SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8940
Philip Morris Companies Inc.
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(Exact name of registrant as specified in its charter)
Virginia 13-3260245
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 Park Avenue, New York, New York 10017
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (917) 663-5000
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
At October 31, 2000, there were 2,223,534,382 shares outstanding of the
registrant's common stock, par value $0.33 1/3 per share.
<PAGE>
PHILIP MORRIS COMPANIES INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited).
Condensed Consolidated Balance Sheets at
September 30, 2000 and December 31, 1999 3 - 4
Condensed Consolidated Statements of Earnings for the
Nine Months Ended September 30, 2000 and 1999 5
Three Months Ended September 30, 2000 and 1999 6
Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 1999 and the
Nine Months Ended September 30, 2000 7
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999 8 - 9
Notes to Condensed Consolidated Financial Statements 10 - 29
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 30 - 53
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 54
Item 6. Exhibits and Reports on Form 8-K. 54
Signature 55
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
September 30, December 31,
2000 1999
------------- ------------
ASSETS
Consumer products
Cash and cash equivalents $ 4,779 $ 5,100
Receivables (less allowances of
$145 and $164) 4,549 4,313
Inventories:
Leaf tobacco 3,732 4,294
Other raw materials 1,693 1,794
Finished product 2,675 2,940
------- -------
8,100 9,028
Other current assets 2,171 2,454
------- -------
Total current assets 19,599 20,895
Property, plant and equipment, at cost 21,753 21,599
Less accumulated depreciation 9,501 9,328
------- -------
12,252 12,271
Goodwill and other intangible assets
(less accumulated amortization of
$6,142 and $5,840) 16,381 16,879
Other assets 3,910 3,625
------- -------
Total consumer products assets 52,142 53,670
Financial services
Finance assets, net 7,972 7,527
Other assets 165 184
------- -------
Total financial services assets 8,137 7,711
------- -------
TOTAL ASSETS $60,279 $61,381
======= =======
See notes to condensed consolidated financial statements.
Continued
-3-
<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars, except per share data)
(Unaudited)
September 30, December 31,
2000 1999
------------- ------------
LIABILITIES
Consumer products
Short-term borrowings $ 200 $ 641
Current portion of long-term debt 1,741 1,601
Accounts payable 2,703 3,351
Accrued marketing 2,809 2,756
Accrued taxes, except income taxes 1,480 1,519
Accrued settlement charges 4,102 2,320
Other accrued liabilities 2,961 3,577
Income taxes 1,318 1,124
Dividends payable 1,192 1,128
-------- --------
Total current liabilities 18,506 18,017
Long-term debt 9,327 11,280
Deferred income taxes 1,423 1,214
Accrued postretirement health care costs 2,697 2,606
Other liabilities 6,375 6,853
-------- --------
Total consumer products liabilities 38,328 39,970
Financial services
Short-term borrowings 795
Long-term debt 890 946
Deferred income taxes 4,666 4,466
Other liabilities 698 694
-------- --------
Total financial services liabilities 7,049 6,106
-------- --------
Total liabilities 45,377 46,076
Contingencies (Note 5)
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 32,617 29,556
Accumulated other comprehensive losses (including
currency translation of $2,945 and $2,056) (2,997) (2,108)
-------- --------
30,555 28,383
Less cost of repurchased stock
(575,507,791 and 467,441,576 shares) (15,653) (13,078)
-------- --------
Total stockholders' equity 14,902 15,305
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 60,279 $ 61,381
======== ========
See notes to condensed consolidated financial statements.
-4-
<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Nine Months Ended
September 30,
-------------------------
2000 1999
------- -------
Operating revenues $60,942 $59,185
Cost of sales 22,091 22,198
Excise taxes on products 13,172 12,992
------- -------
Gross profit 25,679 23,995
Marketing, administration and research costs 14,043 13,307
Amortization of goodwill 442 434
------- -------
Operating income 11,194 10,254
Interest and other debt expense, net 536 627
------- -------
Earnings before income taxes 10,658 9,627
Provision for income taxes 4,159 3,809
------- -------
Net earnings $ 6,499 $ 5,818
======= =======
Per share data:
Basic earnings per share $ 2.86 $ 2.42
======= =======
Diluted earnings per share $ 2.85 $ 2.41
======= =======
Dividends declared $ 1.49 $ 1.36
======= =======
See notes to condensed consolidated financial statements.
-5-
<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Three Months Ended
September 30,
--------------------------
2000 1999
------- -------
Operating revenues $20,058 $19,878
Cost of sales 7,271 7,451
Excise taxes on products 4,301 4,386
------- -------
Gross profit 8,486 8,041
Marketing, administration and research costs 4,373 4,383
Amortization of goodwill 149 142
------- -------
Operating income 3,964 3,516
Interest and other debt expense, net 158 199
------- -------
Earnings before income taxes 3,806 3,317
Provision for income taxes 1,487 1,316
------- -------
Net earnings $ 2,319 $ 2,001
======= =======
Per share data:
Basic earnings per share $ 1.04 $ 0.84
======= =======
Diluted earnings per share $ 1.03 $ 0.84
======= =======
Dividends declared $ 0.53 $ 0.48
======= =======
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
for the Year Ended December 31, 1999 and
the Nine Months Ended September 30, 2000
(in millions of dollars, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Losses
--------------------------------
Earnings Total
Reinvested Currency Cost of Stock-
Common in the Translation Repurchased holders'
Stock Business Adjustments Other Total Stock Equity
-------- ---------- ----------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1999 $ 935 $ 26,261 $ (1,081) $ (25) $ (1,106) $ (9,893) $ 16,197
Comprehensive earnings:
Net earnings 7,675 7,675
Other comprehensive losses,
net of income taxes:
Currency translation adjustments (975) (975) (975)
Additional minimum pension liability (27) (27) (27)
--------
Total other comprehensive losses (1,002)
--------
Total comprehensive earnings 6,673
--------
Exercise of stock options and
issuance of other stock awards 13 115 128
Cash dividends
declared ($1.84 per share) (4,393) (4,393)
Stock repurchased (3,300) (3,300)
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1999 935 29,556 (2,056) (52) (2,108) (13,078) 15,305
Comprehensive earnings:
Net earnings 6,499 6,499
Other comprehensive losses,
net of income taxes:
Currency translation adjustments (889) (889) (889)
--------
Total other comprehensive losses (889)
--------
Total comprehensive earnings 5,610
--------
Exercise of stock options and
issuance of other stock awards (58) 146 88
Cash dividends
declared ($1.49 per share) (3,380) (3,380)
Stock repurchased (2,721) (2,721)
-------- -------- -------- -------- -------- -------- --------
Balances, September 30, 2000 $ 935 $ 32,617 $ (2,945) $ (52) $ (2,997) $(15,653) $ 14,902
======== ======== ======== ======== ======== ======== ========
</TABLE>
Total comprehensive earnings, which represents net earnings partially offset by
currency translation adjustments, were $1,884 million and $1,855 million,
respectively, for the quarters ended September 30, 2000 and 1999, and $5,069
million for the first nine months of 1999.
See notes to condensed consolidated financial statements.
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<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)
For the Nine Months Ended
September 30,
-------------------------
2000 1999
------- -------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 6,377 $ 5,714
- Financial services 122 104
------- -------
Net earnings 6,499 5,818
Adjustments to reconcile net earnings to
operating cash flows:
Consumer products
Depreciation and amortization 1,279 1,254
Deferred income tax provision (benefit) 530 (51)
Gains on sales of businesses (174) (20)
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (425) (280)
Inventories 616 189
Accounts payable (565) (943)
Income taxes 246 332
Accrued liabilities and other current assets 1,217 2,831
Other (345) (74)
Financial services
Deferred income tax provision 200 151
Other 37 37
------- -------
Net cash provided by operating activities 9,115 9,244
------- -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures (1,118) (1,151)
Purchases of businesses, net of acquired cash (391) (434)
Proceeds from sales of businesses 302 48
Other (4) (240)
Financial services
Investments in finance assets (581) (490)
Proceeds from finance assets 106 54
------- -------
Net cash used in investing activities (1,686) (2,213)
------- -------
See notes to condensed consolidated financial statements.
Continued
-8-
<PAGE>
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)
For the Nine Months Ended
September 30,
-------------------------
2000 1999
------- -------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net (repayment) issuance of short-term borrowings $ (470) $ 60
Long-term debt proceeds 87 1,300
Long-term debt repaid (1,679) (1,384)
Financial services
Net issuance of short-term borrowings 795
Long-term debt proceeds 500
Long-term debt repaid (200)
Repurchase of common stock (2,710) (2,213)
Dividends paid (3,316) (3,195)
Issuance of common stock 37 108
Other (127) (110)
------- -------
Net cash used in financing activities (7,383) (5,134)
------- -------
Effect of exchange rate changes on cash and
cash equivalents (367) (102)
------- -------
Cash and cash equivalents:
(Decrease) increase (321) 1,795
Balance at beginning of period 5,100 4,081
------- -------
Balance at end of period $ 4,779 $ 5,876
======= =======
See notes to condensed consolidated financial statements.
-9-
<PAGE>
Note 1. Accounting Policies:
The interim condensed consolidated financial statements of Philip Morris
Companies Inc. (the "Company") are unaudited. It is the opinion of the Company's
management that all adjustments necessary for a fair statement of the interim
results presented have been reflected therein. All such adjustments were of a
normal recurring nature. For interim reporting purposes, certain expenses are
charged to results of operations as a percentage of sales. Operating revenues
and net earnings for any interim period are not necessarily indicative of
results that may be expected for the entire year.
These statements should be read in conjunction with the consolidated financial
statements and related notes which appear in the Company's Annual Report to
Stockholders and which are incorporated by reference into the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999 Form 10-K").
Balance sheet accounts are segregated by two broad types of businesses. 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.
Note 2. Acquisitions and Divestitures:
In June 2000, the Company entered into definitive agreements to acquire all of
the outstanding shares of Nabisco Holdings Corp. ("Nabisco") for $55 per share
in cash. The transaction reflects an aggregate cost of approximately $19.2
billion, which includes the assumption of approximately $4.0 billion in net
debt. The acquisition will be financed initially through a combination of
available cash balances and short-term debt. The transaction, which has been
approved by the shareholders of Nabisco Group Holdings and by the European
Commission, remains under review by United States anti-trust authorities. The
parties are working to close the transaction by year-end. The acquisition will
be accounted for as a purchase.
Subsequent to the acquisition, the Company's wholly owned subsidiary, Kraft
Foods, Inc. ("Kraft") plans to undertake an initial public offering ("IPO") of
less than 20% of the combined food company. The IPO proceeds will be used to
retire a portion of the debt incurred as a result of the acquisition of Nabisco.
During the first nine months of 2000, the Company sold several small
international and domestic food businesses. The aggregate proceeds received in
these transactions were $302 million and the Company recorded pre-tax gains of
$174 million. In addition, in October 2000, Miller Brewing Company announced
that it reached an agreement in principle with Molson Canada and with Foster's
Brewing Group Limited to strengthen its commitment behind the Foster's brand in
the United States, as well as an agreement in principle to sell its rights to
Molson trademarks in the United States. The transactions are expected to close
in the fourth quarter.
-10-
<PAGE>
Note 3. Earnings Per Share:
Basic and diluted earnings per share ("EPS") were calculated using the
following:
For the Nine Months Ended
September 30,
-------------------------
2000 1999
------ ------
(in millions)
Net earnings $6,499 $5,818
====== ======
Weighted average shares for
basic EPS 2,276 2,406
Plus incremental shares from conversions:
Restricted stock and stock rights 3 1
Stock options 5 10
------ ------
Weighted average shares for
diluted EPS 2,284 2,417
====== ======
For the Three Months Ended
September 30,
--------------------------
2000 1999
------ ------
(in millions)
Net earnings $2,319 $2,001
====== ======
Weighted average shares for
basic EPS 2,240 2,386
Plus incremental shares from conversions:
Restricted stock and stock rights 4 2
Stock options 9 8
------ ------
Weighted average shares for
diluted EPS 2,253 2,396
====== ======
Options on shares of common stock were excluded from the calculation of weighted
average shares for diluted EPS because their effects were antidilutive, as
follows:
2000 1999
------ ------
(in millions)
For the nine months ended September 30, 87 25
For the three months ended September 30, 69 58
Note 4. Segment Reporting:
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 financings. These products
and services
-11-
<PAGE>
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.
Reportable segment data were as follows:
For the Nine Months Ended
September 30,
-------------------------
2000 1999
-------- --------
Operating revenues: (in millions)
Domestic tobacco $ 16,987 $ 14,352
International tobacco 20,552 21,419
North American food 13,534 13,193
International food 6,115 6,601
Beer 3,449 3,361
Financial services 305 259
-------- --------
Total operating revenues $ 60,942 $ 59,185
======== ========
Operating companies income:
Domestic tobacco $ 3,849 $ 3,436
International tobacco 4,180 3,922
North American food 2,690 2,404
International food 951 785
Beer 491 454
Financial services 193 168
-------- --------
Total operating companies income 12,354 11,169
Amortization of goodwill (442) (434)
General corporate expenses (626) (386)
Minority interest (92) (95)
-------- --------
Total operating income 11,194 10,254
Interest and other debt expense, net (536) (627)
-------- --------
Total earnings before income taxes $ 10,658 $ 9,627
======== ========
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<PAGE>
For the Three Months Ended
September 30,
--------------------------
2000 1999
-------- --------
Operating revenues: (in millions)
Domestic tobacco $ 5,835 $ 5,157
International tobacco 6,753 7,153
North American food 4,276 4,171
International food 1,939 2,155
Beer 1,149 1,153
Financial services 106 89
-------- --------
Total operating revenues $ 20,058 $ 19,878
======== ========
Operating companies income:
Domestic tobacco $ 1,459 $ 1,367
International tobacco 1,439 1,239
North American food 827 773
International food 416 264
Beer 145 140
Financial services 66 58
-------- --------
Total operating companies income 4,352 3,841
Amortization of goodwill (149) (142)
General corporate expenses (207) (151)
Minority interest (32) (32)
-------- --------
Total operating income 3,964 3,516
Interest and other debt expense, net (158) (199)
-------- --------
Total earnings before income taxes $ 3,806 $ 3,317
======== ========
General corporate expenses of $626 million for the first nine months of 2000 and
$207 million for the third quarter of 2000 increased $240 million (62.2%) and
$56 million (37.1%), respectively, over the comparable periods of 1999. These
increases were due primarily to increased spending for the Company's corporate
image campaign.
During the third quarter of 2000, Kraft Foods International, Inc., Kraft's
international food subsidiary, sold a French confectionery business for proceeds
of $251 million and an estimated pre-tax gain of $139 million. This gain, which
is subject to adjustment, is included in the operating results of the
international food segment.
During the first quarter of 1999, Philip Morris Incorporated ("PM Inc."), the
Company's domestic tobacco subsidiary, announced plans to phase out cigarette
production capacity at its Louisville, Kentucky manufacturing plant by August
2000 (the "Louisville Closure"). The Louisville Closure, which occurred in
stages, has been completed. As a result, PM Inc. recorded pre-tax charges for
the first nine months and the third quarter of 1999 of $183 million and $8
million, respectively. These charges, which are in marketing, administration and
research costs in the respective consolidated statements of earnings, included
enhanced severance, pension and postretirement benefits for approximately 1,500
hourly and salaried employees. Severance benefits, which were either paid in a
lump sum or as income protection payments over a period of time, commenced upon
termination of employment. Payments of enhanced pension and postretirement
benefits are being made over the remaining lives of the former employees in
accordance with the terms of the related benefit plans. All operating costs of
the manufacturing plant, including increased depreciation, were charged to
expense as incurred during the closing period.
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<PAGE>
During the first quarter of 1999, Kraft announced that it was offering voluntary
retirement incentive or separation programs to certain eligible hourly and
salaried employees in the United States (the "Kraft Separation Programs").
Employees electing to terminate employment under the terms of the Kraft
Separation Programs were entitled to enhanced retirement or severance benefits.
Approximately 1,100 hourly and salaried employees accepted the benefits offered
by these programs and elected to retire or terminate. As a result, Kraft
recorded a pre-tax charge of $157 million for the first nine months of 1999.
This charge was included in marketing, administration and research costs in the
consolidated statement of earnings for the North American food segment. Payments
of pension and postretirement benefits are made in accordance with the terms of
the applicable benefit plans. Severance benefits, which are paid over a period
of time, commenced upon dates of termination that ranged from April 1999 to
March 2000. Salary and related benefit costs of employees prior to the
retirement or termination date were expensed as incurred.
During the third quarter of 1999, a subsidiary of the Company announced the
closure of a cigarette factory and the corresponding reduction of cigarette
production capacity in Brazil. Prior to the factory closure, existing employees
were offered voluntary dismissal benefits. These benefits were accepted by half
of the approximately 1,000 employees at the facility. During the third quarter
of 1999, the factory was closed and employment of the remaining employees was
terminated. For the first nine months and third quarter of 1999, a pre-tax
charge of $136 million was recorded in marketing, administration and research
costs in the consolidated statement of earnings of the international tobacco
segment to write down the tobacco machinery and equipment no longer in use and
to recognize the cost of severance benefits. Payments of severance benefits to
former employees were in accordance with the local Brazilian regulations.
Note 5. Contingencies:
Legal proceedings covering a wide range of matters are pending or threatened in
various United States and foreign jurisdictions against the Company, its
subsidiaries and affiliates, including PM Inc., and 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, claims for contribution and claims of
competitors and distributors.
Overview of Tobacco-Related Litigation
Types and Number of Cases
Pending claims related to tobacco products generally fall within the following
categories: (i) smoking and health cases alleging personal injury brought on
behalf of individual plaintiffs, (ii) smoking and health cases primarily
alleging personal injury and purporting to be brought on behalf of a class of
individual plaintiffs, including cases brought pursuant to a 1997 settlement
agreement involving claims by flight attendants alleging injury from exposure to
environmental tobacco smoke ("ETS") in aircraft cabins, (iii) health care cost
recovery cases brought by governmental (both domestic and foreign) and
non-governmental plaintiffs seeking reimbursement for health care expenditures
allegedly caused by cigarette smoking and/or disgorgement of profits, and (iv)
other tobacco-related litigation, including suits by former asbestos
manufacturers seeking 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 and suits by foreign governments
seeking to recover damages for taxes lost as a result of the allegedly illegal
importation of cigarettes into their jurisdictions. Damages claimed in some of
the smoking and health class actions, health care cost recovery cases and other
tobacco-related litigation range into the billions of dollars. In July 2000, a
jury in a Florida smoking and health class action returned a punitive damages
award of approximately $74 billion against PM Inc. (See discussion of the Engle
case below.) Plaintiffs' theories of recovery and the defenses raised in the
smoking and health and health care cost recovery cases are discussed below.
Exhibit 99.1 hereto lists the smoking and health class actions, health care cost
recovery cases and certain other actions pending as of, November 1, 2000, and
discusses certain developments in such cases since August 10, 2000.
As of November 1, 2000, there were approximately 1,500 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 400 such
cases on November 1, 1999, and approximately 450 such cases on November 1, 1998.
Approximately 1,200 of these cases are pending before a single West Virginia
state court in a consolidated proceeding. Approximately 1,100 of the West
Virginia cases were filed during the third quarter of 2000. An estimated 20 of
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<PAGE>
the individual cases involve allegations of various personal injuries allegedly
related to exposure to ETS. In addition, approximately 3,120 additional
individual cases are pending in Florida by current and former flight attendants
claiming personal injuries allegedly related to ETS. The flight attendants
allege that they are members of an ETS smoking and health class action which was
settled in 1997. The terms of the court-approved settlement in that case allow
class members to file individual lawsuits seeking compensatory damages, but
prohibit them from seeking punitive damages. The deadline for class members to
file such suits was September 7, 2000.
As of November 1, 2000, there were an estimated 37 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 November 1, 1999, and approximately 65 such cases on November 1, 1998. Some
of these actions purport to constitute statewide class actions and were filed
after May 1996 when the United States Court of Appeals for the Fifth Circuit, 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.
As of November 1, 2000, there were approximately 55 health care cost recovery
actions pending in the United States (excluding the cases covered by the 1998
Master Settlement Agreement discussed below), compared with approximately 80
health care cost recovery cases pending on November 1, 1999, and 140 cases on
November 1, 1998.
There are also a number of tobacco-related actions pending outside the United
States against PMI and its affiliates and subsidiaries, including an estimated
68 smoking and health cases brought on behalf of individuals (Argentina (48),
Australia (1), Brazil (9), Canada (1), Germany (3), Hong Kong (1), Ireland (1),
Israel (1), Japan (1), the Philippines (1), and Poland (1)), compared with
approximately 45 such cases on November 1, 1999. In addition, there are 8
smoking and health putative class actions pending outside the United States
(Australia (1), Brazil (3), Canada (3), and Israel (1)), compared with nine on
November 1, 1999. In addition, during the past two years, health care cost
recovery actions have been brought in Israel, the Marshall Islands, British
Columbia, Canada and France (by a local agency of the French social security
health insurance system) and, in the United States, by Bolivia, Ecuador,
Guatemala (dismissed, as discussed below), Honduras, Nicaragua (dismissed, as
discussed below), Province of Ontario, Canada (dismissed, as discussed below),
Panama, the Russian Federation, Thailand (voluntarily dismissed), Ukraine
(dismissed, as discussed below), Venezuela, and the Brazilian States of Espirito
Santo, Goias, Mato Grosso do Sul, Rio de Janeiro, Sao Paulo, and Tocantins.
Federal Government's Lawsuit
In September 1999, the U.S. government filed a lawsuit in the U.S. District
Court for the District of Columbia against various cigarette manufacturers and
others, including the Company and PM Inc., asserting claims under three federal
statutes, the Medical Care Recovery Act ("MCRA"), the Medicare Secondary Payer
("MSP") provisions of the Social Security Act, and the Racketeer Influenced and
Corrupt Organizations Act ("RICO"). The lawsuit seeks to recover an unspecified
amount of health care costs for tobacco-related illnesses allegedly caused by
defendants' fraudulent and tortious conduct and paid for by the government under
various federal health care programs, including Medicare, military and veterans'
health benefits programs, and the Federal Employees Health Benefits Program. The
complaint alleges that such costs total more than $20 billion annually. It also
seeks various types of equitable and declaratory relief, including disgorgement,
an
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<PAGE>
injunction prohibiting certain actions by the defendants, and a declaration that
the defendants are liable for the federal government's future costs of providing
health care resulting from defendants' alleged past tortious and wrongful
conduct. The Company and PM Inc. moved to dismiss this lawsuit on numerous
grounds, including that the statutes invoked by the government do not provide a
basis for the relief sought. In September 2000, the trial court dismissed the
government's MCRA and MSP claims, but permitted discovery to proceed on the
government's claims for equitable relief under RICO. In October 2000, the
government moved for reconsideration of the trial court's order to the extent
that it dismissed the MCRA claims for health care costs paid pursuant to
government health benefit programs other than Medicare and the Federal Employees
Health Benefits Act. A hearing on the motion has not been scheduled. Trial is
scheduled for July 2003, although trial dates are subject to change. The Company
and PM Inc. believe that they have a number of valid defenses to the lawsuit and
will continue to vigorously defend it.
Recent Industry Trial Results
There have been several jury verdicts in tobacco-related litigation during the
past three years. In July, 2000, the jury in the Engle smoking and health class
action in Florida, returned a verdict assessing punitive damages totaling
approximately $145 billion against all defendants in the case, including
approximately $74 billion against PM Inc. (see "Engle Trial," below, for a more
detailed discussion of this verdict and certain other developments in this
case).
In October 2000, a jury in Florida awarded the plaintiff in an individual
smoking and health case $200,000 in compensatory damages and no punitive
damages. Neither the Company nor its affiliates were parties to that action. In
July 2000, a jury in Mississippi returned a verdict in favor of another
cigarette manufacturer in an individual smoking and health case. In June 2000, a
jury in New York returned a verdict in favor of all defendants including, PM
Inc., in another individual smoking and health case. In March 2000, a jury in
California awarded a former smoker with lung cancer $1.72 million in
compensatory damages against PM Inc. and another cigarette manufacturer and $10
million in punitive damages against PM Inc. as well as an additional $10 million
against the other defendant. The verdicts in all of these cases are being
challenged in post trial motions or are on appeal.
In July 1999, a Louisiana jury returned a verdict in favor of defendants in an
individual smoking and health case against other cigarette manufacturers. In
June 1999, a Mississippi jury returned a verdict in favor of defendants,
including PM Inc., in an action brought on behalf of an individual who died
allegedly as a result of exposure to ETS. In May 1999, a Missouri jury returned
a verdict in favor of defendant in an individual smoking and health case against
another cigarette manufacturer. Also in May 1999, a Tennessee jury returned a
verdict in favor of defendants, including PM Inc., in two of three individual
smoking and health cases consolidated for trial. In the third case (not
involving PM Inc.), the jury found liability against defendants and apportioned
fault equally between plaintiff and defendants. Under Tennessee's system of
modified comparative fault, because the jury found plaintiff's fault equal to
that of defendants, recovery was not permitted.
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In March 1999, an Oregon jury awarded the estate of a deceased smoker $800,000
in actual damages, $21,500 in medical expenses and $79.5 million in punitive
damages against PM Inc. In February 1999, a California jury awarded a former
smoker $1.5 million in compensatory damages and $50 million in punitive damages
against PM Inc. The punitive damage awards in the Oregon and California actions
have been reduced to $32 million and $25 million, respectively. PM Inc. is
appealing the verdicts and the damage awards in these cases.
In March 1999, a jury returned a verdict in favor of defendants, including PM
Inc., in a union health care cost recovery action brought on behalf of
approximately 114 employer-employee trust funds in Ohio.
In December 1999, a French court, in an action brought on behalf of a deceased
smoker, found that another cigarette manufacturer had a duty to warn him about
risks associated with smoking prior to 1976, when the French government required
warning labels on cigarette packs, and failed to do so. The court did not
determine causation or liability, which shall be considered in future
proceedings. Neither the Company nor its affiliates are parties to this action.
Engle Trial
As discussed below, verdicts have been returned and judgment has been entered
against PM Inc. and other cigarette manufacturers and defendants in the first
two phases of this three-phase smoking and health class action trial in Florida.
The class consists of all Florida residents and citizens, and their survivors,
"who have suffered, presently suffer or have died from diseases and medical
conditions caused by their addiction to cigarettes that contain nicotine."
In July 1999, the jury returned a verdict against defendants in phase one of the
trial concerning certain issues determined by the trial court to be "common" to
the causes of action of the plaintiff class. Among other things, the jury found
that smoking cigarettes causes 20 diseases or medical conditions, that
cigarettes are addictive or dependence-producing, defective and unreasonably
dangerous, that defendants made materially false statements with the intention
of misleading smokers, that defendants concealed or omitted material information
concerning the health effects
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and/or the addictive nature of smoking cigarettes, and that defendants were
negligent and engaged in extreme and outrageous conduct or acted with reckless
disregard with the intent to inflict emotional distress. The jury also found
that defendants' conduct "rose to a level that would permit a potential award or
entitlement to punitive damages."
During phase two of the trial, the claims of three of the named plaintiffs were
adjudicated in a consolidated trial before the same jury that returned the
verdict in phase one. In April 2000, the jury determined liability against the
defendants and awarded $12.7 million in compensatory damages to the three named
plaintiffs.
In July 2000, the same jury returned a verdict assessing punitive damages on a
lump sum basis for the entire class totaling approximately $145 billion against
the various defendants in the case, including approximately $74 billion
severally against PM Inc. PM Inc. believes that the punitive damages award was
determined improperly and that it should ultimately be set aside on any one of
numerous grounds. Included among these grounds are the following: under
applicable law (i) defendants are entitled to have liability and damages for
each plaintiff tried by the same jury, an impossibility due to the jury's
dismissal; (ii) punitive damages cannot be assessed before the jury determines
entitlement to and the amount of compensatory damages for all class members;
(iii) punitive damages must bear a reasonable relationship to compensatory
damages, a determination that cannot be made before compensatory damages are
assessed for all class members; and (iv) punitive damages can "punish" but
cannot "destroy" the defendant. In March 2000, at the request of the Florida
legislature, the Attorney General of Florida issued an advisory legal opinion
stating that "Florida law is clear that compensatory damages must be determined
prior to an award of punitive damages" in cases such as Engle. As noted above,
compensatory damages for all but three members of the class members have not
been determined.
Following the verdict in the second phase of the trial, the jury was dismissed,
notwithstanding that liability and compensatory damages for all but three class
members have not yet been determined. According to the trial plan, phase three
of the trial will address other class members' claims, including issues of
specific causation, reliance, affirmative defenses and other individual-specific
issues regarding entitlement to damages, in individual trials before separate
juries.
It is unclear how the trial plan will be further implemented. The trial plan
provides that the punitive damages award should be standard as to each class
member and acknowledges that the actual size of the class will not be known
until the last class member's case has withstood appeal, i.e., the punitive
damages amount would be divided equally among those plaintiffs who, in addition
to the successful phase two plaintiffs, are ultimately successful in phase three
of the trial and in any appeal.
Following the jury's punitive damages verdict in July, the Engle trial judge
scheduled a hearing on numerous pending phase one and two motions, including
defendants' challenges of various rulings made by the judge and the jury's
verdicts on
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compensatory and punitive damages. Prior to the commencement of the hearing,
defendants removed the case to federal district court following the intervention
application of a union health fund that raised federal issues in the case.
Plaintiffs and the health fund filed motions to remand the case to state court,
and on November 3, 2000, the federal district court remanded the case to state
court on the grounds that the removal was premature.
The trial judge in the state court promptly denied the defendants' post trial
motions and entered judgment on the compensatory and punitive damages awarded by
the jury. PM Inc. and the Company believe that the entry of judgment at this
time by the trial court is unconstitutional and violates Florida law. On
November 7, 2000, PM Inc. filed an appeal with respect to the entry of judgment,
class certification and numerous other reversible errors that have occurred
during the trial. PM Inc. has also posted a $100 million dollar bond to stay
execution of the judgment with respect to the $74 billion in punitive damages
that has been awarded against it. The bond was posted pursuant to legislation
that was enacted in Florida in May 2000 that limits the size of the bond that
must be posted in order to stay execution of a judgment for punitive damages in
a certified class action to no more than $100 million regardless of the amount
of punitive damages ("bond cap legislation"). Plaintiffs have indicated that
they believe the bond cap legislation is unconstitutional and it is possible
that they may seek to challenge the $100 million bond. If the bond were found to
be invalid, it would be commercially impossible for PM Inc. to post a bond in
the full amount of the judgment and, absent appellate relief, PM Inc. would not
be able to stay any attempted execution of the judgment in Florida. PM Inc. and
the Company will take all appropriate steps to seek to prevent this worst case
scenario from occurring and believe these efforts should be successful.
In other developments, in August 1999, the trial judge denied a motion filed by
PM Inc. and other defendants to disqualify the judge. The motion asserted, among
other things, that the trial judge was required to disqualify himself because he
is a former smoker who has a serious medical condition of a type that the
plaintiffs claim, and the jury has found, is caused by smoking, making him
financially interested in the result of the case and, under plaintiffs' theory
of the case, a member of the plaintiff class. The Third District Court of Appeal
denied defendants' petition to disqualify the trial judge. In January 2000,
defendants filed a petition for a writ of certiorari to the United States
Supreme Court requesting that it review the issue of the trial judge's
disqualification and in May 2000 the writ of certiorari was denied.
PM Inc. and the Company remain of the view that the Engle case should not have
been certified as a class action. The certification is inconsistent with the
overwhelming majority of federal and state court decisions that have held that
mass smoking and health claims are inappropriate for class treatment. As
indicated above, PM Inc. has filed an appeal challenging the class certification
and the compensatory and punitive damage awards, as well as numerous other
reversible errors that it believes occurred during the trial to date.
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Pending and Upcoming Trials
A trial is underway in New York in an individual case which PM Inc. is a
defendant. Jury selection in an asbestos contribution action, in which PM Inc.
is a defendant, is scheduled to begin on November 27, 2000 in New York. Trial in
a smoking and health class action, in which PM Inc. is a defendant, is scheduled
to begin in December 2000 in West Virginia; plaintiffs in this action seek the
creation of a medical monitoring fund for members of the purported class. As set
forth in Exhibit 99.3, additional cases against PM Inc. and, in some cases, the
Company as well, are scheduled for trial through the end of 2001, including four
health care cost recovery actions; -two asbestos contribution cases; three
purported smoking and health class actions; and approximately 46 other
individual smoking and health cases, including a consolidated trial of
individual smoking and health cases scheduled to begin in June 2001 in West
Virginia. As of November 1, 2000, nine cases involving flight attendants' claims
for damages from ETS were scheduled for trial between January and May 2001.
Cases against other tobacco companies are also scheduled for trial through the
end of 2001. Trial dates, however, are subject to change.
Litigation Settlements
In November 1998, PM Inc. and certain other United States tobacco product
manufacturers entered into the 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.
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 with tobacco growers discussed below),
subject to adjustment for several factors, including inflation, market share and
industry volume: 2000, $9.2 billion; 2001, $9.9 billion; 2002, $11.3 billion;
2003, $10.9 billion; 2004 through 2007, $8.4 billion each year; and, thereafter,
$9.4 billion each year. 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: 2000, $416 million; and 2001
through 2003, $250 million each year. These payment obligations are the several
and not joint obligations of each settling defendant. PM Inc.'s portion of
ongoing adjusted payments and legal fees is based on its share of domestic
cigarette shipments in the year preceding that in which the
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payment is due. Accordingly, PM Inc. records its portions of ongoing settlement
payments as part of cost of sales as product is shipped.
The State Settlement Agreements also include provisions, discussed below in
Management's Discussion and Analysis of Financial Condition and Results of
Operations, relating to advertising and marketing restrictions, public
disclosure of certain industry documents, limitations on challenges to certain
tobacco control and underage use laws, restrictions on lobbying activities and
other provisions.
As set forth in Exhibit 99.2, the MSA has been initially approved by trial
courts in all settling jurisdictions. If a jurisdiction does not obtain "final
judicial approval" (i.e., trial court approval and expiration of the time for
review or appeal of such approval) of the MSA by December 31, 2001, then, unless
the settling defendants and the relevant jurisdiction agree otherwise, the
agreement will be terminated with respect to such jurisdiction. As of November
1, 2000, the MSA has received final judicial approval in 50 jurisdictions.
As part of the MSA, the settling defendants committed to work cooperatively with
the tobacco-growing states to address concerns about the potential adverse
economic impact of the MSA on tobacco growers and quota-holders. To that end,
four of the major domestic tobacco product manufacturers, including PM Inc., and
the grower states, have established a trust fund to provide aid to tobacco
growers and quota-holders. The trust will be funded by these four manufacturers
over 12 years with payments, prior to application of various adjustments,
scheduled to total $5.15 billion. Future industry payments (in 2000, $280
million; 2001, $400 million; 2002 through 2008, $500 million each year; 2009 and
2010, $295 million each year) are subject to adjustment for several factors,
including inflation, United States cigarette volume and certain other contingent
events, and, in general, are to be allocated based on each manufacturer's
relative market share. PM Inc. records its portion of these payments as part of
cost of sales as product is shipped.
The State Settlement Agreements have materially adversely affected the volumes
of PM Inc. and the Company; the Company believes that they may materially
adversely affect the business, volume, results of operations, cash flows or
financial position of PM Inc. and the Company in future periods. 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. Manufacturers representing almost all
domestic shipments in 1998 have agreed to become subject to the terms of the
MSA.
Certain litigation, described in Exhibit 99.1, has arisen challenging the
validity of the MSA and alleging violation of the antitrust laws.
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.
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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 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 and smoking cessation funds, disgorgement of
profits, and injunctive and equitable relief. Defenses raised in 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 United States Court of Appeals for the Fifth Circuit held in
the Castano case that a class consisting of all "addicted" smokers nationwide
did not meet the standards and requirements of the federal rules governing class
actions. Since this class decertification, lawyers for plaintiffs have filed
numerous putative 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 (although a few cases purport to be
nationwide in scope) and raise "addiction" claims similar to those raised in the
Castano case and, in many cases, claims of physical injury as well. As of
November 1, 2000, smoking and health putative class actions were pending in
Alabama, Florida, Hawaii, Illinois, Indiana, Iowa, Louisiana, Massachusetts,
Michigan, Missouri, Nevada, New Jersey, New Mexico, New York, North Carolina,
Pennsylvania, South Carolina, Tennessee, Texas, Utah and West Virginia, as well
as in Australia, Brazil, Canada and Israel. Class certification has been denied
or reversed by courts in 24 smoking and health class actions involving PM Inc.
in Arkansas, California (2), the District of Columbia, Illinois, Kansas,
Louisiana, Maryland, Michigan, Minnesota, New Jersey (6), New York (2), Ohio,
Oklahoma, Pennsylvania, Puerto Rico, Texas, and Wisconsin, while classes remain
certified in two cases in Florida and Louisiana, and a West Virginia court has
recently certified a class in a smoking and health class action in which the
plaintiffs are seeking the creation of a medical monitoring fund for members of
the purported class. Some of the decisions denying the plaintiffs' motions for
class certification are on appeal. In May 1999, the United States Supreme Court
declined to review the decision of the United States Court of Appeals for the
Third Circuit affirming a lower court's decertification of a class. As mentioned
in Overview of Tobacco-Related Litigation, above, one ETS smoking and health
class action was settled in 1997.
Health Care Cost Recovery Litigation
In certain of the pending proceedings, domestic and foreign governmental
entities and non-governmental plaintiffs, including union health and welfare
funds ("unions"), native American tribes, insurers and self-insurers such as
Blue Cross and Blue Shield Plans, hospitals, taxpayers and others, are seeking
reimbursement of health care cost expenditures
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allegedly caused by tobacco products and, in some cases, of future expenditures
and damages as well. Certain of these cases purport to be brought on behalf of a
class of plaintiffs. 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 lack of proximate cause, remoteness of injury, 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
standing and injury, federal preemption, 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 payer 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 MSA, as of November 1, 2000, there were
approximately 55 health care cost recovery cases pending in the United States
against PM Inc. and, in some cases, the Company, of which approximately 20 were
filed by union trust funds. As discussed above under "Federal Government's
Lawsuit," the U.S. government filed a health care cost recovery action in
September 1999 against various cigarette manufacturers and others, including the
Company and PM Inc., asserting claims under three federal statutes. Health care
cost recovery actions have also been brought in Israel, the Marshall Islands,
British Columbia, Canada and France and, in the United States, by Bolivia,
Ecuador, Guatemala, Honduras, Nicaragua, Province of Ontario, Canada, Panama,
Russian Federation, Thailand (voluntarily dismissed), Ukraine, Venezuela and the
Brazilian States of Espirito Santo, Goias, Mato Grosso do Sul, Rio de Janeiro,
Sao Paulo and Tocantins. The actions brought by Bolivia, Ecuador, Guatemala,
Nicaragua, Ontario, Panama, Russian Federation, Ukraine, Venezuela and the
Brazilian States of Goias, and Espirito Santo and Mato Grosso do Sol were
consolidated for pre-trial purposes and transferred to the United States
District Court for the District of Columbia. As described below, the court has
dismissed the claims of Guatemala, Nicaragua, the Province of Ontario and
Ukraine. The court remanded the Venezuela, and Ecuador, Espirito Santo and Goias
cases to state court in Florida.
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Other entities have stated that they are considering filing health care cost
recovery actions.
Seven federal Circuit Courts of Appeals, the Second, Third, Fifth, Seventh,
Eighth, Ninth and Eleventh Circuits, relying primarily on grounds that
plaintiffs' claims were too remote, have affirmed dismissals of, or reversed
trial courts that had refused to dismiss, such actions. In addition, in January
2000, the United States Supreme Court refused to consider plaintiffs' appeals
from the cases decided by the Court of Appeals for the Second, Third and Ninth
Circuits.
Although there have been some decisions to the contrary, to date, most lower
courts that have decided motions in these cases have dismissed all or most of
the claims against the industry. In December 1999, in the first ruling on a
motion to dismiss a health care cost recovery case brought in the United States
by a foreign governmental plaintiff, the federal district court for the District
of Columbia dismissed a lawsuit filed by Guatemala, ruling that the claimed
injuries were too remote. Subsequently, in March 2000, the court also dismissed
the claims of Nicaragua and Ukraine. Guatemala, Nicaragua and Ukraine each have
appealed these decisions to the United States Court of Appeals for the District
of Columbia Circuit. In August 2000, the federal district court for the District
of Columbia dismissed the claims of the Province of Ontario, and the Province
has appealed. In March 1999, in the only union case to go to trial thus far, the
jury returned a verdict in favor of defendants on all counts. Plaintiffs' motion
for a new trial was denied. In December 1999, the federal district court in the
District of Columbia denied defendants' motion to dismiss a suit filed by union
and welfare funds seeking reimbursement of health care expenditures allegedly
caused by tobacco products. Defendants are appealing this decision. In June
2000, the federal district court in Rhode Island dismissed a suit filed by a
union, finding that the plaintiffs' claims are too remote to permit recovery.
Certain Other Tobacco-Related Litigation
Asbestos Contribution Cases: As of November 1, 2000, 13 suits had 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. Nine of these cases are pending.
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. The aggregate amounts claimed in these
cases range into the billions of dollars. Trials in two of these cases are
scheduled to begin in New York in November 2000 and April 2001.
Lights/Ultra Lights Cases: As of November 1, 2000, there were eleven putative
class actions pending against PM Inc. and the Company, in Arizona, Florida,
Illinois, Massachusetts, Missouri, New Jersey, Ohio, Pennsylvania and Tennessee,
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on behalf of individuals who purchased and consumed various brands of
cigarettes, including Marlboro Lights, Marlboro Ultra Lights, Virginia Slims
Lights and Superslims, Merit Lights and Cambridge Lights. These cases allege, in
connection with the use of the term "Lights" and/or "Ultra Lights," among other
things, deceptive and unfair trade practices and unjust enrichment, and seek
injunctive and equitable relief, including restitution. Trial in one purported
class action is scheduled for November 2001.
Retail Leaders Case: Three domestic tobacco manufacturers have filed suit
against PM Inc. seeking to enjoin the PM Inc. "Retail Leaders" program that
became available to retailers in October 1998. The complaint alleges that this
retail merchandising program is exclusionary, creates an unreasonable restraint
of trade and constitutes unlawful monopolization. In addition to an injunction,
plaintiffs seek unspecified treble damages, attorneys' fees, costs and interest.
In June 1999, the court issued a preliminary injunction enjoining PM Inc. from
prohibiting retail outlets that participate in the program at one of the levels
from installing competitive permanent signage in any section of the "industry
fixture" that displays or holds packages of cigarettes manufactured by a firm
other than PM Inc., or requiring those outlets to allocate a percentage of
cigarette-related permanent signage to PM Inc. greater than PM Inc.'s market
share. The court also enjoined PM Inc. from prohibiting retail outlets
participating in the program from advertising or conducting promotional programs
of cigarette manufacturers other than PM Inc. The preliminary injunction does
not affect any other aspect of the Retail Leaders program.
Vending Machine Case: Plaintiffs, who began their case as a purported nationwide
class of cigarette vending machine operators, allege that PM Inc. has violated
the Robinson-Patman Act in connection with its promotional and merchandising
programs available to retail stores and not available to cigarette vending
machine operators. Plaintiffs request actual damages, treble damages, injunctive
relief, attorneys' fees and costs, and other unspecified relief. In June 1999,
the court denied plaintiffs' motion for a preliminary injunction. Plaintiffs
have withdrawn their request for class action status. Trial on the claims of ten
plaintiffs which was set for trial in November 2000, has been continued without
a new trial date being set, and the court is scheduled to hear PM Inc.'s motion
for summary judgment on those claims in November 2000. The claims of remaining
plaintiffs have been stayed pending disposition of the ten claims previously
scheduled for trial.
Cases Under the California Business and Professions Code: In July 1998, two
suits were filed in California courts alleging that domestic cigarette
manufacturers, including PM Inc. and others, have violated a 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
or requiring issuance of appropriate warnings, restitution, disgorgement of
profits and other relief. Defendants' motion for summary judgment was granted in
part, and plaintiffs' "Proposition 65" claims were dismissed. In August 2000,
the parties to one of the cases entered into a settlement agreement, which was
expressly conditioned upon a finding by the California Attorney General that the
settlement is in the public interest. The Attorney General made that finding in
October 2000. The parties to the remaining action entered into a separate
settlement agreement in October 2000. The two settlement agreements, which
together require PM Inc. to pay approximately $245,000 to the plaintiffs,
collectively resolve all claims that were, or could have been,
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brought in these two actions. The court is scheduled to rule on November 20,
2000 on defendants' motion seeking approval of both settlements and entry of a
final judgment in both cases.
Tobacco Price Cases: As of November 1, 2000, there were approximately 39
putative class actions against PM Inc. and other domestic tobacco manufacturers
alleging that, through the MSA and other activities, the manufacturers conspired
to fix cigarette prices in violation of antitrust laws. These cases are listed
in Exhibit 99.1.
Tobacco Growers' Case: In February 2000, a lawsuit was filed on behalf of a
purported class of tobacco growers and quota-holders. An amended complaint was
filed in May 2000, and a second amended complaint was filed in August 2000. The
second amended complaint alleges that cigarette manufacturers, including PM
Inc., violated antitrust laws by bid-rigging at tobacco auctions and by
conspiring to undermine the tobacco quota and price support system administered
by the federal government. In October 2000, defendants filed motions to dismiss
the second amended complaint and to transfer the case to federal court. In
October, plaintiffs filed a motion for class certification.
Cigarette Importation Cases: As of November 3, 2000, Ecuador, the European
Community, and various Departments of Colombia have filed suits in the United
States against the Company and certain of its subsidiaries, including PM Inc.
and PMI, and other cigarette manufacturers and their affiliates alleging that
defendants illegally imported cigarettes into the plaintiff jurisdictions in an
effort to evade taxes. The claims asserted in these cases include negligence,
negligent misrepresentation, unjust enrichment, violations of RICO and its
state-law equivalents and conspiracy. Plaintiffs in these cases seek actual
damages, treble damages and undisclosed injunctive or equitable relief.
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Consolidated Putative Punitive Damages Cases: As further described in Exhibit
99.1, in September 2000, a putative class action was filed in the federal
district court in the Eastern District of New York which purports to consolidate
punitive damages claims in ten tobacco-related actions currently pending in the
federal district courts in the Eastern Districts of New York and Pennsylvania.
The court hearing this case has indicated that, in its view, it appears likely
that plaintiffs will be able to demonstrate a basis for the certification of an
opt out compensatory damages class and a non-opt out punitive damages class.
Certain Other Actions
National Cheese Exchange Cases: Since 1996, seven putative class actions have
been filed alleging that 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. Two of the actions were voluntarily dismissed by plaintiffs
after class certification was denied. Two other actions were dismissed in 1998
after Kraft's motions to dismiss were granted, and plaintiffs appealed those
dismissals. In one of those cases, in February 2000 the court reversed the trial
court's decision to dismiss the case. The remaining three cases were
consolidated in state court in Wisconsin, and in November 1999, the court
granted Kraft's motion for summary judgment. Plaintiffs have appealed.
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Italian Tax 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 alleged unpaid taxes assessed
to date is the Italian lira equivalent of $1.9 billion. In addition, the Italian
lira equivalent of $2.8 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 174 of the assessments. The decisions to overturn 126 assessments
have been appealed by the tax authorities to the regional appellate court in
Milan. To date, the regional appellate court has rejected 41 of the appeals
filed by the tax authorities. The tax authorities have appealed 31 of the 41
decisions of the regional appellate court to the Italian Supreme Court. The
remaining 10 decisions are expected to be appealed as well. 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 tax evasion and related charges to
remain pending. In February 1998, the criminal court in Naples determined that
jurisdiction was not proper, and the case file was transmitted to the public
prosecutor in Milan. Further investigation is being conducted following which a
decision will be made 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.
----------------------
It is not possible to predict the outcome of the litigation pending against the
Company and its subsidiaries. Litigation is subject to many uncertainties.
Unfavorable verdicts awarding compensatory and punitive damages have been
returned in the Engle smoking and health class action trial and judgment has
been entered against PM Inc. It is possible that additional cases could be
decided unfavorably and that there could be further adverse developments in the
Engle case. Three individual smoking and health cases in which PM Inc. is a
defendant have been decided unfavorably at the trial court level and are in the
process of being appealed. 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
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<PAGE>
respective cases, that it has a number of valid defenses to all litigation
pending against it, as well as valid bases for appeal of adverse verdicts
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.
Note 6. Recently Issued Accounting Pronouncements:
During 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which had an initial adoption date by the
Company of January 1, 2000. During 1999, the FASB postponed the adoption date of
SFAS No. 133 until January 1, 2001. 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. Since the impact of SFAS No. 133
is dependent on future market rates and outstanding derivative positions at
January 1, 2001, the Company cannot yet determine the impact that adoption or
subsequent application of SFAS No. 133 will have on its financial position or
results of operations.
During 2000, a number of accounting and financial reporting pronouncements
relating to the recognition, measurement and classification of revenues, various
sales incentives and shipping and handling costs were issued. These
pronouncements will be effective for the fourth quarter of 2000. The Company has
determined that adoption or subsequent application of these pronouncements will
not have a material effect on its financial position or results of operations.
Upon adoption, prior period amounts will be reclassified to conform with the new
pronouncements.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Operating Results
For the Nine Months Ended September 30,
Operating Revenues
--------------------------
(in millions)
2000 1999
-------- --------
Domestic tobacco $ 16,987 $ 14,352
International tobacco 20,552 21,419
North American food 13,534 13,193
International food 6,115 6,601
Beer 3,449 3,361
Financial services 305 259
-------- --------
Operating revenues $ 60,942 $ 59,185
======== ========
Operating Income
--------------------------
(in millions)
2000 1999
-------- --------
Domestic tobacco $ 3,849 $ 3,436
International tobacco 4,180 3,922
North American food 2,690 2,404
International food 951 785
Beer 491 454
Financial services 193 168
-------- --------
Operating companies income 12,354 11,169
Amortization of goodwill (442) (434)
General corporate expenses (626) (386)
Minority interest (92) (95)
-------- --------
Operating income $ 11,194 $ 10,254
======== ========
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For the Three Months Ended September 30,
Operating Revenues
--------------------------
(in millions)
2000 1999
-------- --------
Domestic tobacco $ 5,835 $ 5,157
International tobacco 6,753 7,153
North American food 4,276 4,171
International food 1,939 2,155
Beer 1,149 1,153
Financial services 106 89
-------- --------
Operating revenues $ 20,058 $ 19,878
======== ========
For the Three Months Ended September 30, (continued)
Operating Income
--------------------------
(in millions)
2000 1999
-------- --------
Domestic tobacco $ 1,459 $ 1,367
International tobacco 1,439 1,239
North American food 827 773
International food 416 264
Beer 145 140
Financial services 66 58
-------- --------
Operating companies income 4,352 3,841
Amortization of goodwill (149) (142)
General corporate expenses (207) (151)
Minority interest (32) (32)
-------- --------
Operating income $ 3,964 $ 3,516
======== ========
Results of Operations for the Nine Months Ended September 30, 2000
Operating revenues for the first nine months of 2000 increased $1.8 billion
(3.0%) over 1999, due primarily to an increase in revenues from the Company's
domestic tobacco operations. Despite this increase, the operating revenue
comparison for the first nine months was adversely affected by approximately
$225 million of incremental sales made during the fourth quarter of 1999, as the
Company's customers planned for potential business failures related to the
Century Date Change ("CDC"). The incremental CDC sales would have normally been
made during the first quarter of 2000. Including the incremental CDC revenues in
the first quarter of 2000, and excluding the revenues of several international
food businesses divested since the beginning of 1999, operating revenues for the
first nine months of 2000 increased $2.1 billion (3.6%) over the first nine
months of 1999.
Operating income for the first nine months of 2000 increased $940 million (9.2%)
over the comparable 1999 period. The operating income comparison was affected by
the following unusual items:
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o Sale of French Confectionery Business - In August 2000, the Company sold a
French confectionery business ("French Confectionery Sale") for proceeds
of $251 million and an estimated pre-tax gain of $139 million. The pre-tax
gain, which is subject to adjustment, is included in the international
food segment's marketing, administration and research costs in the
consolidated statements of earnings.
o Louisville Factory Closure - During the first quarter of 1999, Philip
Morris Incorporated ("PM Inc.") announced plans to phase out cigarette
production capacity at its Louisville, Kentucky manufacturing plant by
August 2000 (the "Louisville Closure"). The closure of this facility,
which occurred in stages, has been completed. In connection with the
closure, PM Inc. recorded pre-tax charges for the first nine months of
1999 of $183 million. These charges, which are in the domestic tobacco
segment's marketing, administration and research costs in the consolidated
statements of earnings, included enhanced severance, pension and
postretirement benefits for approximately 1,500 hourly and salaried
employees. Severance benefits, which were either paid in a lump sum or as
income protection payments over a period of time, commenced upon
termination of employment. Payments of enhanced pension and postretirement
benefits are being made over the remaining lives of the former employees
in accordance with the terms of the related benefit plans. All operating
costs of the manufacturing plant, including increased depreciation, were
charged to expense as incurred during the closing period.
o Kraft Separation Programs - During the first quarter of 1999, Kraft Foods,
Inc. ("Kraft") announced that it was offering voluntary retirement
incentive or separation programs to certain eligible hourly and salaried
employees in the United States (the "Kraft Separation Programs").
Employees electing to terminate employment under the terms of these
programs were entitled to enhanced retirement or severance benefits.
Approximately 1,100 hourly and salaried employees accepted the benefits
offered by these programs and elected to retire or terminate. As a result,
Kraft recorded a pre-tax charge of $157 million for the first nine months
of 1999. This charge was included in marketing, administration and
research costs in the consolidated statements of earnings for the North
American food segment. Payments of pension and postretirement benefits are
made in accordance with the terms of the applicable benefit plans.
Severance benefits, which are paid over a period of time, commenced upon
dates of termination that ranged from April 1999 to March 2000. Salary and
related benefit costs of employees prior to the retirement or termination
date were expensed as incurred.
o Brazil Factory Closure - During the third quarter of 1999, a subsidiary of
the Company announced the closure of a cigarette factory and the
corresponding reduction of cigarette production capacity in Brazil (the
"Brazil Factory Closure"). Prior to the factory closure, existing
employees were offered voluntary dismissal benefits. These benefits were
accepted by half of the approximately 1,000 employees at the facility.
During the third quarter of 1999, the factory was closed and employment of
the remaining employees was terminated. For the first nine months of 1999,
a pre-tax charge of $136 million was recorded in marketing, administration
and research costs in the consolidated statements of earnings of the
international tobacco segment to write down the tobacco machinery and
equipment no longer in use and to recognize the cost of enhanced severance
benefits. Payments of severance benefits to former employees were in
accordance with the local Brazilian regulations.
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<PAGE>
The operating income comparison was adversely affected by approximately $100
million of operating income from the previously mentioned incremental CDC sales.
Including the incremental CDC income and excluding the pre-tax gain on the
French Confectionery Sale and the pre-tax charges for the Louisville Closure,
the Kraft Separation Programs and the Brazil Factory Closure, as well as the
results from operations divested since the beginning of 1999, operating income
for the first nine months of 2000 increased $431 million (4.0%) over the first
nine months of 1999, due primarily to higher operating results from all
segments, partially offset by higher general corporate expenses. The $240
million increase in general corporate expenses over the first nine months of
1999 is due primarily to higher spending on the Company's corporate image
campaign.
Operating companies income, which is defined as operating income before general
corporate expenses, minority interest and amortization of goodwill, increased
$1.2 billion (10.6%) over the first nine months of 1999, due primarily to higher
operating results from all segments and the previously discussed 2000 pre-tax
gain on the French Confectionery Sale, 1999 pre-tax charges for the Louisville
Closure, the Kraft Separation Programs and the Brazil Factory Closure, partially
offset by the incremental CDC income. Including the impact of the incremental
CDC income and excluding the 2000 pre-tax gain and 1999 pre-tax charges, as well
as the results from operations divested since the beginning of 1999, operating
companies income increased $676 million (5.8%).
Currency movements have decreased operating revenues by $1.9 billion ($1.0
billion, after excluding the impact of currency movements on excise taxes), and
operating companies income by $276 million from the first nine months of 1999.
Declines in operating revenues and operating companies income arising from the
strength of the U.S. dollar against the Euro and certain Central and Eastern
European currencies have been partially offset by the weakness of the U.S.
dollar against the Japanese yen. Although the Company cannot predict future
movements in currency rates, strengthening of the dollar, primarily against the
Euro, if sustained during the remainder of 2000, could continue to have an
unfavorable impact on operating revenues and operating companies income
comparisons with 1999.
Interest and other debt expense, net, decreased $91 million (14.5%) in the first
nine months of 2000 from the comparable 1999 period. This decrease was due
primarily to lower average debt outstanding during the first nine months of
2000.
Diluted and basic EPS, which were $2.85 and $2.86, respectively, for the first
nine months of 2000, increased by 18.3% and 18.2%, respectively, over the first
nine months of 1999. Net earnings of $6.5 billion for the first nine months of
2000 increased $681 million (11.7%) over the comparable period of 1999. These
results include the charges for the Louisville Closure, the Kraft Separation
Programs and the Brazil Factory Closure, the gain on the French Confectionery
Sale, and exclude the incremental CDC income. After adjusting for the effects of
these unusual items, net earnings increased 6.0% to $6.5 billion, diluted EPS
increased 12.3% to $2.84 and basic EPS increased 12.2% to $2.85.
Results of Operations for the Three Months Ended September 30, 2000
Operating revenues for the third quarter of 2000 increased $180 million (0.9%)
over the comparable 1999 period, due primarily to an increase in revenues from
the Company's domestic tobacco operations. Excluding the revenues of several
international food businesses divested since the beginning of 1999, underlying
operating revenues for the third quarter of 2000 increased $219 million (1.1%)
over the third quarter of 1999.
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<PAGE>
Operating income for the third quarter of 2000 increased $448 million (12.7%)
over the comparable 1999 period. Third quarter 2000 operating income includes a
pre-tax gain of $139 million related to the French Confectionery Sale. Third
quarter 1999 operating income includes pre-tax charges of $136 million related
to the Brazil Factory Closure and $8 million related to the Louisville Closure.
Excluding the pre-tax gain and pre-tax charges, as well as the results from
operations divested since the beginning of 1999, operating income for 2000
increased $168 million (4.6%) from the third quarter of 1999 due primarily to
higher operating results from all segments, partially offset by higher general
corporate expenses. On a reported basis, operating companies income, which is
defined as operating income before general corporate expenses, minority interest
and amortization of goodwill, increased $511 million (13.3%) from the third
quarter of 1999. Excluding the previously mentioned pre-tax gain and pre-tax
charges, as well as the results of divested operations, operating companies
income increased $231 million (5.8%) from the third quarter of 1999.
Currency movements have decreased operating revenues by $630 million ($335
million, after excluding the impact of currency movements on excise taxes), and
operating companies income by $102 million from the third quarter of 1999.
Declines in operating revenues and operating companies income arising from the
strength of the U.S. dollar against the Euro and certain Central and Eastern
European currencies have been partially offset by the weakness of the U.S.
dollar against the Japanese yen. Although the Company cannot predict future
movements in currency rates, strengthening of the dollar, primarily against the
Euro, if sustained during the remainder of 2000, could continue to have an
unfavorable impact on operating revenues and operating companies income
comparisons with 1999.
Interest and other debt expense, net, decreased $41 million (20.6%) in the third
quarter of 2000 from the comparable 1999 period. This decrease was due primarily
to lower average debt outstanding during the third quarter of 2000.
Diluted and basic EPS, which were $1.03 and $1.04, respectively, for the third
quarter of 2000, increased by 22.6% and 23.8%, respectively, over the third
quarter of 1999. Net earnings of $2.3 billion for the third quarter of 2000
increased $318 million (15.9%) over the comparable 1999 period. These results
reflect the charges for the Brazil Factory Closure and Louisville Closure and
the gain on the French Confectionery Sale. After adjusting for the effect of
these unusual items, net earnings increased 6.8% to $2.2 billion, diluted EPS
increased 13.8% to $0.99 and basic EPS increased 13.6% to $1.00.
Year 2000
To date, the Company and its subsidiaries have experienced no material
disruptions to their business operations as a result of the CDC. External
information technology specialists have stated that CDC-related miscalculations
or systems failures could occur throughout the year 2000 and into 2001. The
experience of the Company and its subsidiaries thus far suggests that no
material disruptions to their business operations are likely to occur. However,
the Company and its subsidiaries will continue to monitor the transition to year
2000 as part of their regular management processes and will respond promptly to
any problems that occur.
The Company's increases in year-end inventories and trade receivables caused by
preemptive contingency plans resulted in incremental cash outflows during 1999
of approximately $300 million.
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<PAGE>
The cash outflows reversed in the first quarter of 2000. In addition, certain
operating subsidiaries of the Company had increased shipments in the fourth
quarter of 1999, because customers purchased additional product in anticipation
of potential CDC-related disruptions, resulting in incremental operating
revenues and operating companies income in 1999 of approximately $225 million
and $100 million, respectively. Accordingly, there were reductions of
corresponding amounts in operating revenues and operating companies income in
the first quarter of 2000.
Euro
On January 1, 1999, eleven of the fifteen member countries of the European Union
established fixed conversion rates between their existing currencies ("legacy
currencies") and one common currency--the Euro. At that time, the Euro began
trading on currency exchanges and could be used in financial transactions.
Beginning in January 2002, new Euro-denominated currency (bills and coins) will
be issued, and legacy currencies will be withdrawn from circulation. The
Company's operating subsidiaries affected by the Euro conversion have
established and, where required, implemented plans to address the systems and
business issues raised by the Euro currency conversion. These issues include,
among others: (1) the need to adapt computer and other business systems and
equipment to accommodate Euro-denominated transactions; and (2) the competitive
impact of cross-border price transparency, which may make it more difficult for
businesses to charge different prices for the same products on a country-by-
country basis, particularly once the Euro currency is issued in 2002. The Euro
conversion has not had, and the Company currently anticipates that it will not
have, a material adverse impact on its financial condition or results of
operations.
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<PAGE>
Operating Results by Business Segment
Tobacco
Business Environment
The tobacco industry, both in the United States and abroad, has faced, and
continues to face, a number of issues that may adversely affect the business,
volume, results of operations, cash flows and financial position of PM Inc.,
Philip Morris International Inc. ("PMI") and the Company.
These issues, some of which are more fully discussed below, include pending and
threatened smoking and health litigation and recent jury verdicts against PM
Inc., including the $74 billion punitive damages verdict in the Engle smoking
and health class action case discussed in Note 5. Contingencies; the civil
lawsuit filed by the U.S. federal government against various cigarette
manufacturers and others as discussed in Note 5; legislation or other
governmental action seeking to ascribe to the industry responsibility and
liability for the adverse health effects associated with both smoking and
exposure to environmental tobacco smoke ("ETS"); price increases in the United
States related to the settlement of certain tobacco litigation; actual and
proposed excise tax increases; an increase in diversion into the United States
market of products intended for sale outside the United States; foreign and
United States governmental investigations into illegal cigarette imports; actual
and proposed requirements regarding disclosure of cigarette ingredients and
other proprietary information; governmental and private bans and restrictions on
smoking; actual and proposed price controls and restrictions on imports in
certain jurisdictions outside the United States; actual and proposed
restrictions affecting tobacco manufacturing, marketing, advertising and sales
outside the United States; actual and proposed legislation in Congress and the
State of New York to require the establishment of fire-safety standards for
cigarettes; the diminishing social acceptance of smoking and increased pressure
from anti-smoking groups and unfavorable press reports; and other tobacco
legislation that may be considered by the Congress, the states and other
jurisdictions inside and outside the United States.
Excise Taxes: Cigarettes are subject to substantial federal, state and local
excise taxes in the United States and to similar taxes in most foreign markets.
The United States federal excise tax on cigarettes is currently $0.34 per pack
of 20 cigarettes and is scheduled to increase to $0.39 per pack on January 1,
2002. In general, excise taxes and other taxes on cigarettes have been
increasing. These taxes vary considerably and, when combined with sales taxes
and the current federal excise tax, may be as high as $1.87 per pack in a given
locality in the United States. Congress has been considering significant
increases in the federal excise tax or other payments from tobacco
manufacturers, and increases in excise and other cigarette-related taxes have
been proposed at the state and local levels and in many jurisdictions outside
the United States.
In the opinion of PM Inc. and PMI, increases in excise and similar taxes have
had an adverse impact on sales of cigarettes. Any future increases, the extent
of which cannot be predicted, could result in volume declines for the cigarette
industry, including PM Inc. and PMI, and might cause sales to shift from the
premium segment to the discount segment.
Federal Trade Commission ("FTC"): In September 1997, the FTC issued a request
for public comments on its proposed revision of its "tar" and nicotine test
methodology and reporting procedures established by a 1970 voluntary agreement
among domestic cigarette manufacturers. In February 1998, PM Inc. and three
other domestic cigarette manufacturers filed comments on the proposed revisions.
In November 1998, the FTC wrote to the Department of Health and Human Services
requesting its
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<PAGE>
assistance in developing specific recommendations on the future of the FTC's
program for testing the "tar," nicotine and carbon monoxide content of
cigarettes.
Food and Drug Administration ("FDA") Regulations: In August 1996, the FDA
promulgated regulations asserting jurisdiction over cigarettes as "drugs" or
"medical devices" under the provisions of the Food, Drug and Cosmetic Act
("FDCA"). The regulations, which included severe restrictions on the
distribution, marketing and advertising of cigarettes, and would have required
the industry to comply with a wide range of labeling, reporting, record-keeping,
manufacturing and other requirements, were declared invalid by the United States
Supreme Court in March 2000. The Company has stated that while it continues to
oppose FDA regulation over cigarettes as "drugs" or "medical devices" under the
provisions of FDCA, it would be prepared to support new legislation that would
provide for reasonable regulation at the federal level of cigarettes as
cigarettes. Currently, there are several bills pending in Congress that if
enacted, would give the FDA authority to regulate tobacco products. The bills
take a variety of approaches to the issue of the FDA's proposed regulation of
tobacco products ranging from codification of the original FDA regulations under
the "drug" and "medical device" provisions of the FDCA to the creation of
provisions that would apply uniquely to tobacco products. All of the pending
legislation could result in substantial Federal regulation of the design,
manufacture and marketing of cigarettes. The ultimate outcome of the pending
bills cannot be predicted.
Ingredient Disclosure Laws: The Commonwealth of Massachusetts has enacted
legislation to require cigarette manufacturers to report yearly the flavorings
and other ingredients used in each brand style of cigarettes sold in the
Commonwealth, and on a qualified, by-brand basis to provide "nicotine-yield
ratings" for their products based on standards established by the Commonwealth.
Cigarette manufacturers sued to have the statute declared unconstitutional,
arguing that it could result in the public disclosure of valuable proprietary
information. In September 2000, the federal district court granted the
plaintiffs' motion for summary judgment and permanently enjoined the defendants
from requiring cigarette manufacturers to disclose brand specific information on
ingredients in their products. Defendants have appealed the district court's
ruling. The ultimate outcome of this lawsuit cannot be predicted. Similar
legislation has been enacted or proposed in other states. Some jurisdictions
outside the United States have also enacted or proposed some form of ingredient
disclosure legislation or regulation.
Health Effects of Smoking and Exposure to ETS: Reports with respect to the
health risks of cigarette smoking have been publicized for many years, and the
sale, promotion and use of cigarettes continue to be subject to increasing
governmental regulation. Since 1964, the Surgeon General of the United States
and the Secretary of Health and Human Services have released a number of reports
linking cigarette smoking with a broad range of health hazards, including
various types of cancer, coronary heart disease and chronic lung disease, and
recommending various governmental measures to reduce the incidence of smoking.
The 1988, 1990, 1992 and 1994 reports focus upon the addictive nature of
cigarettes, the effects of smoking cessation, the decrease in smoking in the
United States, the economic and regulatory
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<PAGE>
aspects of smoking in the Western Hemisphere, and cigarette smoking by
adolescents, particularly the addictive nature of cigarette smoking in
adolescence.
Studies with respect to the health risks of ETS to nonsmokers (including lung
cancer, respiratory and coronary illnesses, and other conditions) have also
received significant publicity. In 1986, the Surgeon General of the United
States and the National Academy of Sciences reported that nonsmokers were at
increased risk of lung cancer and respiratory illness due to ETS. In 1993, the
United States Environmental Protection Agency (the "EPA") issued a report
relating to certain health effects of ETS. The report included a risk assessment
relating to the association between ETS and lung cancer in nonsmokers, and a
determination by the EPA to classify ETS as a "Group A" carcinogen. In July
1998, a federal district court vacated those sections of the report relating to
lung cancer, finding that the EPA may have reached different conclusions had it
complied with certain relevant statutory requirements. The federal government
has appealed the court's ruling. The ultimate outcome of this litigation cannot
be predicted.
In 1999, PM Inc. and PMI established Web sites that included, among other
things, views of public authorities on smoking, disease causation in smokers and
addiction. In October 2000, the sites were updated to reflect PM Inc.'s and
PMI's agreement with the overwhelming medical and scientific consensus that
cigarette smoking is addictive, and causes lung cancer, heart disease, emphysema
and other serious diseases in smokers. The Web sites advise smokers and
potential smokers to rely on the messages of public health authorities in making
all smoking-related decisions. The sites further PM Inc.'s and PMI's efforts to
implement the Company's commitment to take steps to ensure that there will be a
single, consistent public health message on disease causation in smokers, and
smoking and addiction.
Other Legislative Initiatives: In recent years, various members of Congress have
introduced legislation, some of which has been the subject of hearings or floor
debate, that would subject cigarettes to various regulations under the
Department of Health and Human Services or regulation under the Consumer
Products Safety Act, establish anti-smoking educational campaigns or
anti-smoking programs, or provide additional funding for governmental
anti-smoking activities, further restrict the advertising of cigarettes,
including requiring additional warnings on packages and in advertising,
eliminate or reduce the tax deductibility of tobacco advertising, provide that
the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act
not be used as a defense against liability under state statutory or common law,
and allow state and local governments to restrict the sale and distribution of
cigarettes.
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<PAGE>
Legislative initiatives adverse to the tobacco industry have also been
considered in a number of jurisdictions outside the United States.
In August 2000, New York State enacted legislation that requires the State's
Office of Fire Prevention and Control to promulgate by January 1, 2003
fire-safety standards for cigarettes sold in New York. The legislation requires
that cigarettes sold in New York stop burning within a time period to be
specified by the standards or meet other performance standards set by the Office
of Fire Prevention and Control. All cigarettes sold in New York will be required
to meet the established standards within one hundred and eighty days after the
standards are promulgated. It is not possible to predict the impact of this law
on PM Inc. until the standards are issued. Similar legislation has been proposed
in other states and localities and at the federal level.
It is not possible to predict what, if any, additional foreign or domestic
governmental legislation or regulations will be adopted relating to the
manufacturing, advertising, sale or use of cigarettes, or to the tobacco
industry generally. However, if any or all of the foregoing were to be
implemented, the business, volume, results of operations, cash flows and
financial position of PM Inc., PMI and the Company could be materially adversely
affected.
Tobacco-Related Litigation: There is substantial litigation pending related to
tobacco products in the United States and certain foreign jurisdictions,
including the Engle class action case in Florida in which PM Inc. is a defendant
and a civil health care cost recovery action filed by the United States
Department of Justice in September 1999 against domestic tobacco manufacturers
and others, including the Company and PM Inc. (See Note 5. Contingencies, above,
for a discussion of such litigation.)
State Settlement Agreements: As discussed in Note 5. Contingencies, during 1997
and 1998, PM Inc. and other major domestic tobacco product manufacturers entered
into agreements with states and various U.S. jurisdictions settling asserted and
unasserted health care cost recovery and other claims. These settlements provide
for substantial annual payments. They also place numerous restrictions on the
tobacco industry's conduct of its business operations, including restrictions on
the advertising and marketing of cigarettes. Among these are restrictions or
prohibitions on the following: targeting youth; use of cartoon characters; use
of brand name sponsorships and brand name non-tobacco products; outdoor and
transit brand advertising; payments for product placement; and free sampling. In
addition, the settlement agreements require companies to affirm corporate
principles to reduce underage use of cigarettes; impose requirements regarding
lobbying activities; mandate public disclosure of certain industry documents;
limit the industry's ability to challenge certain tobacco control and underage
use laws; and provide for the dissolution of certain tobacco-related
organizations and place restrictions on the establishment of any replacement
organizations.
Operating Results
For the Nine Months Ended September 30,
----------------------------------------------
Operating
Operating Revenues Companies Income
-------------------- --------------------
(in millions)
2000 1999 2000 1999
------- ------- ------- -------
Domestic tobacco $16,987 $14,352 $ 3,849 $ 3,436
International tobacco 20,552 21,419 4,180 3,922
------- ------- ------- -------
Total tobacco $37,539 $35,771 $ 8,029 $ 7,358
======= ======= ======= =======
Domestic tobacco. During the first nine months of 2000, PM Inc.'s operating
revenues increased $2.6 billion (18.4%) over the comparable 1999 period, due
primarily to higher pricing ($2.2 billion, including amounts related to the
January 1, 2000 federal excise tax increase) and higher volume ($406 million).
-39-
<PAGE>
Operating companies income for the first nine months of 2000 increased $413
million (12.0%) over the comparable 1999 period, due primarily to price
increases, net of cost increases ($909 million), higher volume ($317 million)
and the 1999 pre-tax charges for the Louisville Closure ($183 million),
partially offset by higher marketing, administration and research costs ($976
million, primarily marketing). Excluding the impact of the 1999 pre-tax charges
for the Louisville Closure, PM Inc.'s operating companies income of $3,849
million for the first nine months of 2000 increased by 6.4% over the $3,619
million earned during the comparable 1999 period.
Shipment volume for the domestic tobacco industry during the first nine months
of 2000 increased to 317.0 billion units, a 0.7% increase over the first nine
months of 1999. PM Inc.'s shipment volume for the first nine months of 2000 was
160.5 billion units, an increase of 3.0% over the comparable 1999 period.
Shipment growth for the industry and PM Inc. during the first nine months of
2000 was largely driven by wholesalers' decisions to rebuild their inventory
levels after the January 1, 2000 federal excise tax increase. In contrast,
wholesalers decreased their inventory levels during 1999, as inventory held at
the end of 1999 was subject to the federal excise tax increase through a "floor
tax". PM Inc. estimates that after adjusting for this factor, industry shipment
volume declined approximately 1.0% to 2.0% from the first nine months of 1999,
while PM Inc.'s shipment volume was essentially flat.
For the first nine months of 2000, PM Inc.'s shipment market share was 50.6%, an
increase of 1.1 share points over the comparable period of 1999. Marlboro
shipment volume increased 5.6 billion units (4.9%) over the first nine months of
1999 to 119.6 billion units for a 37.7% share of the total industry, an increase
of 1.5 share points over the comparable period of 1999. Contributing to this
growth were introductory shipments of Marlboro Milds, which were launched
nationally at retail in May.
Based on shipments, the premium segment accounted for approximately 73.6% of the
domestic cigarette industry volume in the first nine months of 2000, an increase
of 0.2 share points over the comparable period of 1999. In the premium segment,
PM Inc.'s volume increased 3.2% during the first nine months of 2000, compared
with a 1.0% increase for the industry, resulting in a premium segment share of
60.6%, an increase of 1.3 share points over the first nine months of 1999.
In the discount segment, PM Inc.'s shipments increased 1.4% to 19.1 billion
units in the first nine months of 2000, compared with an industry decrease of
0.1%, resulting in a discount segment share of 22.8%, an increase of 0.3 share
points from the comparable period of 1999. Basic shipment volume for the first
nine months of 2000 was up 7.7% to 16.4 billion units, for a 19.6% share of the
discount segment, an increase of 1.5 share points from the comparable 1999
period. Basic shipment volume was influenced by the timing of promotional
shipments year-over-year.
According to consumer purchase data from Information Resources Inc./Capstone, PM
Inc.'s share of cigarettes sold at retail grew 0.5 share points to 50.6% for the
first nine months of 2000. The first nine months of 2000 retail share for
Marlboro rose 1.0 share points to 37.2%.
PM Inc. cannot predict future changes or rates of change in domestic tobacco
industry volume, the relative sizes of the premium and discount segments or in
PM Inc.'s shipments, shipment market share or retail market share; however, it
believes that PM Inc.'s shipments may be materially adversely affected by price
increases related to tobacco litigation settlements and, if enacted, by
increased excise taxes or other tobacco legislation discussed under "Tobacco--
Business Environment" above.
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<PAGE>
In July 2000, PM Inc. announced a price increase of $3.00 per thousand
cigarettes on its domestic premium and discount brands. This followed price
increases of $6.50 per thousand in January 2000 and $9.00 per thousand in August
1999. Each $1.00 per thousand increase by PM Inc. equates to a $0.02 increase in
the price to wholesalers of each pack of twenty cigarettes.
International tobacco. During the first nine months of 2000, international
tobacco operating revenues, including excise taxes, decreased $867 million
(4.0%) from the first nine months of 1999. Excluding excise taxes, operating
revenues decreased $215 million (2.0%), due primarily to unfavorable currency
movements ($534 million) and the previously discussed CDC revenues ($97
million), partially offset by price increases ($320 million) and favorable
volume/mix ($67 million).
Operating companies income for the first nine months of 2000 increased $258
million (6.6%) over the comparable 1999 period, due primarily to price increases
and favorable costs ($457 million) and the 1999 pre-tax charge for the Brazil
Factory Closure ($136 million), partially offset by unfavorable currency
movements ($234 million), the shift of CDC income ($59 million) to the fourth
quarter of 1999 and unfavorable volume/mix ($73 million). Adjusting for the
shift in CDC income and excluding the 1999 impact of the pre-tax charge for the
Brazil Factory Closure, operating companies income of $4,239 million for the
first nine months of 2000 increased 4.5% over $4,058 million for the comparable
period of 1999.
PMI's volume for the first nine months of 2000 of 520.1 billion units decreased
4.5 billion units (0.8%) from the first nine months of 1999. Adjusting for the
shift in CDC volume, (the basis of presentation for all following PMI volume
disclosures), PMI's volume of 524.3 billion units for the first nine months of
2000 decreased 0.3 billion units from the comparable 1999 period, due primarily
to lower volume in Central Europe, as well as by lower worldwide duty-free
shipments, which were affected by the July 1999 cessation of intra-EU duty-free
sales, partially offset by higher volume in Western and Eastern Europe, Asia and
Japan. Volume advanced in a number of important markets, including Italy,
France, Spain, the Benelux countries, Portugal, Greece, Russia, Ukraine,
Kazakhstan, Saudi Arabia, Egypt, Japan, Indonesia, Thailand, Korea, Malaysia
and Mexico. PMI recorded market share gains in many of its major markets. Volume
and share in Germany was adversely affected by intense competition, the growth
of trade brands and a reduction in the number of cigarettes per vending pack
following a fourth quarter 1999 industry price increase. A lower total industry
in Poland and trade purchasing patterns in the Czech Republic contributed to an
overall volume decline in Central Europe. In Turkey, lower volume and share
resulted from lower total industry volume following fourth quarter 1999 industry
price increases. Volume was lower in Australia due to lower total industry
volume and in Argentina due to the recessionary environment. International
volume for Marlboro increased 0.7%, as higher volumes in Japan, Italy, France,
Spain, Saudi Arabia, Russia, Ukraine, Thailand and Mexico were partially offset
by lower volumes in Poland, Czech Republic and certain Eastern European markets
and by lower worldwide duty-free shipments.
For the Three Months Ended September 30,
----------------------------------------------
Operating
Operating Revenues Companies Income
-------------------- --------------------
(in millions)
2000 1999 2000 1999
------- ------- ------- -------
Domestic tobacco $ 5,835 $ 5,157 $ 1,459 $ 1,367
International tobacco 6,753 7,153 1,439 1,239
------- ------- ------- -------
Total tobacco $12,588 $12,310 $ 2,898 $ 2,606
======= ======= ======= =======
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<PAGE>
Domestic tobacco. During the third quarter of 2000, PM Inc.'s operating revenues
increased $678 million (13.1%) over the comparable 1999 period, due primarily to
higher pricing ($739 million, including amounts related to the January 1, 2000
federal excise tax increase) partially offset by lower volume ($67 million).
Operating companies income for the third quarter of 2000 increased $92 million
(6.7%) from the comparable 1999 period, due primarily to price increases, net of
cost increases ($311 million), partially offset by lower volume ($52 million)
and higher marketing, administration and research costs ($208 million, primarily
marketing). Excluding the $8 million impact of the 1999 pre-tax charges for the
Louisville Closure, PM Inc.'s operating companies income of $1,459 million for
the third quarter of 2000 increased by 6.1% over the $1,375 million earned
during the comparable 1999 period.
Shipment volume for the domestic tobacco industry during the third quarter of
2000 declined to 107.3 billion units, a 3.5% decrease from the third quarter of
1999. PM Inc.'s shipment volume for the third quarter of 2000 was 54.0 billion
units, a decrease of 1.3% from the comparable 1999 period. The decline in the
third quarter 2000 shipment volume for the industry and PM Inc. can primarily be
attributed to one less shipping day in the quarter. PM Inc. estimates that after
adjusting for this factor, industry shipment volume declined approximately 1.0%
to 2.0% from the third quarter of 1999, while PM Inc.'s shipment volume was
essentially flat.
For the third quarter of 2000, PM Inc.'s shipment market share was 50.4%, an
increase of 1.1 share points over the comparable period of 1999. Marlboro
shipment volume increased 634 million units (1.6%) over the third quarter of
1999 to 40.3 billion units for a 37.6% share of the total industry, an increase
of 1.9 share points over the comparable period of 1999. Contributing to this
increase were introductory shipments of Marlboro Milds, which were launched
nationally at retail in May.
Based on shipments, the premium segment accounted for approximately 73.5% of
domestic cigarette industry volume in the third quarter of 2000, an increase of
0.4 share points over the comparable period of 1999. In the premium segment, PM
Inc.'s third-quarter volume decreased 0.6%, compared with a 3.0% decrease for
the industry, resulting in a premium segment share of 60.4%, an increase of 1.4
share points from the third quarter of 1999.
In the discount segment, PM Inc.'s third quarter shipments decreased 5.9% to 6.4
billion units in 2000, compared with a 4.8% decrease in shipments for the
industry, resulting in a discount segment share of 22.6%, a decrease of 0.3
share points from the comparable period of 1999. Basic third quarter shipment
volume increased slightly to 5.7 billion units, for a 20.0% share of the
discount segment, an increase of 1.0 share points from the comparable 1999
period. The increase in shipment volume and the growth in market share for Basic
were each influenced by the timing of promotional shipments in the third
quarters of 2000 and 1999.
According to consumer purchase data from Information Resources Inc./Capstone, PM
Inc.'s share of cigarettes sold at retail for the third quarter of 2000 was
50.2%, an increase of 0.3 share points over the third quarter of 1999. The third
quarter 2000 retail share for Marlboro rose 0.9 share points over the comparable
1999 period to 36.8%.
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<PAGE>
PM Inc. cannot predict future changes or rates of change in domestic tobacco
industry volume, the relative sizes of the premium and discount segments or in
PM Inc.'s shipments, shipment market share or retail market share; however, it
believes that PM Inc.'s shipments may be materially adversely affected by price
increases related to tobacco litigation settlements and, if enacted, by
increased excise taxes or other tobacco legislation discussed under
"Tobacco--Business Environment" above.
International tobacco. During the third quarter of 2000, international tobacco
operating revenues, including excise taxes, decreased $400 million (5.6%) from
the third quarter of 1999. Excluding excise taxes, operating revenues decreased
$70 million (1.9%) from the third quarter of 1999, due primarily to unfavorable
currency movements ($174 million), partially offset by price increases ($55
million) and favorable volume/mix ($45 million).
Operating companies income for the third quarter of 2000 increased $200 million
(16.1%) over the comparable 1999 period, due primarily to price increases and
favorable costs ($108 million), the 1999 pre-tax charge for the Brazil Factory
Closure ($136 million) and lower marketing, administration and research costs,
partially offset by unfavorable currency movements ($87 million).
PMI's volume of 176.4 billion units for the third quarter of 2000 increased 1.5
billion units (0.8%) over the third quarter of 1999. Improving economies in Asia
and Eastern Europe, primarily Russia, as well as volume and share growth in the
important markets of Italy, France and Spain in Western Europe contributed to
this growth. These volume gains were partially offset by lower volume in
Germany, Poland, Japan and Australia, as well as by lower worldwide duty-free
shipments. Volume advanced in a number of important markets including Italy,
France, Spain, Portugal, Greece, Russia, Ukraine, Kazakhstan, Saudi Arabia,
Egypt, Indonesia, Thailand, Korea, Malaysia and Mexico. PMI recorded market
share gains in many of its major markets. Volume and share in Germany continued
to be adversely affected by intense competition, the growth of trade brands and
a reduction in the number of cigarettes per vending pack following a fourth
quarter 1999 industry price increase as well as higher trade purchases in
September 1999 in advance of the price increase. In Poland, lower volume was due
to a lower total industry and trade purchasing patterns related to tax driven
price increases. Volume was lower in Japan due solely to the timing of
shipments. Volume was lower in Australia due to a lower total industry and in
Argentina due to the recessionary environment. International volume for Marlboro
grew 2.8%, driven by growth in Japan, Italy, France, Spain, Saudi Arabia,
Russia, Ukraine, Thailand, Hong Kong and Mexico, partly offset by lower volume
in Germany, Poland and certain Eastern European markets and by lower worldwide
duty-free shipments.
Food
Business Environment
Kraft, the largest processor and marketer of retail packaged food in the United
States, and its subsidiary, Kraft Foods International, Inc. ("KFI"), which
markets coffee, confectionery and cheese and grocery products in Europe, Latin
America and the Asia/Pacific region, are subject to fluctuating commodity costs,
currency movements and competitive challenges in various product categories and
markets, including a trend toward increasing consolidation in the retail trade.
To confront these challenges, Kraft and KFI continue to take steps to build the
value of premium brands with new product and marketing initiatives, to improve
their food business portfolios and to reduce costs.
-43-
<PAGE>
Fluctuations in commodity costs can cause retail price volatility, intensify
price competition and influence consumer and trade buying patterns. The North
American and international food businesses are subject to fluctuating commodity
costs, particularly in dairy, coffee bean and cocoa. Dairy commodity costs in
the United States on average have been below the levels seen during the first
nine months of 1999. Coffee and cocoa bean prices were also lower than the first
nine months of 1999.
During the first quarter of 2000, Kraft completed its purchase of the
outstanding common stock of Balance Bar Co., a maker of energy and nutrition
snack products. In a separate transaction, Kraft also completed its acquisition
of Boca Burger, Inc., a privately held manufacturer and marketer of soy-based
meat alternatives. The total cost of these acquisitions was $358 million.
Neither transaction is expected to have a material effect on 2000 operating
revenues or operating companies income of Kraft or the Company.
In June 2000, the Company entered into definitive agreements to acquire all of
the outstanding shares of Nabisco Holdings Corp. ("Nabisco") for $55 per share
in cash. The transaction reflects an aggregate cost of approximately $19.2
billion, which includes the assumption of approximately $4.0 billion in net
debt. The acquisition will be financed initially through a combination of
available cash balances and short-term debt. The transaction, which has been
approved by the shareholders of Nabisco Group Holdings and by the European
Commission, remains under review by United States anti-trust authorities. The
parties are working to close the transaction by year-end. The acquisition will
be accounted for as a purchase.
Subsequent to the acquisition, Kraft plans to undertake an initial public
offering ("IPO") of less than 20% of the combined food company. The IPO proceeds
will be used to retire a portion of the debt incurred as a result of the
acquisition of Nabisco.
During 2000 and 1999, KFI and Kraft sold several small international and
domestic food businesses. The aggregate proceeds received in these transactions
were $302 million in 2000 and $48 million in 1999. The Company recorded pre-tax
gains of $174 million in 2000 and $20 million in 1999. The operating results of
businesses divested were not material to consolidated operating results in any
of the periods presented.
During the third quarter of 2000, Kraft recalled taco shells, supplied to Kraft
under a manufacturing agreement with an unrelated food company, which were found
to contain genetically modified corn not intended for human consumption. The
costs related to the recall are not expected to be material to the operating
results of the North American food segment or the Company. Kraft cannot predict
the impact, if any, that negative publicity surrounding the recall will have on
future sales of its Mexican dinner products.
Operating Results
For the Nine Months Ended September 30,
----------------------------------------------
Operating
Operating Revenues Companies Income
-------------------- --------------------
(in millions)
2000 1999 2000 1999
------- ------- ------- -------
North American food $13,534 $13,193 $ 2,690 $ 2,404
International food 6,115 6,601 951 785
------- ------- ------- -------
Total food $19,649 $19,794 $ 3,641 $ 3,189
======= ======= ======= =======
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<PAGE>
North American food. During the first nine months of 2000, operating revenues
increased $341 million (2.6%) from the first nine months of 1999, due primarily
to higher volume ($228 million), higher pricing ($81 million) and the impact of
acquisitions ($113 million), partially offset by the shift in CDC revenues ($69
million) and unfavorable product mix ($40 million).
Operating companies income for the first nine months of 2000 increased $286
million (11.9%) from the comparable period of 1999, primarily reflecting
favorable margins ($355 million, driven by lower manufacturing and
commodity-related costs), the 1999 pre-tax charge for the Kraft Separation
Programs ($157 million), and higher volume ($156 million), partially offset by
higher marketing, administration and research costs ($292 million, the majority
of which related to higher marketing expenses), unfavorable product mix ($65
million) and the shift in CDC income ($26 million). Excluding the impact of the
pre-tax charges for the Kraft Separation Programs and adjusting for the shift in
CDC income, operating companies income of $2,716 million for the first nine
months of 2000 increased 6.1% over $2,561 million in the first nine months of
1999.
Volume for the first nine months of 2000 increased over the comparable 1999
period. Volume gains were achieved by beverages, from the strength of
ready-to-drink beverages; processed meats, from lunch combinations and the
first-quarter acquisition of Boca Burger; pizza, from new product introductions;
coffee, from the continued success of Starbucks grocery coffee; cheese, from
natural and cream cheese products; and desserts and snacks, due to shelf-stable
puddings, frozen toppings, confectionery and the first-quarter acquisition of
Balance Bar. Offsetting these volume gains were volume declines in enhancers,
due to barbecue sauces and seasoned coatings; meals, due to dinners, rice and
ethnic foods; and cereals, due primarily to a decline in the ready-to-eat cereal
category. In Canada, volume was up slightly due to gains in the retail grocery
business, driven by new products, mostly offset by a planned discontinuation of
low-margin foodservice products.
International food. Operating revenues for the first nine months of 2000
decreased $486 million (7.4%) from the first nine months of 1999, due primarily
to unfavorable currency movements ($514 million), lower pricing ($31 million,
due primarily to lower coffee prices) and the shift in CDC revenues ($28
million), partially offset by higher volume ($144 million).
Operating companies income for the first nine months of 2000 increased $166
million (21.1%) from the first nine months of 1999, due primarily to the gain on
the French Confectionery Sale ($139 million), higher volume ($88 million) and
favorable margins ($53 million, primarily related to lower commodity costs),
partially offset by unfavorable currency ($46 million), higher marketing,
administration and research costs ($43 million) and the shift in CDC income.
Excluding the gain on the French Confectionery Sale, the operating results of
the international food businesses divested since the beginning of 1999, and
adjusting for the shift in CDC revenues and income, operating revenues of $6,009
million in the first nine months of 2000 decreased 5.1% from $6,330 million in
1999, and operating companies income of $793 million for the first nine months
of 2000 increased 6.4% over $745 million for the comparable 1999 period.
Coffee volume for the first nine months of 2000 increased over the comparable
period of 1999, with volume growth in Sweden, Austria, Italy, Switzerland,
Poland, the Slovak Republic, Hungary, Lithuania and in the Away From Home
business. In the Asia/Pacific region, volume grew in China. This volume growth
was driven by new product launches and line extensions. In the roast and ground
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<PAGE>
category, KFI brands experienced share gains in France, while soluble coffee
brands gained share in the United Kingdom.
Confectionery volume for the first nine months of 2000 increased over the
comparable period of 1999. The volume growth was driven primarily by increases
in the Asia/Pacific region and most Western European markets. In China and
Indonesia, higher chewy candy sales contributed to the volume growth. New
product launches and line extensions also contributed to the confectionery
volume growth.
Volume for the first nine months of 2000 also increased in the cheese and
grocery business, driven by cream cheese in Italy and Iberia; lunch combinations
in the United Kingdom; new product introductions for powdered soft drinks in the
Czech Republic, Bulgaria and Thailand; and cheese and powdered soft drinks in
the Philippines. Also contributing to the volume gain were higher grocery
shipments to the Caribbean; increased cheese sales in Puerto Rico; and higher
ready-to-drink beverage volume in Mexico. Partially offsetting these increases
was lower powdered soft drink volume in Argentina, due to continued intense
price competition with carbonated beverages.
For the Three Months Ended September 30,
----------------------------------------------
Operating
Operating Revenues Companies Income
-------------------- --------------------
(in millions)
2000 1999 2000 1999
------- ------- ------- -------
North American food $4,276 $4,171 $ 827 $ 773
International food 1,939 2,155 416 264
------ ------ ------ ------
Total food $6,215 $6,326 $1,243 $1,037
====== ====== ====== ======
North American food. During the third quarter of 2000, operating revenues
increased $105 million (2.5%) over the third quarter of 1999, due primarily to
higher volume ($45 million) and the impact of acquisitions ($46 million).
Operating companies income for the third quarter of 2000 increased $54 million
(7.0%) over the third quarter of 1999, due primarily to favorable margins ($168
million, driven by lower manufacturing and commodity-related costs) and higher
volume ($34 million), partially offset by higher marketing, administration and
research costs ($112 million) and unfavorable mix ($28 million).
Volume for the third quarter of 2000 increased over the comparable 1999 period.
Volume gains were achieved by beverages, led by the continued success of
ready-to-drink beverages; frozen pizza, aided by new product introductions;
coffee, driven by the continued success of Starbucks grocery coffee; desserts
and snacks, led by growth in confectionery and shelf-stable puddings, and the
first-quarter acquisition of Balance Bar; processed meats, due to hot dogs,
luncheon meats and lunch combinations and the first-quarter acquisition of Boca
Burger; cheese, with gains in natural and cream cheese; and enhancers, where
gains in mayonnaise and pourable salad dressings were essentially offset by a
decline in barbecue sauce. Offsetting these volume increases were volume
declines in cereals, due primarily to a decline in the ready-to-eat cereal
category; and meals, due mainly to lower shipments of dinners, stuffing mix and
rice. In Canada, overall volume was up, driven by new product introductions in
frozen pizza, refrigerated ready-to-eat desserts and ready-to-drink beverages.
-46-
<PAGE>
International food. Operating revenues for the third quarter of 2000 decreased
$216 million (10.0%) from the third quarter of 1999, due primarily to
unfavorable currency movements ($171 million) and the impact of divestitures
($39 million).
Operating companies income for the third quarter of 2000 increased $152 million
(57.6%) from the third quarter of 1999, due primarily to the gain on the French
Confectionery Sale ($139 million), favorable margins, driven by lower
commodity-related costs, and higher volume/mix. Excluding the gain on the French
Confectionery Sale and the operating results of the international food
businesses divested since the beginning of 1999, operating revenues of $1,906
million in the third quarter of 2000 decreased 8.5% from $2,083 million in 1999,
and operating companies income of $265 million for the third quarter of 2000
increased 6.4% over $249 million for the comparable 1999 period.
KFI's third quarter 2000 coffee volume was below the comparable period of 1999,
due to the timing of promotions and increased price competition in several
Western European markets, primarily Germany. In Central and Eastern Europe,
double-digit coffee volume growth was driven by Poland, the Slovak Republic,
Lithuania, Ukraine and Turkey.
Confectionery volume for the third quarter of 2000 increased over the comparable
period of 1999, with gains in all regions and double-digit growth in several
developing markets. In Europe, volume increased in Germany, Iberia, Sweden,
Denmark, Finland, Poland, the Czech and Slovak Republics, Hungary, Lithuania and
Ukraine. In the Asia/Pacific region, double-digit volume growth was driven by
the continued success of chewy candy in Indonesia and China. Share growth was
registered for KFI's products in several markets, including pralines and
countlines in Germany; chocolate tablets in France and Norway; and chocolate
products in Sweden.
Volume for the third quarter of 2000 also increased in the cheese and grocery
business. Cream cheese volume grew, due to gains in Italy, Spain, Germany,
Australia, the Nordic region and in the Middle East and Africa region. Cream
cheese share also increased in several markets, including Italy, the United
Kingdom, Sweden and Japan. In powdered beverages, volume growth was driven by
double-digit gains in Southeast Asia, the recent introduction of a powdered soft
drink in the Czech Republic and Thailand and the launch of a new powdered soft
drink flavor in Turkey. Lunch combinations continued to grow in Europe, due to a
recently launched line extension in the United Kingdom. In salty snacks,
double-digit volume gains were driven by growth in the Nordic region and the
acquisition of a snacks company in Ukraine last year. In Latin America, higher
volume for the third quarter of 2000 was driven by ready-to-drink and powdered
beverages in Mexico, cheese in Puerto Rico and dinners and gelatin in the
Caribbean.
Beer
Business Environment
During the first quarter of 1999, Miller Brewing Company ("Miller") purchased
four trademarks from the Pabst Brewing Company ("Pabst") and the Stroh Brewery
Company ("Stroh"). Miller also agreed to increase its contract manufacturing of
Pabst products. Miller began brewing and shipping the newly acquired brands
during the second quarter of 1999. In the third quarter of 1999, Miller assumed
ownership of the former Pabst brewery in Tumwater, Washington as part of these
agreements.
-47-
<PAGE>
Miller's license agreement for the rights to brew and sell Lowenbrau in the
United States expired on September 30, 1999. The expiration of this agreement
did not have a material impact on Miller's operating revenues or operating
companies income for the first nine months and third quarter of 2000 and is not
expected to have a material impact on future operating revenues and operating
companies income.
During October 2000, Miller announced that it reached an agreement in principle
with Molson Canada and with Foster's Brewing Group Limited to strengthen its
commitment behind the Foster's brand in the United States, as well as an
agreement in principle to sell its rights to Molson trademarks in the United
States. The transactions are expected to close in the fourth quarter.
Operating Results
Nine Months Ended September 30
Miller's operating revenues for the first nine months of 2000 increased $88
million (2.6%) over the first nine months of 1999, due primarily to higher
pricing ($158 million) and the previously mentioned acquired brands and contract
manufacturing fees (aggregating $110 million), partially offset by lower volume
($180 million). Operating companies income for the first nine months of 2000
increased $37 million (8.1%) over the first nine months of 1999, due primarily
to higher pricing ($127 million) and income from acquired brands and contract
manufacturing, partially offset by lower volume ($106 million) and higher
marketing, administration and research costs.
Miller's domestic shipment volume of 33.0 million barrels for the first nine
months of 2000 decreased 2.0% from the comparable 1999 period, reflecting higher
pricing and Miller's continuing efforts to reduce distributor inventories.
Excluding discontinued brands, total domestic shipment volume was down 1.0%.
Domestic shipments of premium/near premium brands were above the comparable 1999
period, due primarily to the shipments of acquired brands. Domestic shipments of
below-premium products decreased on lower shipments across most brands.
Wholesalers' sales to retailers in the first nine months of 2000 decreased 1.6%
from the comparable 1999 period. Excluding the acquired brands, wholesalers'
sales to retailers in the first nine months of 2000 decreased 3.5% from the
first nine months of 1999, reflecting lower retail sales of Miller Genuine
Draft, Milwaukee's Best, Molson and Red Dog, as well as the discontinuance of
Lowenbrau, partially offset by increased sales of Miller Lite.
Three Months Ended September 30
Miller's operating revenues for the third quarter of 2000 decreased $4 million
(0.3%) from the third quarter of 1999, due primarily to lower volume ($98
million), essentially offset by higher pricing ($91 million). Operating
companies income for the third quarter of 2000 increased $5 million (3.6%) over
the third quarter of 1999, due primarily to higher pricing essentially offset by
lower volume.
Miller's domestic shipment volume of 10.9 million barrels for the third quarter
of 2000 decreased 4.8% from the comparable 1999 period, reflecting higher
pricing and Miller's continuing efforts to reduce distributor inventories.
Excluding discontinued brands, total domestic shipment volume was down 4.0%.
Domestic shipments of premium/near-premium products decreased from the prior
year due mainly to Miller Genuine Draft, Miller High Life and Icehouse, while
below-premium products decreased on lower shipments across most brands.
Wholesalers' sales to retailers in the third quarter of
-48-
<PAGE>
2000 decreased 6.3% from the comparable 1999 period, reflecting lower retail
sales of Miller Genuine Draft, Milwaukee's Best, Miller Lite, Red Dog and
Molson, as well as the discontinuance of Lowenbrau.
Financial Services
Philip Morris Capital Corporation's ("PMCC") financial services operating
revenues and operating companies income for the first nine months of 2000
increased $46 million (17.8%) and $25 million (14.9%), respectively, over the
comparable 1999 period. During the third quarter of 2000, operating revenues and
operating companies income increased $17 million (19.1%) and $8 million (13.8%),
respectively, over the third quarter of 1999. These increases were due primarily
to new leasing and structured finance investments and gains realized on related
portfolio management activities.
Financial Review
Net Cash Provided by Operating Activities
During the first nine months of 2000, net cash provided by operating activities
was $9.1 billion compared with $9.2 billion in the comparable 1999 period.
Net Cash Used in Investing Activities
During the first nine months of 2000, net cash used in investing activities was
$1.7 billion, down from $2.2 billion in 1999. The decrease primarily reflects
the proceeds received from the French Confectionery Sale.
In June 2000, the Company announced that it entered into definitive agreements
to acquire all of the outstanding shares of Nabisco. The pending transaction has
an aggregate cost of approximately $19.2 billion, including the assumption of
approximately $4.0 billion in net debt. The parties are working to close the
transaction by year-end.
Net Cash Used in Financing Activities
During the first nine months of 2000, net cash of $7.4 billion was used in
financing activities, as compared with $5.1 billion used in financing activities
during the comparable 1999 period. This difference was primarily due to net debt
repayments of $1.3 billion for the first nine months of 2000, compared with net
proceeds from the issuance of debt ($276 million) in 1999. Higher stock
repurchases and dividends paid during the first nine months of 2000 also
contributed to the increase. The Company intends to finance the purchase price
of the outstanding shares of Nabisco initially with available cash and
short-term debt.
Debt and Liquidity
The Company's total debt (consumer products and financial services) was $13.0
billion and $14.5 billion at September 30, 2000 and December 31, 1999,
respectively. Total consumer products debt was $11.3 billion and $13.5 billion
at September 30, 2000 and December 31, 1999, respectively. At September 30, 2000
and December 31, 1999, the Company's ratio of consumer products debt to total
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equity was 0.76 and 0.88, respectively. The ratio of total debt to total equity
was 0.87 and 0.95 at September 30, 2000 and December 31, 1999, respectively.
The Company and its subsidiaries maintain credit facilities with a number of
lending institutions, amounting to approximately $19.1 billion, including a $9.0
billion, 364-day revolving credit facility, entered into in October 2000,
obtained in connection with the pending acquisition of Nabisco. These credit
facilities also include a revolving bank credit agreement for $8.0 billion,
which may be used to support commercial paper borrowings by the Company and
which is available for acquisitions and other general corporate purposes. This
revolving bank agreement expires in October 2002 and enables the Company to
reclassify short-term debt on a long-term basis. The Company may continue to
refinance long-term and short-term debt from time to time. The nature and amount
of the Company's long-term and short-term debt and the proportionate amount of
each can be expected to vary as a result of future business requirements, market
conditions and other factors.
The Company's credit ratings by Moody's at September 30, 2000 and December 31,
1999 were "P-1" in the commercial paper market and "A2" for long-term debt
obligations. The Company's credit ratings by Standard & Poor's ("S&P") at
September 30, 2000 and December 31, 1999 were "A-1" in the commercial paper
market and "A" for long-term debt obligations.
As discussed in Note 5, PM Inc., along with other domestic tobacco companies,
has entered into tobacco litigation settlement agreements that require the
domestic tobacco industry to make substantial annual payments in the following
amounts (excluding future annual payments contemplated by the agreement with
tobacco growers discussed below), subject to adjustment for several factors,
including inflation, market share and industry volume: 2000, $9.2 billion; 2001,
$9.9 billion; 2002, $11.3 billion; 2003, $10.9 billion; 2004 through 2007, $8.4
billion each year; and thereafter, $9.4 billion each year. 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: 2000, $416 million; and 2001 through 2003, $250 million each year.
These payment obligations are the several and not joint obligations of each
settling defendant. PM Inc.'s portion of ongoing adjusted payments and legal
fees is based on its share of domestic cigarette shipments in the year preceding
that in which the payment is due. Accordingly, PM Inc. records its portions of
ongoing settlement payments as part of cost of sales as product is shipped.
As part of the MSA, the settling defendants committed to work cooperatively with
the tobacco-growing states to address concerns about the potential adverse
economic impact of the MSA on tobacco growers and quota-holders. To that end,
four of the major domestic tobacco product manufacturers, including PM Inc., and
the grower states, have established a trust fund to provide aid to tobacco
growers and quota-holders. The trust will be funded by these four manufacturers
over 12 years with payments, prior to application of various adjustments,
scheduled to total $5.15 billion. Future industry payments (in 2000, $280
million; 2001, $400 million; 2002 through 2008, $500 million each year; 2009 and
2010, $295 million each year) are subject to adjustment for several factors,
including inflation, United States cigarette volume and certain other contingent
events, and, in general, are to be allocated based on each manufacturer's
relative market share. PM Inc. records its portion of these payments as part of
cost of sales as product is shipped.
As discussed above under "Tobacco--Business Environment," the present
legislative and litigation environment is substantially uncertain and could
result in material adverse consequences for the business, financial condition,
cash flows or results of operations of the Company, PM Inc. and PMI.
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Equity and Dividends
During the first nine months of 2000 and 1999, the Company repurchased 113.3
million and 56.6 million shares, respectively, of its common stock at a cost of
$2.7 billion and $2.2 billion, respectively. The repurchases were made under an
existing $8 billion authority that expires in November 2001. At September 30,
2000, cumulative repurchases under the $8 billion authority totaled 217.7
million shares at an aggregate cost of $6.4 billion.
Dividends paid in the first nine months of 2000 and 1999 were $3.3 billion and
$3.2 billion, respectively. During the third quarter of 2000, the Company's
Board of Directors approved a 10.4% increase in the current quarterly dividend
rate to $0.53 per share. As a result, the present annualized dividend rate is
$2.12 per share.
Cash and Cash Equivalents
Cash and cash equivalents were $4.8 billion at September 30, 2000 and $5.1
billion at December 31, 1999.
Market Risk
The Company is exposed to market risk, primarily related to foreign exchange,
commodity prices and interest rates. These exposures are actively monitored by
management. To manage the volatility relating to these exposures, the Company
enters into a variety of derivative financial instruments. The Company's
objective is to reduce, where it is deemed appropriate to do so, fluctuations in
earnings and cash flows associated with changes in interest rates, foreign
currency rates and commodity prices. It is the Company's policy and practice to
use derivative financial instruments only to the extent necessary to manage
exposures. Since the Company uses currency rate-sensitive and commodity
price-sensitive instruments to hedge a certain portion of its existing and
anticipated transactions, the Company expects that any loss in value for the
hedge instruments generally would be offset by increases in the value of the
underlying transactions. The Company does not hold or issue derivative financial
instruments for trading or speculative purposes.
Foreign exchange rates. The Company is exposed to foreign exchange movements,
primarily in European, Japanese and other Asian and Latin American currencies.
Consequently, it enters into various contracts, which change in value as foreign
exchange rates fluctuate, to preserve the value of commitments and anticipated
transactions. The Company uses foreign currency option and forward contracts to
hedge certain anticipated foreign currency cash flows. The Company also enters
into short-term foreign currency swap contracts, primarily to hedge intercompany
transactions denominated in foreign currencies. At September 30, 2000 and
December 31, 1999, the Company had option and forward foreign exchange
contracts, principally for the Japanese yen, British pound, Swiss franc and the
Euro, with aggregate notional amounts of $4.5 billion and $3.8 billion,
respectively, for both the purchase and/or sale of foreign currencies.
The Company also seeks to protect its foreign currency net asset exposure,
primarily the Swiss franc and the Euro, through the use of foreign-currency
denominated debt or currency swap agreements. At
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September 30, 2000 and December 31, 1999, the notional amounts of currency swap
agreements aggregated $2.1 billion and $2.6 billion, respectively.
Commodities. The Company is exposed to price risk related to anticipated
purchases of certain commodities used as raw materials by the Company's food
businesses. Accordingly, the Company enters into commodity future, forward and
option contracts to manage fluctuations in prices of anticipated purchases,
primarily cheese, coffee, cocoa, milk, sugar, wheat and corn. At September 30,
2000 and December 31, 1999, the Company had net long commodity positions of $406
million and $163 million, respectively. Unrealized gains/losses on net commodity
positions were immaterial at September 30, 2000 and December 31, 1999.
Interest rates. The Company manages its exposure to interest rate risk through
the proportion of fixed rate debt and variable rate debt in its total debt
portfolio. To manage this mix, the Company may enter into interest rate swap
agreements, in which it exchanges the periodic payments, based on a notional
amount and agreed-upon fixed and variable interest rates. At December 31, 1999,
the Company had an interest rate swap agreement, which converted $800 million of
fixed rate debt to variable rate debt, and which matured during the first
quarter of 2000.
Use of the above-mentioned derivative financial instruments has not had a
material impact on the Company's financial position at September 30, 2000 and
December 31, 1999, or the Company's results of operations for the three and nine
months ended September 30, 2000 or the year ended December 31, 1999.
New Accounting Standards
During 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which had an initial adoption date by the
Company of January 1, 2000. During 1999, the FASB postponed the adoption date of
SFAS No. 133 until January 1, 2001. 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. Since the impact of SFAS No. 133
is dependent on future market rates and outstanding derivative positions at
January 1, 2001, the Company cannot yet determine the impact that adoption or
subsequent application of SFAS No. 133 will have on its financial position or
results of operations.
During 2000, a number of accounting and financial reporting pronouncements
relating to the recognition, measurement and classification of revenues, various
sales incentives and shipping and handling costs were issued. These
pronouncements will be effective for the fourth quarter of 2000. The Company has
determined that adoption or subsequent application of these pronouncements will
not have a material effect on its financial position or results of operations.
Upon adoption, prior period amounts will be reclassified to conform with the new
pronouncements.
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Contingencies
See Note 5 to the Condensed Consolidated Financial Statements for a discussion
of contingencies.
Forward-Looking and Cautionary Statements
The Company and its representatives may from time to time make written or oral
forward-looking statements, including statements contained in the Company's
filings with the Securities and Exchange Commission and in its reports to
stockholders. One can identify these forward-looking statements by use of words
such as "expects," "plans," "believes," "will," "estimates," "intends,"
"projects," "goals" and other words of similar meaning. One can also identify
them by the fact that they do not relate strictly to historical or current
facts. In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby identifying important
factors that could cause actual results and outcomes to differ materially from
those contained in any forward-looking statement made by or on behalf of the
Company; any such statement is qualified by reference to the following
cautionary statements.
The tobacco industry continues to be subject to health concerns relating to the
use of tobacco products and exposure to ETS, legislation, including actual and
potential excise tax increases, increasing marketing and regulatory
restrictions, governmental regulation, privately imposed smoking restrictions,
governmental and grand jury investigations, litigation, including risks
associated with adverse jury and judicial determinations, courts reaching
conclusions at variance with the Company's understanding of applicable law,
bonding requirements and the absence of adequate appellate remedies to get
timely relief from any of the foregoing, and the effects of price increases
related to concluded tobacco litigation settlements and excise tax increases on
consumption rates. Each of the Company's consumer products subsidiaries is
subject to intense competition, changes in consumer preferences, the effects of
changing prices for its raw materials and local economic conditions. Their
results are dependent upon their continued ability to promote brand equity
successfully, to anticipate and respond to new consumer trends, to develop new
products and markets and to broaden brand portfolios, in order to compete
effectively with lower priced products in a consolidating environment at the
retail and manufacturing levels, and to improve productivity. In addition, PMI,
KFI and Kraft are subject to the effects of foreign economies and the related
shifts in consumer preferences, and currency movements. Developments in any of
these areas, which are more fully described above and which descriptions are
incorporated into this section by reference, could cause the Company's results
to differ materially from results that have been or may be projected by or on
behalf of the Company. The Company cautions that the foregoing list of important
factors is not exclusive. The Company does not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
the Company.
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Part II - OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 5. Contingencies, of the Notes to the Condensed Consolidated
Financial Statements included in Part I, Item 1 of this report for a discussion
of legal proceedings pending against the Company and its subsidiaries. See also
Exhibits 99.1, 99.2 and 99.3 to this report.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
12 Statement regarding computation of ratios of earnings to fixed
charges.
27 Financial Data Schedule.
99.1 Certain Pending Litigation Matters and Recent Developments.
99.2 Status of Master Settlement Agreement.
99.3 Trial Schedule for Certain Cases.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
quarter ended September 30, 2000.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
/s/ LOUIS C. CAMILLERI
Louis C. Camilleri, Senior Vice President and
Chief Financial Officer
November 13, 2000
