, the Company
sold its equity interest in a Canadian beer operation and sold a minority
interest in a beer import operation for proceeds of $306 million and a
pre-tax gain of $12 million. The Company also sold its real estate
operations for total proceeds of $424 million and a pre-tax gain of $103
million.
During 1996, the Company sold several domestic and international food
businesses, including its North American bagel business, for total proceeds
of $612 million and net pre-tax gains of $320 million.
The operating results of these businesses were not material to the
Company's consolidated operating results in any of the periods presented.
Pre-tax gains on these divestitures were included in marketing,
administration and research costs on the Company's consolidated statements
of earnings.
Continued
9
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
NOTE 3. ACQUISITIONS:
During December 1998, the Company's domestic tobacco subsidiary paid $150
million for options to purchase the voting and non-voting common stock of a
company ("the acquiree"), the sole assets of which are three U.S. cigarette
brands. The exercise of the options is subject to regulatory approval. Upon
exercise of these options, the Company will acquire all the common stock of
the acquiree for an additional $150 million.
During 1997, the Company acquired a controlling interest in a Portuguese
tobacco company at a cost of $217 million and increased its ownership
interest in a Mexican cigarette business from 28.8% to 50.0% at a cost of
$403 million.
During 1996, the Company acquired a controlling interest in a Polish
tobacco company, at a cost of $285 million and nearly all of the remaining
voting shares of a Brazilian confectionery company, at a cost of $314
million.
The effects of these and other smaller acquisitions were not material to
the Company's financial position or results of operations in any of the
periods presented.
NOTE 4. FOOD REALIGNMENT CHARGES:
In the fourth quarter of 1997, the Company's international food operations
recorded a charge of $342 million related primarily to the downsizing or
closure of manufacturing and other facilities, as well as the
discontinuance of certain low-margin product lines. The Company also
recorded a charge of $288 million for incremental postemployment benefits,
primarily related to severance.
In 1996, the Company's North American food and international food
operations charged $252 million and $68 million, respectively, to
marketing, administration and research costs. These charges related
primarily to the downsizing and closure of certain food manufacturing
facilities, related incremental postemployment costs, primarily severance,
and an early retirement program.
These charges, which were recorded to marketing, administration and
research costs, reduced earnings before income taxes by $630 million and
$320 million in 1997 and 1996, respectively.
NOTE 5. INVENTORIES:
The cost of approximately 50% of inventories in 1998 and 1997 was
determined using the LIFO method. The stated LIFO values of inventories
were approximately $1.1 billion and $1.0 billion lower than the current
cost of inventories at December 31, 1998 and 1997, respectively.
Continued
10
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
NOTE 6. SHORT-TERM BORROWINGS AND BORROWING ARRANGEMENTS:
At December 31, the Company's short-term borrowings and related average
interest rates consisted of the following:
<TABLE>
<CAPTION>
1998 1997
------------------------- ---------------------------
(in millions)
Average Average
Amount Year-end Amount Year-end
Outstanding Rate Outstanding Rate
-------------- ---------- ------------- -----------
<S> <C> <C> <C> <C>
Consumer products:
Bank loans $ 260 10.3% $ 194 8.8%
Amount reclassified
as long-term debt (35) (37)
------- --------
$ 225 $ 157
====== =======
</TABLE>
The fair values of the Company's short-term borrowings at December 31, 1998
and 1997, based upon market rates, approximate the amounts disclosed
above.
The Company and its subsidiaries maintain credit facilities with a
number of lending institutions, amounting to approximately $12.2
billion at December 31, 1998. Approximately $12.0 billion of these
facilities were unused at December 31, 1998. Certain of these
facilities are used to support commercial paper borrowings, are
available for acquisitions and other corporate purposes and require
the maintenance of a fixed charges coverage ratio.
The Company's credit facilities include revolving bank credit agreements
totaling $10.0 billion. Included in this total is an agreement for
$2.0 billion, which expires in October 1999, and an agreement for
$8.0 billion, expiring in 2002, which enables the Company to
refinance short-term debt on a long-term basis. Accordingly,
short-term borrowings intended to be refinanced were reclassified as
long-term debt.
Continued
11
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
NOTE 7. LONG-TERM DEBT:
At December 31, 1998 and 1997 the Company's long-term debt consisted of
the following:
<TABLE>
<CAPTION>
1998 1997
------ ------
(in millions)
<S> <C> <C>
Consumer products:
Short-term borrowings, reclassified $ 35 $ 37
Notes, 6.15% to 9.25% (average effective
rate 7.39%), due through 2008 9,615 9,735
Debentures, 6.00% to 8.50%
(average effective rate 9.90%),
$1.9 billion face amount, due through 2027 1,691 1,830
Foreign currency obligations:
Swiss franc, 1.39% to 5.50%
(average effective rate 4.96%), due through 2000 463 857
German mark, 5.63% to 6.38%
(average effective rate 5.63%), due through 2008 1,566 341
Other foreign 122 61
Other 236 240
--------- ---------
13,728 13,101
Less current portion of long-term debt (1,822) (1,516)
--------- ---------
$ 11,906 $ 11,585
========= =========
Financial services:
Eurodollar note, 6.63%, due 1999 $ 200 $ 200
Foreign currency obligations:
French franc, 6.88%, due 2006 179 169
German mark, 6.50% and 5.38%,
(average effective rate 5.89%)
due 2003 and 2004 330 311
ECU note, 8.50%, due 1998 165
--------- ---------
$ 709 $ 845
--------- ---------
--------- ---------
</TABLE>
Aggregate maturities of long-term debt, excluding short-term borrowings
reclassified as long-term debt, are as follows:
<TABLE>
<CAPTION>
Consumer Products Financial Services
----------------- ------------------
(in millions)
<S> <C> <C>
1999 $1,822 $200
2000 1,662
2001 1,843
2002 1,402
2003 1,251 150
2004-2008 4,795 359
2009-2013 248
Thereafter 815
</TABLE>
Continued
12
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
Based on market quotes, where available, or interest rates currently
available to the Company for issuance of debt with similar terms and
remaining maturities, the aggregate fair value of consumer products
and financial services long-term debt, including current portion of
long-term debt, at December 31, 1998 and 1997 was $15.4 billion and
$14.6 billion, respectively.
NOTE 8. CAPITAL STOCK:
In 1997, the Company's Board of Directors declared a three-for-one split
of the Company's common stock, changed the common stock's par value
from $1.00 to $0.33 1/3 per share and increased the number of
authorized shares of common stock from 4 billion to 12 billion
shares. All references in the consolidated financial statements to
shares and related prices, weighted average number of shares, per
share amounts and stock plan data have been adjusted to reflect the
split.
Shares of common stock issued, repurchased and outstanding were as
follows:
<TABLE>
<CAPTION>
Shares Shares Net Shares
Issued Repurchased Outstanding
-------- ----------- -----------
<S> <C> <C> <C>
Balances, January 1, 1996 2,805,961,317 (312,451,299) 2,493,510,018
Exercise of stock options and
issuance of other stock awards 23,672,505 23,672,505
Repurchased (85,836,249) (85,836,249)
---------------------- ------------- ---------------
Balances, December 31, 1996 2,805,961,317 (374,615,043) 2,431,346,274
Exercise of stock options and
issuance of other stock awards 12,345,228 12,345,228
Repurchased (18,204,213) (18,204,213)
---------------------- ------------- ---------------
Balances, December 31, 1997 2,805,961,317 (380,474,028) 2,425,487,289
Exercise of stock options and
issuance of other stock awards 11,501,286 11,501,286
Repurchased (6,454,000) (6,454,000)
---------------------- -------------- ----------------
Balances, December 31, 1998 2,805,961,317 (375,426,742) 2,430,534,575
---------------------- -------------- ----------------
---------------------- -------------- ----------------
</TABLE>
At December 31, 1998, 173,607,574 shares of common stock were reserved
for stock options and other stock awards under the Company's stock
plans and 10 million shares of Serial Preferred Stock, $1.00 par
value, were authorized, none of which have been issued.
NOTE 9. STOCK PLANS:
Under the Philip Morris 1997 Performance Incentive Plan (the "Plan"),
the Company may grant to eligible employees stock options, stock
appreciation rights, restricted stock, and other stock-based awards,
as well as cash-based annual and long-term incentive awards. Up to
120 million shares of common stock may be issued under the Plan, of
which no more than 36 million shares may be awarded as restricted
stock. Shares available to be granted at December 31, 1998 were
85,883,360.
Continued
13
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
Stock options are granted at an exercise price of not less than fair
value on the date of the grant. Stock options granted under the Plan
generally become exercisable on the first anniversary of the grant
date and have a maximum term of ten years.
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting
for Stock-Based Compensation." The Company applies the intrinsic
value-based methodology permitted by SFAS No. 123 in accounting for
the Plan. Accordingly, no compensation expense has been recognized
other than for restricted stock awards. Had compensation cost for
stock option awards under the Plan been determined on the fair value
at the grant date, the Company's net earnings, basic EPS and diluted
EPS would have been $5,280 million, $2.17 and $2.16, respectively,
for the year ended December 31, 1998; $6,218 million, $2.57 and
$2.55, respectively, for the year ended December 31, 1997; and
$6,235 million, $2.54 and $2.51, respectively, for the year ended
December 31, 1996. The foregoing impact of compensation cost,
calculated in accordance with the fair value method prescribed by
SFAS No. 123, was determined using a modified Black-Scholes
methodology and the following assumptions:
<TABLE>
<CAPTION>
Weighted
Average Expected
Risk-free Expected Expected Dividend Fair Value
Interest Rate Life Volatility Yield at Grant Date
------------- --------- ---------- -------- --------------
<S> <C> <C> <C> <C> <C>
1998 5.52% 5 23.83% 4.03% $ 7.78
1997 6.38 5 27.86 3.65 10.83
1996 6.70 5 23.80 3.83 7.73
</TABLE>
Option activity was as follows for the years ended December 31, 1996, 1997
and 1998:
<TABLE>
<CAPTION>
Weighted
Shares Subject Options Average
to Option Exercisable Exercise Price
-------------- ----------- ---------------
<S> <C> <C> <C>
Balance at January 1, 1996 85,224,372 62,102,802 $20.09
Options granted 22,627,215 36.08
Options exercised (25,310,940) 18.94
Options canceled (1,327,266) 26.21
------------
Balance at December 31, 1996 81,213,381 58,949,796 24.81
Options granted 16,105,390 43.88
Options exercised (12,782,568) 19.86
Options canceled (890,644) 34.75
-------------
Balance at December 31, 1997 83,645,559 67,827,399 29.13
Options granted 18,652,100 39.74
Options exercised (12,042,497) 22.56
Options canceled (3,051,498) 31.74
-------------
Balance at December 31, 1998 87,203,664 68,864,594 $32.21
-------------
-------------
</TABLE>
Continued
14
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
The weighted average exercise prices of options exercisable at December 31,
1998, 1997 and 1996 were $30.21, $25.69 and $20.56, respectively.
The following table summarizes the status of stock options outstanding
and exercisable as of December 31, 1998, by range of exercise price:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- -----------------------------
Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
-------- ------------- ------------ -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$11.80 - 17.23 10,965,163 3 years $15.70 10,965,163 $15.70
18.35 - 26.28 24,813,444 5 years 24.16 24,813,444 24.16
28.27 - 40.00 36,608,512 8 years 37.89 18,291,382 36.06
41.62 - 58.72 14,816,545 8 years 43.89 14,794,605 43.88
---------- ----------
87,203,664 68,864,594
---------- ----------
---------- ----------
</TABLE>
The Company may grant shares of restricted stock and rights to receive
shares of stock to eligible employees, giving them in most instances
all of the rights of stockholders, except that they may not sell,
assign, pledge or otherwise encumber such shares and rights. Such
shares and rights are subject to forfeiture if certain employment
conditions are not met. During 1998, 1997 and 1996 the Company
granted 603,650, 692,100 and 180,000 shares, respectively, of
restricted stock to eligible U.S. based employees and also issued to
eligible non-U.S. employees rights to receive 120,500 and 392,400
like shares, respectively, during 1998 and 1997. At December 31,
1998, restrictions on the stock, net of forfeitures, lapse as
follows: 1999-120,300 shares, 2000-654,000 shares, 2002-1,263,450
shares, 2003-290,250 shares; and 2004 and thereafter-636,000 shares.
The fair value of the restricted shares and rights at the date of grant
is amortized to expense ratably over the restriction period. The
Company recorded compensation expense related to restricted stock
and other stock awards of $34 million, $29 million and $37 million
for the years ended December 31, 1998, 1997 and 1996, respectively.
The unamortized portion is reported as a reduction of earnings
reinvested in the business and was $59 million and $49 million at
December 31, 1998 and 1997, respectively.
Continued
15
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued
-------------
NOTE 10. EARNINGS PER SHARE:
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
per Share," which established standards for computing and presenting
both basic and diluted earnings per share ("EPS"). Basic and diluted
EPS were calculated using the following for the years ended December
31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Net earnings $5,372 $6,310 $6,303
------- ------- -------
------- ------- -------
Weighted average shares for basic EPS 2,429 2,420 2,456
Plus incremental shares from conversions:
Restricted stock and stock rights 1 1 8
Stock options 16 21 18
------- ------- -------
Weighted average shares for diluted EPS 2,446 2,442 2,482
------- ------- -------
------- ------- -------
</TABLE>
In 1998, 1997, and 1996, options on 14,797,260, 11,988,118 and
18,737,224 shares of common stock, respectively, were not included
in the calculation of weighted average shares for diluted EPS
because their effects would be antidilutive.
NOTE 11. PRE-TAX EARNINGS AND PROVISION FOR INCOME TAXES:
Pre-tax earnings and provision for income taxes consisted of the
following for the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Pre-tax earnings:
United States $ 5,134 $ 7,515 $ 7,399
Outside United States 3,953 3,096 3,284
------- --------- ---------
Total pre-tax earnings $ 9,087 $ 10,611 $ 10,683
------- --------- ---------
------- --------- ---------
Provision for income taxes:
United States federal:
Current $ 1,614 $ 2,027 $ 1,836
Deferred 171 12 438
------- --------- ---------
1,785 2,039 2,274
State and local 350 354 430
------- --------- ---------
Total United States 2,135 2,393 2,704
------- --------- ---------
Outside United States:
Current 1,475 1,851 1,727
Deferred 105 57 (51)
------- --------- ---------
Total outside United States 1,580 1,908 1,676
------- --------- ---------
Total provision for income taxes $ 3,715 $ 4,301 $ 4,380
------- --------- ---------
------- --------- ---------
</TABLE>
Continued
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
At December 31, 1998, applicable United States federal income taxes and
foreign withholding taxes have not been provided on approximately $3.4
billion of accumulated earnings of foreign subsidiaries that are
expected to be permanently reinvested. If these amounts were not
considered permanently reinvested, additional deferred income taxes of
approximately $173 million would have been provided.
The Company and its subsidiaries are subject to tax examinations in various
U.S. and foreign jurisdictions. The Company believes that adequate tax
payments have been made and accruals recorded for all years.
The effective income tax rate on pre-tax earnings differed from the U.S.
federal statutory rate for the following reasons for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
U.S. federal statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
State and local income taxes, net of
federal tax benefit 2.5 2.2 2.6
Rate differences - foreign operations 0.6 3.7 3.3
Goodwill amortization 2.0 1.7 1.8
Other 0.8 (2.1) (1.7)
----- ---- ----
Effective tax rate 40.9% 40.5% 41.0%
----- ---- ----
----- ---- ----
</TABLE>
The tax effects of temporary differences which gave rise to consumer
products deferred income tax assets and liabilities consisted of the
following at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
--------- --------
(in millions)
<S> <C> <C>
Deferred income tax assets:
Accrued postretirement and postemployment
benefits $ 1,104 $ 1,084
Accrued liabilities 568 577
Realignment and other reserves 356 427
Settlement charges 476 261
Other 154 167
--------- --------
Total deferred income tax assets 2,658 2,516
--------- --------
Deferred income tax liabilities:
Property, plant and equipment (1,866) (1,695)
Prepaid pension costs (279) (326)
--------- --------
Total deferred income tax liabilities (2,145) (2,021)
--------- --------
Net deferred income tax assets $ 513 $ 495
--------- --------
--------- --------
</TABLE>
Financial services deferred income tax liabilities are primarily
attributable to temporary differences from investments in finance
leases.
Continued
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
NOTE 12. SEGMENT REPORTING:
Effective December 31, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
supersedes previously issued segment reporting disclosure rules and
requires reporting of segment information that is consistent with the
way in which management operates the Company. The adoption of SFAS No.
131 at December 31, 1998 did not have any impact on the Company's
financial position or the results of operations. The segment
disclosures presented for prior years have been restated to conform
with the presentation adopted for the current year.
The Company's products include cigarettes, food (consisting principally of
coffee, cheese, chocolate confections, processed meat products and
various packaged grocery products) and beer. A subsidiary of the
Company, Philip Morris Capital Corporation, invests in leveraged and
direct finance leases, other tax-oriented financing transactions and
third-party financial instruments. These products and services
constitute the Company's reportable segments of domestic tobacco,
international tobacco, North American food, international food, beer
and financial services.
The Company's management reviews operating companies income to evaluate
segment performance and allocate resources. Operating companies income
for the reportable segments excludes general corporate expenses,
minority interest and amortization of goodwill. Interest and other debt
expense, net (consumer products) and provision for income taxes are
centrally managed at the corporate level and accordingly, such items
are not presented by segment since they are excluded from the measure
of segment profitability reviewed by the Company's management. The
Company's assets are managed on a worldwide basis by major products and
accordingly, asset information is reported for the tobacco, food, beer
and financial services segments. Goodwill and amortization of goodwill
is principally attributable to the North American food segment. Other
assets consist primarily of cash and cash equivalents. The accounting
policies of the segments are the same as those described in the Summary
of Significant Accounting Policies.
Reportable segment data were as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
-------------------------------------------------
1998 1997 1996
---------- ---------- ----------
(in millions)
<S> <C> <C> <C>
Operating revenues:
Domestic tobacco $15,310 $13,584 $12,462
International tobacco 27,390 26,240 24,087
North American food 17,312 16,838 16,447
International food 9,999 10,852 11,503
Beer 4,105 4,201 4,327
Financial services 275 340 378
---------- ---------- ----------
Total operating revenues $74,391 $72,055 $69,204
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Continued
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
<TABLE>
<CAPTION>
For the years ended December 31,
-----------------------------------------------
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Operating companies income:
Domestic tobacco $ 1,489 $ 3,287 $ 4,206
International tobacco 5,029 4,572 4,078
North American food 3,055 2,873 2,628
International food 1,127 1,326 1,303
Beer 451 459 440
Financial services 183 297 193
-------- --------- ----------
Total operating companies income 11,334 12,814 12,848
General corporate expenses (645) (479) (442)
Minority interest (128) (87) (43)
Amortization of goodwill (584) (585) (594)
-------- --------- ----------
Total operating income 9,977 11,663 11,769
Interest and other debt expense, net (890) (1,052) (1,086)
-------- -------- ---------
Total earnings before income taxes $ 9,087 $10,611 $10,683
-------- --------- ----------
-------- --------- ----------
</TABLE>
Operating companies income for the domestic tobacco segment included
pre-tax tobacco litigation settlement charges of $3,381 million and
$1,457 million for the years ended December 31, 1998 and 1997,
respectively. General corporate expenses for the year ended December
31, 1998 included a pre-tax charge of $116 million related to the
settlement of shareholder litigation. In addition, during 1998 pre-tax
charges of $319 million and $18 million were recorded for voluntary
separation and early retirement and severance programs by the domestic
tobacco operations and the Company's corporate headquarters,
respectively. See Notes 2, 3 and 4 regarding divestitures, acquisitions
and food realignment charges.
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------------------
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Depreciation expense:
Domestic tobacco $ 216 $ 171 $ 172
International tobacco 267 236 206
North American food 267 268 268
International food 227 246 270
Beer 108 104 104
--------- --------- ---------
1,085 1,025 1,020
Other 21 19 17
--------- --------- ---------
Total depreciation expense $ 1,106 $ 1,044 $ 1,037
--------- --------- ---------
--------- --------- ---------
Assets:
Tobacco $16,395 $15,012 $13,545
Food 31,397 31,170 33,241
Beer 1,503 1,451 1,705
Financial services 6,480 5,886 5,917
--------- --------- ---------
55,775 53,519 54,408
Other 4,145 2,428 463
--------- --------- ---------
Total assets $59,920 $55,947 $54,871
--------- --------- ---------
--------- --------- ---------
</TABLE>
Continued
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Capital expenditures:
Domestic tobacco $ 217 $ 483 $ 457
International tobacco 588 455 372
North American food 534 440 430
International food 307 297 382
Beer 129 115 122
-------- -------- --------
1,775 1,790 1,763
Other 29 84 19
-------- -------- --------
Total capital expenditures $1,804 $1,874 $1,782
-------- -------- --------
-------- -------- --------
</TABLE>
The Company's operations outside the United States, which are principally
in the tobacco and food businesses, are organized into geographic
regions within each segment, with Europe being the most significant.
Total tobacco and food segment revenues attributable to customers
located in Germany were $9.2 billion, $9.5 billion and $10.4 billion
for the years ended December 31, 1998, 1997 and 1996, respectively.
Geographic data for operating revenues and long-lived assets (which
consists of all financial services assets and non-current consumer
products assets other than goodwill and other intangible assets) were
as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Operating revenues:
United States - domestic $35,432 $33,208 $31,993
- export 6,005 6,705 6,476
Europe 25,169 24,796 24,232
Other 7,785 7,346 6,503
--------- --------- ---------
Total operating revenues $74,391 $72,055 $69,204
--------- --------- ---------
--------- --------- ---------
Long-lived assets:
United States $15,616 $14,533 $13,985
Europe 4,159 4,057 4,575
Other 2,349 2,128 2,123
--------- --------- ---------
Total long-lived assets $22,124 $20,718 $20,683
--------- --------- ---------
--------- --------- ---------
</TABLE>
NOTE 13. BENEFIT PLANS:
The Company and its subsidiaries sponsor noncontributory defined benefit
pension plans covering substantially all U.S. employees. Pension
coverage for employees of the Company's non-U.S. subsidiaries is
provided, to the extent deemed appropriate, through separate plans,
many of which are governed by local statutory requirements. In
addition, the Company and its U.S. and Canadian subsidiaries provide
health care and other benefits to substantially all retired employees.
Health care benefits for retirees outside the United States and Canada
are generally covered through local government plans.
Continued
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
Effective December 31, 1998, the Company adopted SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." SFAS No.
132 does not change the measurement or recognition of those plans, but
revises the disclosure requirements for pension and other
postretirement benefit plans for all years presented.
PENSION PLANS
Net pension cost (income) consisted of the following for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
U. S. Plans Non-U.S. Plans
------------------------- -----------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Service cost $ 156 $ 137 $ 143 $ 91 $ 83 $ 80
Interest cost 406 382 373 165 163 166
Expected return on plan assets (615) (564) (533) (150) (135) (131)
Amortization:
Net gain on adoption of SFAS No. 87 (24) (24) (25)
Unrecognized net loss (gain) from
experience differences 9 (4) (1)
Prior service cost 15 14 14 6 6 3
Termination, settlement and curtailment 251 (22) (35)
------ ------- ------- --------- -------- ------
Net pension cost (income) $ 189 $ (77) $ (54) $ 108 $ 116 $ 118
------ ------- ------- --------- -------- ------
------ ------- ------- --------- -------- ------
</TABLE>
During 1998, 1997 and 1996, the Company instituted early retirement and
workforce reduction programs and, during 1997 and 1996, the Company
also sold businesses. These actions resulted in additional termination
benefits and curtailment losses of $279 million, net of settlement
gains of $28 million in 1998, settlement gains of $22 million in 1997
and settlement gains of $69 million, net of additional termination
benefits of $34 million in 1996.
Continued
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
The changes in benefit obligations and plan assets, as well as the funded
status of the Company's pension plans at December 31, 1998 and 1997
were as follows:
<TABLE>
<CAPTION>
U.S. Plans Non-U.S. Plans
---------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Benefit obligation at January 1 $ 5,523 $ 4,880 $ 2,701 $ 2,642
Service cost 156 137 91 83
Interest cost 406 382 165 163
Benefits paid (396) (309) (129) (79)
Termination, settlement and curtailment 305 (22)
Actuarial losses 238 461 263 80
Currency 95 (188)
Other (12) (6) 15
-------- --------- --------- ----------
Benefit obligation at December 31 6,220 5,523 3,201 2,701
-------- --------- --------- ----------
Fair value of plan assets at January 1 8,085 7,101 2,189 1,927
Actual return on plan assets 973 1,308 116 269
Contributions 14 15 53 49
Benefits paid (372) (292) (93) (70)
Currency 39 (26)
Actuarial (losses) gains 3 (47) (56) 40
-------- --------- --------- ----------
Fair value of plan assets at December 31 8,703 8,085 2,248 2,189
------- ------- ------- -------
Excess (Deficit) of plan assets versus benefit
obligations at December 31 2,483 2,562 (953) (512)
Unrecognized actuarial (gains) losses (1,718) (1,659) 171 (187)
Unrecognized prior service cost 107 121 37 40
Unrecognized net transition obligation (58) (83) 12 11
-------- -------- -------- --------
Net prepaid pension asset (liability) $ 814 $ 941 $ (733) $ (648)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The combined domestic and foreign pension plans resulted in a net prepaid
pension asset of $81 million and $293 million at December 31, 1998 and
1997, respectively. These amounts were recognized in the Company's
consolidated balance sheets at December 31, 1998 and 1997 as other
assets of $1.9 billion and $1.7 billion, respectively, for those plans
in which plan assets exceeded their accumulated benefit obligations
and other liabilities of $1.8 billion and $1.4 billion, respectively,
for those plans in which the accumulated benefit obligations exceeded
their plan assets.
For domestic plans with accumulated benefit obligations in excess of plan
assets, the projected benefit obligation, accumulated benefit
obligation and fair value of plan assets were $1,484 million, $1,374
million and $1,123 million, respectively, as of December 31, 1998 and
$297 million, $229 million and $54 million, respectively, as of
December 31, 1997. For foreign plans with accumulated benefit
obligations in excess of plan assets, the projected benefit
obligation, accumulated benefit obligation and fair value of plan
assets were $1,111 million, $996 million and $155 million,
respectively, as of December 31, 1998 and $935 million, $814 million
and $115 million, respectively, as of December 31, 1997.
Continued
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
The following weighted-average assumptions were used to determine the
Company's obligations under the plans:
<TABLE>
<CAPTION>
U.S. Plans Non-U.S. Plans
------------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Discount rate 7.00% 7.25% 5.37% 6.30%
Expected rate of return on plan assets 9.00 9.00 7.63 7.18
Rate of compensation increase 4.50 4.50 3.73 4.18
</TABLE>
The Company and certain of its subsidiaries sponsor deferred profit-sharing
plans covering certain salaried, nonunion and union employees.
Contributions and costs are determined generally as a percentage of
pre-tax earnings, as defined by the plans. Certain other subsidiaries
of the Company also maintain defined contribution plans. Amounts
charged to expense for defined contribution plans totaled $201 million,
$200 million and $199 million in 1998, 1997 and 1996, respectively.
POSTRETIREMENT BENEFIT PLANS
Net postretirement health care costs consisted of the following for the
years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Service cost $ 56 $ 54 $ 59
Interest cost 182 182 180
Amortization:
Unrecognized net (gain) loss from experience differences (3) (3) 4
Unrecognized prior service cost (12) (12) (12)
Other expense (income) 30 (8)
----- ------- -------
Net postretirement health care costs $253 $221 $223
----- ------- -------
----- ------- -------
</TABLE>
During 1998, 1997 and 1996 the Company instituted early retirement and
workforce reduction programs and, in 1996, the Company also sold
businesses. These actions resulted in additional postretirement health
care costs of $20 million and curtailment losses of $10 million in
1998 and curtailment gains in 1996, all of which are included in other
expense (income) above.
Continued
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
The Company's postretirement health care plans currently are not funded.
The changes in the benefit obligations of the plans at December 31,
1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(in millions)
<S> <C> <C>
Accumulated postretirement benefit obligation at January 1 $2,627 $2,426
Service cost 56 54
Interest cost 182 182
Benefits paid (135) (136)
Termination, settlement and curtailment 107
Plan amendments 1 6
Actuarial (gains) losses (67) 95
-------- -------
Accumulated postretirement benefit obligation at December 31 2,771 2,627
Unrecognized actuarial losses (201) (173)
Unrecognized prior service cost 96 109
-------- -------
Accrued postretirement health care costs $2,666 $2,563
-------- -------
-------- -------
</TABLE>
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation for U.S. plans was 8.0% in 1997, 7.5%
in 1998 and 7.0% in 1999, gradually declining to 5.0% by the year 2003
and remaining at that level thereafter. For Canadian plans, the assumed
health care cost trend rate was 13.0% in 1997, 12.0% in 1998 and 11.0%
in 1999, gradually declining to 4.0% by the year 2005 and remaining at
that level thereafter. A one-percentage-point increase in the assumed
health care cost trend rates for each year would increase the
accumulated postretirement benefit obligation as of December 31, 1998
and postretirement health care cost (service cost and interest cost)
for the year then ended by approximately 9.6% and 13.9%, respectively.
A one-percentage-point decrease in the assumed health care cost trend
rates for each year would decrease the accumulated postretirement
benefit obligation as of December 31, 1998 and postretirement health
care cost (service cost and interest cost) for the year then ended by
approximately 7.9% and 10.9%, respectively.
The accumulated postretirement benefit obligations for U.S. plans at
December 31, 1998 and 1997 were determined using assumed discount rates
of 7.0% and 7.25%, respectively. The accumulated postretirement benefit
obligation at December 31, 1998 and 1997 for Canadian plans was
determined using an assumed discount rate of 6.50%.
Continued
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
NOTE 14. ADDITIONAL INFORMATION:
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------
1998 1997 1996
---- ---- ----
(in millions)
<S> <C> <C> <C>
Research and development expense $ 506 $ 533 $ 515
------- ------- -------
------- ------- -------
Advertising expense $ 2,416 $ 2,530 $ 2,605
------- ------- -------
------- ------- -------
Interest and other debt expense, net:
Interest expense $ 1,144 $ 1,184 $ 1,183
Interest income (254) (132) (97)
------- ------- -------
$ 890 $ 1,052 $ 1,086
------- ------- -------
------- ------- -------
Interest expense of financial services
operations included in cost of sales $ 77 $ 67 $ 80
------- ------- -------
------- ------- -------
Rent expense $ 429 $ 443 $ 430
------- ------- -------
------- ------- -------
</TABLE>
NOTE 15. FINANCIAL INSTRUMENTS:
DERIVATIVE FINANCIAL INSTRUMENTS
The Company operates internationally, with manufacturing and sales
facilities in various locations around the world. Derivative financial
instruments are used by the Company for purposes other than trading,
principally to reduce exposures to market risks resulting from
fluctuations in interest rates and foreign exchange rates by creating
offsetting exposures. The Company is not a party to leveraged
derivatives.
The Company has foreign currency and related interest rate swap agreements
which were executed to reduce the Company's borrowing costs and serve
as hedges of the Company's net assets in foreign subsidiaries,
principally those denominated in Swiss francs. At December 31, 1998 and
1997, the notional principal amounts of these agreements were $3.3
billion and $1.4 billion, respectively. Aggregate maturities at
December 31, 1998 were as follows (in millions): 1999, $371; 2000,
$1,015; 2002, $182; 2003, $150; and 2004 and thereafter $1,604. The
notional amount is used to calculate interest payments which are
exchanged over the life of the swap transaction and is equal to the
amount of foreign currency or dollar principal exchanged at maturity.
Forward exchange contracts and foreign currency options are used by the
Company to reduce the effect of fluctuating foreign currencies on
foreign currency denominated intercompany and third party transactions.
At December 31, 1998, the Company had long and short forward
exchange/option contracts with U.S. dollar equivalent values of $3.6
billion and $4.5 billion, respectively. At December 31, 1997, the
Company had long and short foreign exchange/option contracts with U.S.
dollar equivalent values of $1.3 billion and $1.2 billion,
respectively.
Continued
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
CREDIT EXPOSURE AND CREDIT RISK
The Company is exposed to credit loss in the event of nonperformance by
counterparties. However, the Company does not anticipate nonperformance
and such exposure was not material at December 31, 1998.
FAIR VALUE
The aggregate fair value, based on market quotes, of the Company's total
debt at December 31, 1998 was $15.6 billion as compared to its carrying
value of $14.7 billion. The aggregate fair value of the Company's total
debt at December 31, 1997 was $14.7 billion as compared to its carrying
value of $14.1 billion.
The carrying values of the foreign currency and related interest rate swap
agreements, the forward currency contracts and the currency option
contracts, which did not differ materially from their fair values, were
not material.
See Notes 6 and 7 for additional disclosures of fair value for
short-term borrowings and long-term debt.
NOTE 16. CONTINGENCIES:
Legal proceedings covering a wide range of matters are pending in various
United States and foreign jurisdictions against the Company, its
subsidiaries and affiliates, including Philip Morris Incorporated ("PM
Inc."), the Company's domestic tobacco subsidiary, Philip Morris
International Inc. ("PMI"), the Company's international tobacco
subsidiary, and their respective indemnitees. Various types of claims
are raised in these proceedings, including product liability, consumer
protection, antitrust, tax, patent infringement, employment matters and
claims for contribution.
OVERVIEW OF TOBACCO-RELATED LITIGATION
TYPES AND NUMBER OF CASES
Pending claims related to tobacco products generally fall within three
categories: (i) smoking and health cases alleging personal injury
brought on behalf of individual plaintiffs, (ii) smoking and health
cases alleging personal injury and purporting to be brought on behalf
of a class of individual plaintiffs, and (iii) health care cost
recovery cases brought by governmental and non-governmental plaintiffs
seeking reimbursement for health care expenditures allegedly caused by
cigarette smoking. Governmental plaintiffs have included local, state
and certain foreign governmental entities. Non-governmental plaintiffs
in these cases include union health and welfare trust funds ("unions"),
Blue Cross/Blue Shield groups, health maintenance organizations
("HMOs"), hospitals, native American tribes, taxpayers and others.
Damages claimed in some of the smoking and health class actions and
health care cost recovery cases range into the billions of dollars.
Plaintiffs' theories of recovery and the defenses raised in those cases
are discussed below.
Continued
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
In recent years, there has been a substantial increase in the number of
smoking and health cases being filed.
As of December 31, 1998, there were approximately 510 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, compared with
approximately 375 such cases on December 31, 1997, and 185 such cases
on December 31, 1996. Many of these cases are pending in Florida, West
Virginia and New York. Fifteen of the individual cases involve
allegations of various personal injuries allegedly related to exposure
to environmental tobacco smoke ("ETS").
In addition, as of December 31, 1998, there were approximately 60 smoking
and health putative class actions pending in the United States against
PM Inc. and, in some cases, the Company (including eight that involve
allegations of various personal injuries related to exposure to ETS),
compared with approximately 50 such cases on December 31, 1997, and 20
such cases on December 31, 1996. Most of these actions purport to
constitute statewide class actions and were filed after May 1996 when
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.
During 1997 and 1998, PM Inc. and certain other United States tobacco
product manufacturers entered into agreements settling the asserted and
unasserted health care cost recovery and other claims of all 50 states
and several commonwealths and territories of the United States. The
settlements are in the process of being approved by the courts, and
some of the settlements are being challenged by various third parties.
As of December 31, 1998, there were approximately 95 health care cost
recovery actions pending in the United States (excluding the cases
covered by the settlements), compared with approximately 105 health
care cost recovery cases pending on December 31, 1997, and 25 such
cases on December 31, 1996.
There are also a number of tobacco-related actions pending outside the
United States against PMI and its affiliates and subsidiaries
including, as of December 31, 1998, approximately 27 smoking and health
cases initiated by one or more individuals (Argentina (20), Brazil (1),
Canada (1), Italy (1), Japan (1), Scotland (1) and Turkey (2)), and six
smoking and health class actions (Brazil (2), Canada (3) and Nigeria
(1)). In addition, health care cost recovery actions have been brought
in Israel, the Republic of the Marshall Islands and British Columbia,
Canada, and, in the United States, by the Republics of Bolivia,
Guatemala, Panama and Nicaragua.
PENDING AND UPCOMING TRIALS
As of January 22, 1999, trials against PM Inc. and, in one case, the
Company, were underway in the ENGLE smoking and health class action in
Florida (discussed below) and in individual smoking and health cases in
California and Tennessee.
Additional cases are scheduled for trial during 1999, including three
health care cost recovery actions brought by unions in Ohio (February),
Washington (September) and New York (September), and two smoking and
health class actions in Illinois (August) and Alabama (August). Also,
twelve individual smoking and health cases against PM Inc. and, in some
cases, the Company, are currently scheduled for trial during 1999.
Trial dates, however, are subject to change.
Continued
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
VERDICTS IN INDIVIDUAL CASES
During the past three years, juries have returned verdicts for defendants
in three individual smoking and health cases and in one individual ETS
smoking and health case. In June 1998, a Florida appeals court reversed
a $750,000 jury verdict awarded in August 1996 against another United
States cigarette manufacturer. Plaintiff is seeking an appeal of this
ruling to the Florida Supreme Court. Also in June 1998, a Florida jury
awarded the estate of a deceased smoker in a smoking and health case
against another United States cigarette manufacturer $500,000 in
compensatory damages, $52,000 for medical expenses and $450,000 in
punitive damages. A Florida appeals court has ruled that this case was
tried in the wrong venue and, accordingly, defendants are seeking to
set aside the verdict and retry the case in the correct venue. In
Brazil, a court in 1997 awarded plaintiffs in a smoking and health case
the Brazilian currency equivalent of $81,000, attorneys' fees and a
monthly annuity for 35 years equal to two-thirds of the deceased
smoker's last monthly salary. Neither the Company nor its affiliates
were parties to that action.
LITIGATION SETTLEMENTS
In November 1998, PM Inc. and certain other United States tobacco product
manufacturers entered into a Master Settlement Agreement (the "MSA")
with 46 states, the District of Columbia, the Commonwealth of Puerto
Rico, Guam, the United States Virgin Islands, American Samoa and the
Northern Marianas to settle asserted and unasserted health care cost
recovery and other claims. PM Inc. and certain other United States
tobacco product manufacturers had previously settled similar claims
brought by Mississippi, Florida, Texas and Minnesota (together with the
MSA, the "State Settlement Agreements") and an ETS smoking and health
class action brought on behalf of airline flight attendants. The State
Settlement Agreements and certain ancillary agreements are filed as
exhibits to various of the Company's reports filed with the Securities
and Exchange Commission, and such agreements and the ETS settlement are
discussed in detail therein.
PM Inc. recorded pre-tax charges of $3,081 million and $1,457 million
during 1998 and 1997, respectively, to accrue for its share of all
fixed and determinable portions of its obligations under the tobacco
settlements, as well as $300 million during 1998 for its unconditional
obligation under an agreement in principle to contribute to a tobacco
growers trust fund, discussed below. As of December 31, 1998, PM Inc.
had accrued costs of its obligations under the settlements and to
tobacco growers aggregating $1,359 million, payable principally before
the end of the year 2000. The settlement agreements require that the
domestic tobacco industry make substantial annual payments in the
following amounts (excluding future annual payments contemplated by the
agreement in principle with tobacco growers discussed below), subject
to adjustment for several factors, including inflation, market share
and industry volume: 1999, $4.2 billion (of which $2.7 billion related
to the MSA and has already been paid by the industry); 2000, $9.2
billion; 2001, $9.9 billion; 2002, $11.3 billion; 2003, $10.9 billion;
2004 through 2007, $8.4 billion; and thereafter, $9.4 billion. In
addition, the domestic tobacco industry is required to pay settling
plaintiffs' attorneys' fees, subject to an annual cap of $500 million,
as well as additional amounts as follows: 1999, $450 million; 2000,
$416 million; and 2001 through 2002, $250 million. These payment
obligations are the several and not joint obligations of each settling
defendant. PM Inc.'s portion of the future adjusted payments and legal
fees, which is not currently estimable, will be based on its share of
domestic cigarette shipments in the
Continued
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
year preceding that in which the payment is made. PM Inc.'s shipment
share in 1998 was approximately 50%.
The State Settlement Agreements also include provisions relating to
advertising and marketing restrictions, public disclosure of certain
industry documents, limitations on challenges to tobacco control and
underage use laws and other provisions.
As of January 22, 1999, the MSA had been approved by courts in 41 states
and in the District of Columbia, Puerto Rico, Guam, the United States
Virgin Islands, American Samoa and Northern Marianas. If a jurisdiction
does not obtain final judicial approval of the MSA by December 31,
2001, the agreement will be terminated with respect to such
jurisdiction.
As part of the MSA, the settling defendants committed to work
cooperatively with the tobacco grower community to address concerns
about the potential adverse economic impact of the MSA on that
community. To that end, in January 1999, the four major domestic
tobacco product manufacturers, including PM Inc., agreed in principle
to participate in the establishment of a $5.15 billion trust fund to be
administered by the tobacco growing states. It is currently
contemplated that the trust will be funded by industry participants
over twelve years, beginning in 1999. PM Inc. has agreed to pay $300
million into the trust in 1999, which amount has been charged to 1998
operating income. Subsequent annual industry payments are to be
adjusted for several factors, including inflation and United States
cigarette consumption, and are to be allocated based on each
manufacturer's market share.
The Company believes that the State Settlement Agreements may materially
adversely affect the business, volume, results of operations, cash
flows or financial position of PM Inc. and the Company in future years.
The degree of the adverse impact will 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, and the effect of any resulting cost
advantage of manufacturers not subject to the MSA and the other State
Settlement Agreements. As of January 22, 1999, manufacturers
representing almost all domestic shipments in 1998 had agreed to become
subject to the terms of the MSA.
A description of the smoking and health litigation, health care cost
recovery litigation and certain other proceedings 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, breach of
special duty, 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. In certain of these cases, plaintiffs claim
that cigarette smoking exacerbated the injuries caused by their
exposure to asbestos. Plaintiffs in the smoking and health actions seek
various forms of relief, including compensatory and punitive damages,
treble/multiple damages and other statutory damages and penalties,
creation of medical monitoring funds, disgorgement of profits, and
injunctive and equitable relief. Defenses raised in
Continued
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
these cases include lack of proximate cause, assumption of the risk,
comparative fault and/or contributory negligence, statutes of
limitations and preemption by the Federal Cigarette Labeling and
Advertising Act.
In May 1996, the Fifth Circuit Court of Appeals held that a putative class
consisting of all "addicted" smokers nationwide did not meet the
standards and requirements of the federal rules governing class actions
(CASTANO, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL.). Since this
class decertification, lawyers for plaintiffs have filed numerous
smoking and health class action suits in various state and federal
courts. In general, these cases purport to be brought on behalf of
residents of a particular state or states and raise "addiction" claims
similar to those raised in the CASTANO case and, in some cases, claims
of physical injury as well. As of December 31, 1998, smoking and health
class actions were pending in Alabama, Arkansas, California, the
District of Columbia, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas,
Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi,
Missouri, Nevada, New Jersey, New Mexico, New York, North Carolina,
Ohio, Oklahoma, Pennsylvania, Puerto Rico, South Carolina, Tennessee,
Texas, Utah, Virginia, West Virginia and Wisconsin, as well as in
Canada, Brazil and Nigeria. Class certification has been denied or
reversed by courts in 13 smoking and health class actions involving PM
Inc. in Louisiana, the District of Columbia, New York (2),
Pennsylvania, Puerto Rico, New Jersey (5), Wisconsin and Kansas, while
classes remain certified in three cases in Florida, Louisiana and
Maryland. A number of these class certification decisions are on
appeal. Class certification motions are pending in a number of the
other putative smoking and health class actions. As mentioned above,
one ETS smoking and health class action was settled in 1997.
ENGLE TRIAL
Trial in this Florida class action case began in July 1998. Plaintiffs seek
compensatory and punitive damages ranging into the billions of dollars,
as well as equitable relief including, but not limited to, a medical
fund for future health care costs, attorneys' fees and court costs. The
class consists of all Florida residents and citizens, and their
survivors, who claim to have suffered, presently suffer or have died
from diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine.
The current trial plan calls for the case to be tried in three "Phases."
The court has stated, however, that the trial plan may be modified
further. Phase One, which is currently underway, involves evidence
concerning certain "common" class issues relating to the plaintiff
class's causes of action. Entitlement to punitive damages will be
decided at the end of Phase One, but no amount will be set at that
time.
If plaintiffs prevail in Phase One, the first two stages of Phase Two will
involve individual determination of specific causation and other
individual issues regarding entitlement to compensatory damages for the
class representatives. Stage three of Phase Two will involve an
assessment of the amount of punitive damages, if any, that individual
class representatives will be awarded. Stage four of Phase Two will
involve the setting of a percentage or ratio of punitive damages for
absent class members, assuming entitlement was found at the end of
Phase One.
Phase Three of the trial will be held before separate juries to address
absent class members' claims, including issues of specific causation
and other individual issues regarding entitlement to compensatory
damages.
Continued
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
HEALTH CARE COST RECOVERY LITIGATION
In certain of the pending proceedings, domestic and foreign governmental
entities and non-governmental plaintiffs, including unions, Blue
Cross/Blue Shield groups, HMOs, hospitals, native American tribes,
taxpayers and others are seeking reimbursement of health care cost
expenditures allegedly caused by tobacco products and, in some cases,
for future expenditures and damages as well. Certain of these cases
purport to be brought on behalf of a class of plaintiffs and, in some
cases, the class has been certified by the court. In one health care
cost recovery case, private citizens seek recovery of alleged
tobacco-related health care expenditures incurred by the federal
Medicare program. In others, Blue Cross subscribers seek 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/multiple damages and other statutory damages and penalties,
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 include the
equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to
smoking, 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 include failure to state a valid claim, lack of benefit,
adequate remedy at law, "unclean hands" (namely, that plaintiffs cannot
obtain equitable relief because they participated in, and benefited
from, the sale of cigarettes), lack of antitrust injury, federal
preemption, lack of proximate cause, remoteness of injury, lack of
statutory authority to bring suit 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 traditional theories of recovery, a payor of medical costs (such
as an insurer) 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 any
actions as subrogees of individual health care recipients and should be
subject to all defenses available against the injured party.
Excluding the cases covered by the State Settlement Agreements described
above, as of December 31, 1998, there were approximately 95 health care
cost recovery cases pending against PM Inc. and, in some cases, the
Company, of which approximately 75 were filed by unions. Health care
cost recovery actions have also been brought in Israel, the Republic of
the Marshall Islands, and British Columbia, Canada, and, in the United
States, by the Republics of Bolivia, Guatemala, Panama and Nicaragua.
Other foreign governmental entities have stated that they are
considering filing health care cost recovery actions. In addition, in
January 1999, President Clinton
Continued
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
announced that the United States Department of Justice is preparing a
litigation plan to take tobacco companies to court and to use
recovered funds to strengthen Medicare.
Courts have ruled on preliminary motions to dismiss various claims in
approximately 50 health care cost recovery actions. Although many of
the rulings in cases not settled by the State Settlement Agreements
have been favorable to the industry, a number have been adverse,
including rulings in the three union cases currently scheduled for
trial in 1999. In late January and in February of 1999, the Third and
Second Circuit Courts of Appeal are scheduled to hear oral argument on
appeals from lower court rulings on motions to dismiss various claims
in health care cost recovery actions filed by unions. The Company
cannot predict the ultimate outcome of such appeals.
CERTAIN OTHER TOBACCO-RELATED LITIGATION
Since September 1997, a number of suits have been filed by former asbestos
manufacturers, asbestos manufacturers' personal injury settlement
trusts and an insurance company against domestic tobacco manufacturers,
including PM Inc. and others. These cases seek, among other things,
contribution or reimbursement for amounts expended in connection with
the defense and payment of asbestos claims that were allegedly caused
in whole or in part by cigarette smoking. Plaintiffs in most of these
cases also seek punitive damages.
Since June 1998, five class actions have been filed against PM Inc. and the
Company, in Florida, New Jersey, Pennsylvania, Massachusetts and
Tennessee, on behalf of individuals who purchased and consumed MARLBORO
LIGHTS and, in one case, MARLBORO ULTRA LIGHTS, as well. These cases
allege, in connection with the use of the term "Lights" and/or "Ultra
Lights," among other things, deceptive and unfair trade practices,
unjust enrichment, and seek injunctive and equitable relief.
Since July 1998, two suits have been filed in California courts alleging
that domestic cigarette manufacturers, including PM Inc. and others,
have violated the California statute known as "Proposition 65" by not
informing the public of the alleged risks of ETS to non-smokers.
Plaintiffs also allege violations of California's Business and
Professions Code regarding unfair and fraudulent business practices.
Plaintiffs seek statutory penalties, injunctions barring the sale of
cigarettes, restitution, disgorgement of profits and other relief. The
courts have denied defendants' motions to dismiss in both of these
cases.
In December 1998, a putative class action was filed against PM Inc. and
certain other domestic tobacco manufacturers on behalf of a class
consisting of citizens of the United States who consume tobacco
products manufactured by defendants. One count of the complaint alleges
that defendants conspired to raise the prices of their tobacco products
in order to pay the costs of the MSA in violation of the federal
antitrust laws. The other two counts allege that the actions of
defendants amount to an unconstitutional deprivation of property
without due process of law and an unlawful burdening of interstate
trade. The complaint seeks unspecified damages (to be trebled under the
antitrust count), injunctive and declaratory relief, costs and
attorneys' fees.
Continued
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
CERTAIN OTHER ACTIONS
In September 1997, a putative class action suit consolidating several
previously filed class actions was 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. In June 1998, the court denied
Kraft's motion to dismiss as to the antitrust and tortious interference
claims and granted Kraft's motion to dismiss on breach of contract and
false advertising claims. In October 1997, a putative class action suit
was filed in Illinois against Kraft only and, in April 1998, a putative
class action suit was filed in California against Kraft and others.
Both of these suits contain allegations similar to those in the
Wisconsin class action, but the Illinois case seeks a class comprising
all of Kraft's milk suppliers, and the California case seeks a class
comprising all of defendants' milk suppliers in California. In December
1998, the courts in both the Illinois and California cases granted
Kraft's motions to dismiss the complaints.
In November 1998, the United States District Court in the Southern
District of New York approved an agreement settling a class action suit
filed on behalf of all persons who purchased common stock of the
Company between June 11, 1991 and May 6, 1994 (KURZWEIL, ET AL. V.
PHILIP MORRIS COMPANIES INC., ET AL.). It is anticipated that the
settlement will also result in the dismissal of another class action
suit that was filed on behalf of certain persons who purchased common
stock of the Company between July 10, 1991, and April 1, 1993
(LAWRENCE, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL.). The Company
recorded a pre-tax charge of $116 million in the fourth quarter of 1998
in connection with these matters.
-------------------------
One hundred eighty-eight tax assessments alleging the nonpayment of taxes
in Italy (value-added taxes for the years 1988 to 1995 and income taxes
for the years 1987 to 1995) have been served upon certain affiliates of
the Company. The aggregate amount of unpaid taxes assessed to date is
alleged to be the Italian lira equivalent of $2.7 billion. In addition,
the Italian lira equivalent of $3.7 billion in interest and penalties
has been assessed. The Company anticipates that value-added and income
tax assessments may also be received with respect to subsequent years.
All of the assessments are being vigorously contested. To date, the
Italian administrative tax court in Milan has overturned eighty-one of
the assessments. The decisions to overturn forty-three assessments have
been appealed by the tax authorities. In a separate proceeding in
Naples, in October 1997, a court dismissed charges of criminal
association against certain present and former officers and directors
of affiliates of the Company, but permitted charges of tax evasion to
remain pending. In February 1998, the tax evasion charges were
dismissed by the criminal court in Naples following a determination
that jurisdiction was not proper, and the case file was transmitted to
the public prosecutor in Milan, who will determine whether to bring
charges, in which case a preliminary investigations judge will make a
new finding as to whether there should be a trial on these charges. The
Company, its affiliates and the officers and directors who are subject
to the proceedings believe they have complied with applicable Italian
tax laws and are vigorously contesting the pending assessments and
proceedings.
-------------------------
Continued
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
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 or settlement of a pending
smoking and health or health care cost recovery case 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. These developments 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 pending
litigation. The present legislative and litigation environment is
substantially uncertain, and it is possible that the Company's
business, volume, results of operations, cash flows or financial
position could be materially affected by an unfavorable outcome or
settlement of certain pending litigation or by the enactment of federal
or state tobacco legislation. 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. All such cases are, and will
continue to be, vigorously defended. However, the Company and its
subsidiaries may enter into discussions in an attempt to settle
particular cases if they believe it is in the best interests of the
Company's stockholders to do so.
Continued
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------
NOTE 17. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
1998 Quarters
--------------------------------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions, except per share data)
<S> <C> <C> <C> <C>
Operating revenues $ 18,383 $ 18,978 $ 18,587 $ 18,443
-------- -------- -------- --------
-------- -------- -------- --------
Gross profit $ 7,449 $ 7,903 $ 7,842 $ 7,799
-------- -------- -------- --------
-------- -------- -------- --------
Net earnings $ 1,382 $ 1,736 $ 1,980 $ 274
-------- -------- -------- --------
-------- -------- -------- --------
Per share data:
Basic EPS $ 0.57 $ 0.72 $ 0.81 $ 0.11
-------- -------- -------- --------
-------- -------- -------- --------
Diluted EPS $ 0.57 $ 0.71 $ 0.81 $ 0.11
-------- -------- -------- --------
-------- -------- -------- --------
Dividends declared $ 0.40 $ 0.40 $ 0.44 $ 0.44
-------- -------- -------- --------
-------- -------- -------- --------
Market price - high $ 47.88 $ 41.56 $ 48.13 $ 59.50
- low $ 39.06 $ 34.75 $ 38.06 $ 45.00
</TABLE>
During 1998, the Company recorded the following pre-tax charges for the
settlement of tobacco and shareholder litigation settlements, voluntary
early retirement and separation programs ("VERS") and severance.
<TABLE>
<CAPTION>
1998 Quarters
--------------------------------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions)
<S> <C> <C> <C> <C>
Tobacco settlements $806 $199 $111 $2,265
Shareholder settlement 116
VERS and severance 95 232 10
----- ----- ----- -------
$901 $431 $121 $2,381
----- ----- ----- -------
----- ----- ----- -------
</TABLE>
Continued
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Concluded
-----------
<TABLE>
<CAPTION>
1997 Quarters
--------------------------------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions, except per share data)
<S> <C> <C> <C> <C>
Operating revenues $ 18,217 $ 18,413 $ 18,092 $ 17,333
--------- --------- --------- ---------
--------- --------- --------- ---------
Gross profit $ 7,376 $ 7,600 $ 7,420 $ 7,029
--------- --------- --------- ---------
--------- --------- --------- ---------
Net earnings $ 1,773 $ 1,836 $ 1,406 $ 1,295
--------- --------- --------- ---------
--------- --------- --------- ---------
Per share data:
Basic EPS $ 0.73 $ 0.76 $ 0.58 $ 0.54
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted EPS $ 0.72 $ 0.75 $ 0.58 $ 0.53
--------- --------- --------- ---------
--------- --------- --------- ---------
Dividends declared $ 0.40 $ 0.40 $ 0.40 $ 0.40
--------- --------- --------- ---------
--------- --------- --------- ---------
Market price - high $ 46.58 $ 48.13 $ 46.56 $ 45.88
- low $ 36.00 $ 37.25 $ 39.94 $ 36.94
</TABLE>
During the fourth quarter of 1997, the Company sold several international
food businesses, including its Brazilian ice cream businesses, for
total proceeds of $1.1 billion and net pre-tax gains of $775 million.
In addition, the Company sold its equity interest in a Canadian beer
operation and sold a minority interest in a beer import operation for
proceeds of $306 million and a pre-tax gain of $12 million.
During the fourth quarter of 1997, the Company recorded a charge of $342
million related primarily to the downsizing or closure of manufacturing
and other facilities, as well as the discontinuance of certain
low-margin product lines of its international food operations. The
Company also recorded a charge of $288 million for incremental
postemployment benefits, primarily related to severance.
During the third and fourth quarters of 1997, the Company recorded
litigation settlement charges of $812 million and $645 million,
respectively.
Concluded
36
