SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) January 26, 2000
----------------
PHILIP MORRIS COMPANIES INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 1-8940 13-3260245
- --------------------------------------------------------------------------------
(State or other (Commission (IRS Employer
jurisdiction File Number) Identification No.)
of incorporation)
120 Park Avenue, New York, New York 10017-5592
- --------------------------------------------------------------------------------
(Address of principal
executive offices) (Zip Code)
Registrant's telephone number, including area code (917) 663-5000
--------------
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
Item 5. Other Events.
Filed as part of this Current Report on Form 8-K are the
consolidated balance sheets of Philip Morris Companies Inc. and subsidiaries
(the "Company") as of December 31, 1999 and 1998, and the related consolidated
statements of earnings, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999 (the "Financial Statements"),
the independent accountants' report thereon and the statement regarding
computation of ratios of earnings to fixed charges. The Financial Statements,
the independent accountants' report and the statement regarding computation of
ratios of earnings to fixed charges will be incorporated by reference in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
Item 7. Financial Statements and Exhibits.
The Financial Statements, together with the independent accountants'
report thereon, are included herein.
(c) Exhibits
12. Statement regarding computation of ratios of earnings to fixed
charges.
23. Consent of independent accountants.
27. Financial Data Schedule.
99. Financial Statements.
2
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
BY /s/ LOUIS C. CAMILLERI
Senior Vice President and
Chief Financial Officer
DATE January 26, 2000
3
<PAGE>
EXHIBIT INDEX
Exhibit No.
- -----------
12. Statement regarding computation of ratios of earnings to fixed charges.
23. Consent of independent accountants.
27. Financial Data Schedule.
99. Financial Statements.
EXHIBIT 12
PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(dollars in millions)
-------------------
Years Ended December 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Earnings before
income taxes and
cumulative effect
of accounting changes $ 12,695 $ 9,087 $ 10,611 $ 10,683 $ 9,347
Add (Deduct):
Equity in net earnings of
less than 50% owned
affiliates (197) (195) (207) (227) (246)
Dividends from less than
50% owned affiliates 56 70 138 160 202
Fixed charges 1,363 1,386 1,438 1,421 1,495
Interest capitalized, net
of amortization (2) (5) (16) 13 2
-------- -------- -------- -------- --------
Earnings available for
fixed charges $ 13,915 $ 10,343 $ 11,964 $ 12,050 $ 10,800
======== ======== ======== ======== ========
Fixed charges:
Interest incurred:
Consumer products $ 1,118 $ 1,166 $ 1,224 $ 1,197 $ 1,281
Financial services and
real estate 89 77 67 81 84
-------- -------- -------- -------- --------
$ 1,207 $ 1,243 $ 1,291 $ 1,278 $ 1,365
Portion of rent expense
deemed to represent
interest factor 156 143 147 143 130
-------- -------- -------- -------- --------
Fixed charges $ 1,363 $ 1,386 $ 1,438 $ 1,421 $ 1,495
======== ======== ======== ======== ========
Ratio of earnings to
fixed charges 10.2 7.5 8.3 8.5 7.2
======== ======== ======== ======== ========
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in Post-Effective Amendment No. 13
to the registration statement of Philip Morris Companies Inc. (the "Company") on
Form S-14 (File No. 2-96149) and in the Company's registration statements on
Form S-3 (File No. 333-35143) and Form S-8 (File Nos. 333-28631, 333-20747,
333-16127, 33-1479, 33-1480, 33-10218, 33-13210, 33-14561, 33-17870, 33-37115,
33-38781, 33-39162, 33-40110, 33-48781, 33-59109, 33-63975 and 33-63977), of our
report dated January 24, 2000 (included herein), on our audits of the
consolidated financial statements of the Company, which is included in this
Current Report on Form 8-K dated January 26, 2000, as indicated in Item 7
herein.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
January 26, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Pages 2-3 of
the Company's consolidated financial statements for the year ended December 31,
1999 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 5,100
<SECURITIES> 0
<RECEIVABLES> 4,477
<ALLOWANCES> 164
<INVENTORY> 9,028
<CURRENT-ASSETS> 20,895
<PP&E> 21,599
<DEPRECIATION> 9,328
<TOTAL-ASSETS> 61,381
<CURRENT-LIABILITIES> 18,017
<BONDS> 12,226
0
0
<COMMON> 935
<OTHER-SE> 14,370
<TOTAL-LIABILITY-AND-EQUITY> 61,381
<SALES> 78,596
<TOTAL-REVENUES> 78,596
<CGS> 29,561
<TOTAL-COSTS> 46,406
<OTHER-EXPENSES> 18,700
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 795
<INCOME-PRETAX> 12,695
<INCOME-TAX> 5,020
<INCOME-CONTINUING> 7,675
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,675
<EPS-BASIC> 3.21
<EPS-DILUTED> 3.19
</TABLE>
EXHIBIT 99
PHILIP MORRIS COMPANIES INC.
and SUBSIDIARIES
Consolidated Financial Statements as of
December 31, 1999 and 1998 and for Each of the
Three Years in the Period Ended December 31, 1999
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Philip Morris Companies Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, stockholders' equity and cash flows present
fairly, in all material respects, the consolidated financial position of Philip
Morris Companies Inc. and its subsidiaries at December 31, 1999 and 1998, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
January 24, 2000
<PAGE>
PHILIP MORRIS COMPANIES INC.
and Subsidiaries
CONSOLIDATED BALANCE SHEETS, at December 31,
(in millions of dollars, except per share data)
----------
1999 1998
---- ----
ASSETS
Consumer products
Cash and cash equivalents $ 5,100 $ 4,081
Receivables, net 4,313 4,691
Inventories:
Leaf tobacco 4,294 4,729
Other raw materials 1,794 1,728
Finished product 2,940 2,988
-------- --------
9,028 9,445
Other current assets 2,454 2,013
-------- --------
Total current assets 20,895 20,230
Property, plant and equipment, at cost:
Land and land improvements 633 655
Buildings and building equipment 5,436 5,386
Machinery and equipment 14,268 13,771
Construction in progress 1,262 1,422
-------- --------
21,599 21,234
Less accumulated depreciation 9,328 8,899
-------- --------
12,271 12,335
Goodwill and other intangible assets
(less accumulated amortization of
$5,840 and $5,436) 16,879 17,566
Other assets 3,625 3,309
-------- --------
Total consumer products assets 53,670 53,440
Financial services
Finance assets, net 7,527 6,324
Other assets 184 156
-------- --------
Total financial services assets 7,711 6,480
-------- --------
TOTAL ASSETS $ 61,381 $ 59,920
======== ========
LIABILITIES
Consumer products
Short-term borrowings $ 641 $ 225
Current portion of long-term debt 1,601 1,822
Accounts payable 3,351 3,359
Accrued liabilities:
Marketing 2,756 2,637
Taxes, except income taxes 1,519 1,408
Employment costs 972 968
Settlement charges 2,320 1,135
Other 2,605 2,608
Income taxes 1,124 1,144
Dividends payable 1,128 1,073
-------- --------
Total current liabilities 18,017 16,379
Long-term debt 11,280 11,906
Deferred income taxes 1,214 929
Accrued postretirement health care costs 2,606 2,543
Other liabilities 6,853 7,019
-------- --------
Total consumer products liabilities 39,970 38,776
Financial services
Long-term debt 946 709
Deferred income taxes 4,466 4,151
Other liabilities 694 87
-------- --------
Total financial services liabilities 6,106 4,947
-------- --------
Total liabilities 46,076 43,723
-------- --------
Contingencies (Note 15)
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 29,556 26,261
Accumulated other comprehensive earnings
(including currency translation of $2,056
and $1,081) (2,108) (1,106)
Cost of repurchased stock
(467,441,576 and 375,426,742 shares) (13,078) (9,893)
-------- --------
Total stockholders' equity 15,305 16,197
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 61,381 $ 59,920
======== ========
See notes to consolidated financial statements.
2
<PAGE>
CONSOLIDATED STATEMENTS of EARNINGS
for the years ended December 31,
(in millions of dollars, except per share data)
----------
1999 1998 1997
---- ---- ----
Operating revenues $78,596 $74,391 $72,055
Cost of sales 29,561 26,820 26,689
Excise taxes on products 16,845 16,578 15,941
------- ------- -------
Gross profit 32,190 30,993 29,425
Marketing, administration and research costs 18,118 17,051 15,720
Settlement charges (Note 15) 3,381 1,457
Amortization of goodwill 582 584 585
------- ------- -------
Operating income 13,490 9,977 11,663
Interest and other debt expense, net 795 890 1,052
------- ------- -------
Earnings before income taxes 12,695 9,087 10,611
Provision for income taxes 5,020 3,715 4,301
------- ------- -------
Net earnings $ 7,675 $ 5,372 $ 6,310
======= ======= =======
Per share data:
Basic earnings per share $ 3.21 $ 2.21 $ 2.61
======= ======= =======
Diluted earnings per share $ 3.19 $ 2.20 $ 2.58
======= ======= =======
See notes to consolidated financial statements.
3
<PAGE>
CONSOLIDATED STATEMENTS of STOCKHOLDERS' EQUITY
(in millions of dollars, except per share data)
----------
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Earnings (Losses)
-------------------------------
Earnings
Reinvested Currency Cost of Total
Common in the Translation Repurchased Stockholders'
Stock Business Adjustments Other Total Stock Equity
------ ---------- ----------- ------ ------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1997 $ 935 $ 22,480 $ 192 $ (2) $ 190 $ (9,387) $ 14,218
Comprehensive earnings:
Net earnings 6,310 6,310
Other comprehensive losses, net of income taxes:
Currency translation adjustments (1,301) (1,301) (1,301)
Net unrealized appreciation on securities 2 2 2
--------
Total other comprehensive losses (1,299)
--------
Total comprehensive earnings 5,011
--------
Exercise of stock options and issuance of other
stock awards 14 300 314
Cash dividends declared ($1.60 per share) (3,880) (3,880)
Stock repurchased (743) (743)
------ -------- -------- ------ -------- --------- --------
Balances, December 31, 1997 935 24,924 (1,109) (1,109) (9,830) 14,920
Comprehensive earnings:
Net earnings 5,372 5,372
Other comprehensive earnings, net of income taxes:
Currency translation adjustments 28 28 28
Additional minimum pension liability (25) (25) (25)
--------
Total other comprehensive earnings 3
--------
Total comprehensive earnings 5,375
--------
Exercise of stock options and issuance of other
stock awards 50 287 337
Cash dividends declared ($1.68 per share) (4,085) (4,085)
Stock repurchased (350) (350)
------ -------- -------- ------ -------- --------- --------
Balances, December 31, 1998 935 26,261 (1,081) (25) (1,106) (9,893) 16,197
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
====== ======== ======== ====== ======== ========= ========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
CONSOLIDATED STATEMENTS of CASH FLOWS
for the years ended December 31,
(in millions of dollars)
----------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 7,534 $5,255 $ 6,152
- Financial services 141 117 158
------- ------ -------
Net earnings 7,675 5,372 6,310
Adjustments to reconcile net earnings to operating cash flows:
Consumer products
Depreciation and amortization 1,702 1,690 1,629
Deferred income tax (benefit) provision (156) 11 (188)
Gain on sale of Brazilian ice cream businesses (774)
Gains on sales of other businesses (62) (196)
Cash effects of changes, net of the effects from acquired and
divested companies:
Receivables, net 95 (352) (168)
Inventories (39) (192) (531)
Accounts payable 122 (150) 37
Income taxes 401 565 48
Accrued liabilities and other current assets 1,343 254 1,356
Other (17) 671 653
Financial services
Deferred income tax provision 300 265 257
Gain on sale of a business (103)
Other 11 (14) 10
------- ------ -------
Net cash provided by operating activities 11,375 8,120 8,340
------- ------ -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures (1,749) (1,804) (1,874)
Purchase of businesses, net of acquired cash (522) (17) (630)
Proceeds from sales of businesses 175 16 1,784
Other 37 (154) 42
Financial services
Investments in finance assets (682) (736) (652)
Proceeds from finance assets 59 141 287
Proceeds from sale of a business 424
------- ------ -------
Net cash used in investing activities (2,682) (2,554) (619)
------- ------ -------
</TABLE>
See notes to consolidated financial statements.
Continued
5
<PAGE>
CONSOLIDATED STATEMENTS of CASH FLOWS (Continued)
for the years ended December 31,
(in millions of dollars)
----------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net issuance (repayment) of short-term borrowings $ 435 $ 61 $(1,482)
Long-term debt proceeds 1,339 2,065 2,893
Long-term debt repaid (1,843) (1,616) (1,987)
Financial services
Net repayment of short-term borrowings (173)
Long-term debt proceeds 500 174
Long-term debt repaid (200) (178) (387)
Repurchase of common stock (3,329) (307) (805)
Dividends paid (4,338) (3,984) (3,885)
Issuance of common stock 74 265 205
Other (135) (200) (74)
------- ------- -------
Net cash used in financing activities (7,497) (3,894) (5,521)
------- ------- -------
Effect of exchange rate changes on cash and cash equivalents (177) 127 (158)
------- ------- -------
Cash and cash equivalents:
Increase 1,019 1,799 2,042
Balance at beginning of year 4,081 2,282 240
------- ------- -------
Balance at end of year $ 5,100 $ 4,081 $ 2,282
======= ======= =======
Cash paid: Interest - Consumer products $ 1,086 $ 1,141 $ 1,219
======= ======= =======
- Financial services $ 75 $ 79 $ 79
======= ======= =======
Income taxes $ 4,308 $ 2,644 $ 3,794
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 1. Summary of Significant Accounting Policies:
Basis of presentation:
The consolidated financial statements include all significant
subsidiaries. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the dates of the financial
statements and the reported amounts of operating revenues and
expenses during the reporting periods. Actual results could differ
from those estimates.
Balance sheet accounts are segregated by two broad types of
business. Consumer products assets and liabilities are classified as
either current or non-current, whereas financial services assets and
liabilities are unclassified, in accordance with respective industry
practices.
Certain prior years' amounts have been reclassified to conform with
the current year's presentation.
Cash and cash equivalents:
Cash equivalents include demand deposits with banks and all highly
liquid investments with original maturities of three months or less.
Inventories:
Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method is used to cost substantially all domestic
inventories. The cost of other inventories is determined by the
average cost or first-in, first-out methods. It is a generally
recognized industry practice to classify leaf tobacco inventory as a
current asset although part of such inventory, because of the
duration of the aging process, ordinarily would not be utilized
within one year.
Impairment of long-lived assets:
The Company reviews long-lived assets for impairment whenever events
or changes in business circumstances indicate that the carrying
amount of the assets may not be fully recoverable. The Company
performs undiscounted cash flow analyses to determine if an
impairment exists. If an impairment is determined to exist, any
related impairment loss is calculated based on fair value.
Impairment losses on assets to be disposed of, if any, are based on
the estimated proceeds to be received, less costs of disposal.
Depreciation, amortization and goodwill valuation:
Depreciation is recorded by the straight-line method. Goodwill and
other intangible assets substantially comprise brand names purchased
through acquisitions, which are amortized on the straight-line
method over 40 years. The Company periodically evaluates the
recoverability of its intangible assets and measures any impairment
by comparison with estimated undiscounted cash flows from future
operations.
Advertising costs:
Advertising costs are expensed as incurred.
Revenue recognition:
The Company's consumer products businesses recognize operating
revenues upon shipment of goods to customers. For the Company's
financial services operation, income attributable to
7
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
leveraged leases is initially recorded as unearned income and
subsequently recognized as finance lease revenue over the terms of
the respective leases at a constant after-tax rate of return on the
positive net investment. The income attributable to direct finance
leases is initially recorded as unearned income and subsequently
recognized as finance lease revenue over the terms of the respective
leases at a constant pre-tax rate of return on the net investment.
Hedging instruments:
The Company utilizes certain financial instruments to manage its
foreign currency, commodity and interest rate exposures. The Company
does not engage in trading or other speculative use of these
financial instruments. To qualify as a hedge, the Company must be
exposed to price, currency or interest rate risk and the financial
instrument must reduce the exposure and be designated as a hedge.
Additionally, for hedges of anticipated transactions, the
significant characteristics and expected terms of the anticipated
transaction must be identified and it must be probable that the
anticipated transaction will occur. Financial instruments qualifying
for hedge accounting must maintain a high correlation between the
hedging instrument and the item being hedged, both at inception and
throughout the hedged period.
The Company uses forward contracts, options and swap agreements to
mitigate its foreign currency exposure. The corresponding gains and
losses on those contracts are deferred and included in the basis of
the underlying hedged transactions when settled. Options are used to
hedge anticipated transactions. Option premiums are recorded
generally as other current assets on the consolidated balance sheets
and amortized to interest and other debt expense, net, over the
lives of the related options. The intrinsic values of options are
recognized as adjustments to the related hedged items. If
anticipated transactions were not to occur, any gains or losses
would be recognized in earnings currently. Foreign currency and
related interest rate swap agreements are used to hedge certain
foreign currency net investments. Realized and unrealized gains and
losses on foreign currency swap agreements that are effective as
hedges of net assets in foreign subsidiaries are offset against
currency translation adjustments as a component of stockholders'
equity. The interest differential to be paid or received under the
currency and related interest rate swap agreements is recognized
over the life of the related debt and is included in interest and
other debt expense, net. Gains and losses on terminated foreign
currency swap agreements, if any, are recorded in stockholders'
equity as currency translation adjustments.
Commodity futures and forward contracts are used by the Company to
procure raw materials, primarily coffee, cocoa, sugar, wheat and
corn. Commodity futures and options are also used to hedge the price
of certain commodities, primarily coffee and cocoa. Realized gains
and losses on commodity futures, forward contracts and options are
deferred as a component of inventories and are recognized when
related raw material costs are charged to cost of sales. If the
anticipated transaction were not to occur, the gain or loss would be
recognized in earnings currently.
Interest rate swap agreements are accounted for on an accrual basis,
with the net receivable or payable recognized as an adjustment to
interest expense. Gains and losses on terminated interest rate
swaps, if any, are recognized over the remaining life of the
arrangement, or immediately, if the hedged items do not remain
outstanding. The fair value of the interest rate swap agreements and
changes in these fair values as a result of changes in market
interest rates are not recognized in the consolidated financial
statements.
8
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
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. The Company has not yet
determined the impact that adoption or subsequent application of
SFAS No. 133 will have on its financial position or results of
operations.
Stock-based compensation:
The Company accounts for employee stock compensation plans in
accordance with the intrinsic value-based method permitted by SFAS
No. 123, "Accounting for Stock-Based Compensation," which generally
does not result in compensation cost.
Software costs:
The Company capitalizes certain computer software and software
development costs incurred in connection with developing or
obtaining computer software for internal use in accordance with
Statement of Position No. 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use,"
which was adopted by the Company as of January 1, 1998. The adoption
of SOP 98-1 had no material effect on the Company's financial
position or results of operations.
Capitalized costs are amortized on a straight-line basis over the
estimated useful lives of the software.
Note 2. Divestitures:
During 1999, the Company sold several small international and domestic
food businesses. The aggregate proceeds received in these transactions
were $175 million and the Company recorded pre-tax gains of $62 million.
During 1997, the Company sold several domestic and international food
businesses, including its Brazilian ice cream businesses and its North
American maple-flavored syrup businesses, for total proceeds of $1.5
billion and net pre-tax gains of $958 million. In addition, the Company
sold its equity interest in a Canadian beer operation and sold a minority
interest in a beer import operation for proceeds of $306 million and a
pre-tax gain of $12 million. The Company also sold its real estate
operations for total proceeds of $424 million and a pre-tax gain of $103
million.
The operating results of the businesses sold were not material to the
Company's consolidated operating results in any of the periods presented.
Pre-tax gains on these divestitures were included in marketing,
administration and research costs in the Company's consolidated statements
of earnings.
9
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 3. Acquisitions:
During 1999, the Company's international tobacco subsidiary increased its
ownership interest in a Portuguese tobacco company from 65% to 90% at a
cost of $70 million. The Company also increased its ownership interest in
a Polish tobacco company from 75% to 96% at a cost of $104 million.
During 1999, the Company's beer subsidiary purchased four trademarks from
the Pabst Brewing Company ("Pabst") and the Stroh Brewery Company
("Stroh"). The Company also agreed to increase its contract manufacturing
of Pabst products, including brands that Pabst acquired from Stroh in a
separate agreement. In addition, the Company assumed ownership of the
Pabst brewery in Tumwater, Washington. The total cost of the four
trademarks and the brewery was $189 million.
During 1998, the Company's domestic tobacco subsidiary paid $150 million
for options to purchase the voting and non-voting common stock of a
company (the "acquiree"), the sole assets of which are three U.S.
cigarette trademarks, L&M, Lark and Chesterfield. During 1999, the Company
substantially completed its acquisition of the acquiree. Including the
$150 million paid in December, the total acquisition price was
approximately $300 million.
During 1997, the Company increased its ownership interest in a Mexican
cigarette business from 28.8% to 50.0% at a cost of $403 million.
The effects of these and other smaller acquisitions were not material to
the Company's financial position or results of operations in any of the
periods presented.
Note 4. Inventories:
The cost of approximately 47% and 50% of inventories in 1999 and 1998,
respectively, was determined using the LIFO method. The stated LIFO values
of inventories were approximately $0.8 billion and $1.1 billion lower than
the current cost of inventories at December 31, 1999 and 1998,
respectively.
10
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 5. Short-Term Borrowings and Borrowing Arrangements:
At December 31, the Company's short-term borrowings and related average
interest rates consisted of the following:
1999 1998
------------------- -------------------
(in millions)
Average Average
Amount Year-end Amount Year-end
Outstanding Rate Outstanding Rate
----------- ---- ----------- ----
Consumer products:
Bank loans $ 676 8.8% $ 260 10.3%
Amount reclassified
as long-term debt (35) (35)
------ ------
$ 641 $ 225
====== ======
The fair values of the Company's short-term borrowings at December 31,
1999 and 1998, based upon current market interest rates, approximate the
amounts disclosed above.
The Company and its subsidiaries maintain credit facilities with a number
of lending institutions, amounting to approximately $12.1 billion at
December 31, 1999. Approximately $11.4 billion of these facilities were
unused at December 31, 1999. Certain of these facilities, used to support
commercial paper borrowings, are available for acquisitions and other
corporate purposes and require the maintenance of a fixed charges coverage
ratio.
The Company's credit facilities include revolving bank credit agreements
totaling $10.0 billion. Of these revolving bank agreements, an agreement
for $8.0 billion will expire in 2002 and a second agreement for $2.0
billion will expire in September 2000. The $8.0 billion credit agreement
enables the Company to reclassify short-term debt on a long-term basis.
Accordingly, short-term borrowings that the Company intended to refinance
were reclassified as long-term debt.
11
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 6. Long-Term Debt:
At December 31, 1999 and 1998, the Company's long-term debt consisted of
the following:
<TABLE>
<CAPTION>
1999 1998
---- ----
(in millions)
<S> <C> <C>
Consumer products:
Short-term borrowings, reclassified $ 35 $ 35
Notes, 6.15% to 9.25% (average effective
rate 7.33%), due through 2008 8,315 9,615
Debentures, 6.00% to 8.50%
(average effective rate 9.38%),
$1.6 billion face amount, due through 2027 1,471 1,691
Foreign currency obligations:
Swiss franc, 2.05% to 5.38%
(average effective rate 4.58%), due through 2000 208 463
German mark, 5.63% to 6.38%
(average effective rate 6.00%), due through 2002 319 361
Euro, 4.50% to 5.63%
(average effective rate 5.07%), due through 2008 2,103 1,205
Other foreign 70 122
Other 360 236
-------- --------
12,881 13,728
Less current portion of long-term debt (1,601) (1,822)
-------- --------
$ 11,280 $ 11,906
======== ========
Financial services:
Eurodollar bonds, 7.50%, due 2009 $ 497
Eurodollar note, 6.63%, due 1999 $ 200
Foreign currency obligations:
French franc, 6.88%, due 2006 158 179
German mark, 6.50% and 5.38%
(average effective rate 5.89%),
due 2003 and 2004 291 330
-------- --------
$ 946 $ 709
======== ========
</TABLE>
Approximately $1.2 billion of consumer products debt, previously reported
as German mark debt in 1998, has been redenominated into euros, and is
reflected as euro debt above.
Aggregate maturities of long-term debt, excluding short-term borrowings
reclassified as long-term debt, are as follows:
Consumer products Financial services
----------------- ------------------
(in millions)
2000 $1,601
2001 2,234
2002 1,344
2003 1,232 $ 132
2004 909 159
2005-2009 4,576 655
2010-2014 256
Thereafter 811
12
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
The current portion of long-term debt and the aggregate maturities for the
year 2000 include $800 million of debt, which may mature in March 2000 if
the ten-year United States Treasury rate exceeds a contractually
determined level.
Based on market quotes, where available, or interest rates currently
available to the Company for issuance of debt with similar terms and
remaining maturities, the aggregate fair value of consumer products and
financial services long-term debt, including current portion of long-term
debt, at December 31, 1999 and 1998 was $13.5 billion and $15.4 billion,
respectively.
Note 7. Capital Stock:
In 1997, the Company's Board of Directors declared a three-for-one split
of the Company's common stock, changed the common stock's par value from
$1.00 to $0.33 1/3 per share and increased the number of authorized shares
of common stock from 4 billion to 12 billion shares. All references in the
consolidated financial statements to shares and related prices, weighted
average number of shares, per share amounts and stock plan data have been
adjusted to reflect the split.
Shares of common stock issued, repurchased and outstanding were as
follows:
<TABLE>
<CAPTION>
Shares Shares Net Shares
Issued Repurchased Outstanding
------------- ------------ -------------
<S> <C> <C> <C>
Balances, January 1, 1997 2,805,961,317 (374,615,043) 2,431,346,274
Exercise of stock options and
issuance of other stock awards 12,345,228 12,345,228
Repurchased (18,204,213) (18,204,213)
------------- ------------ -------------
Balances, December 31, 1997 2,805,961,317 (380,474,028) 2,425,487,289
Exercise of stock options and
issuance of other stock awards 11,501,286 11,501,286
Repurchased (6,454,000) (6,454,000)
------------- ------------ -------------
Balances, December 31, 1998 2,805,961,317 (375,426,742) 2,430,534,575
Exercise of stock options and
issuance of other stock awards 4,614,412 4,614,412
Repurchased (96,629,246) (96,629,246)
------------- ------------ -------------
Balances, December 31, 1999 2,805,961,317 (467,441,576) 2,338,519,741
============= ============ =============
</TABLE>
At December 31, 1999, 165,687,673 shares of common stock were reserved for
stock options and other stock awards under the Company's stock plans and
10 million shares of Serial Preferred Stock, $1.00 par value, were
authorized, none of which have been issued.
Note 8. Stock Plans:
Under the Philip Morris 1997 Performance Incentive Plan (the "Plan"), the
Company may grant to eligible employees stock options, stock appreciation
rights, restricted stock, reload options and other stock-based awards, as
well as cash-based annual and long-term incentive awards. Up to 120
million shares of common stock may be issued under the Plan, of which no
more than 36 million shares may be awarded as restricted stock. Shares
available to be granted at December 31, 1999 were 64,790,605.
13
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Stock options are granted at an exercise price of not less than fair value
on the date of the grant. Stock options granted under the Plan generally
become exercisable on the first anniversary of the grant date and have a
maximum term of ten years.
The Company applies the intrinsic value-based methodology in accounting
for the Plan. Accordingly, no compensation expense has been recognized
other than for restricted stock awards. Had compensation cost for stock
option awards under the Plan been determined by using the fair value at
the grant date, the Company's net earnings, basic and diluted earnings per
share ("EPS") would have been $7,582 million, $3.17 and $3.16,
respectively, for the year ended December 31, 1999; $5,280 million, $2.17
and $2.16, respectively, for the year ended December 31, 1998; and $6,218
million, $2.57 and $2.55, respectively, for the year ended December 31,
1997. The foregoing impact of compensation cost was determined using a
modified Black-Scholes methodology and the following assumptions:
Weighted
Average Expected
Risk-Free Expected Expected Dividend Fair Value
Interest Rate Life Volatility Yield at Grant Date
------------- -------- ---------- -------- -------------
1999 5.81% 5 years 26.06% 4.41% $ 8.21
1998 5.52 5 23.83 4.03 7.78
1997 6.38 5 27.86 3.65 10.83
Option activity was as follows for the years ended December 31, 1997, 1998
and 1999:
Weighted
Shares Subject Average Options
to Option Exercise Price Exercisable
--------- -------------- -----------
Balance at January 1, 1997 81,213,381 $24.81 58,949,796
Options granted 16,105,390 43.88
Options exercised (12,782,568) 19.86
Options canceled (890,644) 34.75
-----------
Balance at December 31, 1997 83,645,559 29.13 67,827,399
Options granted 18,652,100 39.74
Options exercised (12,042,497) 22.56
Options canceled (3,051,498) 31.74
-----------
Balance at December 31, 1998 87,203,664 32.21 68,864,594
Options granted 22,154,585 39.87
Options exercised (5,665,611) 20.37
Options canceled (3,386,670) 30.08
-----------
Balance at December 31, 1999 100,305,968 34.65 78,423,023
===========
The weighted average exercise prices of options exercisable at December
31, 1999, 1998 and 1997 were $33.19, $30.21 and $25.69, respectively.
14
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
The following table summarizes the status of stock options outstanding and
exercisable as of December 31, 1999 by range of exercise price:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------ ----------------------
Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
-------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$15.64 - $21.67 10,979,653 3 years $17.80 10,979,653 $17.80
24.52 - 34.90 31,448,685 5 29.14 31,444,220 29.14
35.81 - 40.00 43,475,575 8 39.82 21,597,095 39.77
41.62 - 58.72 14,402,055 7 43.90 14,402,055 43.90
----------- ----------
100,305,968 78,423,023
=========== ==========
</TABLE>
The Company may grant shares of restricted stock and rights to receive
shares of stock to eligible employees, giving them in most instances all
of the rights of stockholders, except that they may not sell, assign,
pledge or otherwise encumber such shares and rights. Such shares and
rights are subject to forfeiture if certain employment conditions are not
met. During 1999, 1998 and 1997, the Company granted 100,000, 603,650 and
692,100 shares, respectively, of restricted stock to eligible U.S. based
employees and also issued to eligible non-U.S. employees rights to receive
125,000, 120,500 and 392,400 like shares, respectively, during 1999, 1998
and 1997. At December 31, 1999, restrictions on the stock, net of
forfeitures, lapse as follows: 2000-633,500 shares; 2001-25,000 shares;
2002-1,340,900 shares; 2003-295,250 shares; and 2004 and
thereafter-625,000 shares.
The fair value of the restricted shares and rights at the date of grant is
amortized to expense ratably over the restriction period. The Company
recorded compensation expense related to restricted stock and other stock
awards of $9 million, $34 million and $29 million for the years ended
December 31, 1999, 1998 and 1997, respectively. The unamortized portion,
which is reported as a reduction of earnings reinvested in the business,
was $47 million and $59 million at December 31, 1999 and 1998,
respectively.
15
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 9. Earnings per Share:
Basic and diluted EPS were calculated using the following for the years
ended December 31, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
(in millions)
Net earnings $7,675 $5,372 $6,310
====== ====== ======
Weighted average shares for basic EPS 2,393 2,429 2,420
Plus incremental shares from conversions:
Restricted stock and stock rights 2 1 1
Stock options 8 16 21
------ ------ ------
Weighted average shares for diluted EPS 2,403 2,446 2,442
====== ====== ======
In 1999, 1998, and 1997, options on 47 million, 15 million and 12 million
shares of common stock, respectively, were not included in the calculation
of weighted average shares for diluted EPS because their effects would be
antidilutive.
Note 10. Pre-tax Earnings and Provision for Income Taxes:
Pre-tax earnings and provision for income taxes consisted of the following
for the years ended December 31, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
(in millions)
Pre-tax earnings:
United States $ 8,495 $5,134 $ 7,515
Outside United States 4,200 3,953 3,096
-------- ------ -------
Total pre-tax earnings $ 12,695 $9,087 $10,611
======== ====== =======
Provision for income taxes:
United States federal:
Current $ 2,810 $1,614 $ 2,027
Deferred 280 171 12
-------- ------ -------
3,090 1,785 2,039
State and local 485 350 354
-------- ------ -------
Total United States 3,575 2,135 2,393
-------- ------ -------
Outside United States:
Current 1,581 1,475 1,851
Deferred (136) 105 57
-------- ------ -------
Total outside United States 1,445 1,580 1,908
-------- ------ -------
Total provision for income taxes $ 5,020 $3,715 $ 4,301
======== ====== =======
16
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
At December 31, 1999, applicable United States federal income taxes and
foreign withholding taxes have not been provided on approximately $5.8
billion of accumulated earnings of foreign subsidiaries that are expected
to be permanently reinvested. If these amounts were not considered
permanently reinvested, additional deferred income taxes of approximately
$289 million would have been provided.
The Company and its subsidiaries are subject to tax examinations in
various U.S. and foreign jurisdictions. The Company believes adequate tax
payments and accruals have been made and recorded for all years.
The effective income tax rate on pre-tax earnings differed from the U.S.
federal statutory rate for the following reasons for the years ended
December 31, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
U.S. federal statutory rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
State and local income taxes, net of
federal tax benefit 2.5 2.5 2.2
Rate differences - foreign operations (0.3) (0.2) 3.7
Goodwill amortization 1.4 2.0 1.7
Other 0.9 1.6 (2.1)
---- ---- ----
Effective tax rate 39.5% 40.9% 40.5%
==== ==== ====
The tax effects of temporary differences that gave rise to consumer
products deferred income tax assets and liabilities consisted of the
following at December 31, 1999 and 1998:
1999 1998
---- ----
(in millions)
Deferred income tax assets:
Accrued postretirement and postemployment
benefits $ 1,200 $ 1,195
Settlement charges 854 476
Other 959 987
------- -------
Total deferred income tax assets 3,013 2,658
------- -------
Deferred income tax liabilities:
Property, plant and equipment (1,851) (1,866)
Prepaid pension costs (447) (279)
------- -------
Total deferred income tax liabilities (2,298) (2,145)
------- -------
Net deferred income tax assets $ 715 $ 513
======= =======
Financial services deferred income tax liabilities are primarily
attributable to temporary differences from investments in finance leases.
17
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 11. Segment Reporting:
Effective December 31, 1998, the Company adopted SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 supersedes previously issued segment reporting disclosure
rules and requires reporting of segment information that is consistent
with the way in which management operates the Company. The adoption of
SFAS No. 131 at December 31, 1998 did not have any impact on the Company's
financial position or the results of operations.
The 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 constitute the Company's
reportable segments of domestic tobacco, international tobacco, North
American food, international food, beer and financial services.
The Company's management reviews operating companies income to evaluate
segment performance and allocate resources. Operating companies income for
the reportable segments excludes general corporate expenses, minority
interest and amortization of goodwill. Interest and other debt expense,
net (consumer products), and provision for income taxes are centrally
managed at the corporate level and, accordingly, such items are not
presented by segment since they are excluded from the measure of segment
profitability reviewed by the Company's management. The Company's assets
are managed on a worldwide basis by major products and, accordingly, asset
information is reported for the tobacco, food, beer and financial services
segments. Goodwill and the related amortization are principally
attributable to the North American food segment. Other assets consist
primarily of cash and cash equivalents. The accounting policies of the
segments are the same as those described in the Summary of Significant
Accounting Policies.
Reportable segment data were as follows:
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(in millions)
Operating revenues:
Domestic tobacco $19,596 $15,310 $13,584
International tobacco 27,506 27,390 26,240
North American food 17,546 17,312 16,838
International food 9,251 9,999 10,852
Beer 4,342 4,105 4,201
Financial services 355 275 340
------- ------- -------
Total operating revenues $78,596 $74,391 $72,055
======= ======= =======
18
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(in millions)
Operating companies income:
Domestic tobacco $ 4,865 $ 1,489 $ 3,287
International tobacco 4,968 5,029 4,572
North American food 3,107 3,055 2,873
International food 1,146 1,127 1,326
Beer 511 451 459
Financial services 228 183 297
------- ------- -------
Total operating companies income 14,825 11,334 12,814
Amortization of goodwill (582) (584) (585)
General corporate expenses (627) (645) (479)
Minority interest (126) (128) (87)
------- ------- -------
Total operating income 13,490 9,977 11,663
Interest and other debt expense, net (795) (890) (1,052)
------- ------- -------
Total earnings before income taxes $12,695 $ 9,087 $10,611
======= ======= =======
During 1999, Philip Morris Incorporated ("PM Inc."), the Company's
domestic tobacco operation, announced plans to phase out cigarette
production capacity at its Louisville, Kentucky manufacturing plant by
August 2000. The closure of this facility will occur in stages, as
cigarette production is shifted to other PM Inc. manufacturing facilities
in the United States. As a result of this announcement, PM Inc. recorded
pre-tax charges of $183 million during 1999. These charges, which are in
marketing, administration and research costs in the consolidated statement
of earnings, included severance benefits and enhanced pension and
postretirement benefits in accordance with the terms of the underlying
plans, for approximately 1,500 hourly and salaried employees. Severance
benefits, which can either be paid in a lump sum or as income protection
payments over a period of time, commence upon termination of employment.
Payments of enhanced pension and postretirement benefits are made over the
remaining lives of the former employees in accordance with the terms of
the related benefit plans. To date, in light of the payment terms, minimal
amounts have been paid. All operating costs of the manufacturing plant,
including increased depreciation, are charged to expense as incurred
during the closing period. During 1998, pre-tax charges of $319 million
were recorded principally for voluntary separation, early retirement and
severance programs. The 1998 charges were primarily for enhanced pension
and postretirement benefits for the approximately 2,100 hourly and
salaried employees at various operating locations who elected to
participate in the program. Benefit payments were made in accordance with
the provisions of the related pension and postretirement benefit plans.
Operating companies income for the domestic tobacco segment also included
pre-tax tobacco litigation settlement charges of $3,381 million and $1,457
million for the years ended December 31, 1998 and 1997, respectively.
During 1999, Kraft Foods North America ("Kraft") announced that it was
offering voluntary retirement incentive or separation programs to certain
eligible hourly and salaried employees in the United States. 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 during 1999. This charge was included in
marketing, administration and research costs in the consolidated
19
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
statement of earnings and in 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, commence upon dates of retirement or termination that
range from April 1999 to March 2000. Salary and related benefit costs of
employees prior to the retirement or termination date are expensed as
incurred.
During 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 the remaining employees were
severed. 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 are
in accordance with the local Brazilian regulations.
A pre-tax charge of $29 million was recorded in marketing, administration
and research costs in the consolidated statement of earnings of the beer
segment in 1999 to write down the book value of three brewing facilities
to their estimated fair values. One of the facilities is presently closed,
while the remaining two facilities are not expected to generate sufficient
future cash flows to recover the recorded cost of the facilities. The
operating costs of these brewing facilities are charged to expense as
incurred. General corporate expenses for the year ended December 31, 1998
included pre-tax charges of $116 million related to the settlement of
shareholder litigation and $18 million for separation programs covering
approximately 100 hourly and salaried employees at the Company's corporate
headquarters.
See Notes 2 and 3 regarding divestitures and acquisitions.
20
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
Depreciation expense: (in millions)
Domestic tobacco $ 212 $ 216 $ 171
International tobacco 278 267 236
North American food 281 267 268
International food 210 227 246
Beer 114 108 104
------- ------- -------
1,095 1,085 1,025
Other 25 21 19
------- ------- -------
Total depreciation expense $ 1,120 $ 1,106 $ 1,044
======= ======= =======
Assets:
Tobacco $16,102 $16,395 $15,012
Food 30,462 31,397 31,170
Beer 1,769 1,503 1,451
Financial services 7,711 6,480 5,886
------- ------- -------
56,044 55,775 53,519
Other 5,337 4,145 2,428
------- ------- -------
Total assets $61,381 $59,920 $55,947
======= ======= =======
Capital expenditures:
Domestic tobacco $ 122 $ 217 $ 483
International tobacco 561 588 455
North American food 568 534 440
International food 292 307 297
Beer 165 129 115
------- ------- -------
1,708 1,775 1,790
Other 41 29 84
------- ------- -------
Total capital expenditures $ 1,749 $ 1,804 $ 1,874
======= ======= =======
The Company's operations outside the United States, which are principally
in the tobacco and food businesses, are organized into geographic regions
within each segment, with Europe being the most significant. Total tobacco
and food segment revenues attributable to customers located in Germany
were $8.9 billion, $9.2 billion and $9.5 billion for the years ended
December 31, 1999, 1998 and 1997, respectively.
Geographic data for operating revenues and long-lived assets (which
consist of all financial services assets and non-current consumer products
assets, other than goodwill and other intangible assets) were as follows:
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(in millions)
Operating revenues:
United States - domestic $40,287 $35,432 $33,208
- export 5,046 6,005 6,705
Europe 25,103 25,169 24,796
Other 8,160 7,785 7,346
------- ------- -------
Total operating revenues $78,596 $74,391 $72,055
======= ======= =======
21
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(in millions)
Long-lived assets:
United States $17,263 $15,616 $14,533
Europe 4,143 4,159 4,057
Other 2,201 2,349 2,128
------- ------- -------
Total long-lived assets $23,607 $22,124 $20,718
======= ======= =======
Note 12. Benefit Plans:
The Company and its subsidiaries sponsor noncontributory defined benefit
pension plans covering substantially all U.S. employees. Pension coverage
for employees of the Company's non-U.S. subsidiaries is provided, to the
extent deemed appropriate, through separate plans, many of which are
governed by local statutory requirements. In addition, the Company and its
U.S. and Canadian subsidiaries provide health care and other benefits to
substantially all retired employees. Health care benefits for retirees
outside the United States and Canada are generally covered through local
government plans.
Effective December 31, 1998, the Company adopted SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." SFAS No.
132 does not change the measurement or recognition of those plans, but
revises the disclosure requirements for pension and other postretirement
benefit plans for all years presented.
Pension Plans
Net pension cost (income) consisted of the following for the years ended
December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
U. S. Plans Non-U.S. Plans
---------------------- ----------------------
1999 1998 1997 1999 1998 1997
---- ---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Service cost $ 152 $ 156 $ 137 $ 102 $ 91 $ 83
Interest cost 436 406 382 162 165 163
Expected return on plan assets (766) (615) (564) (168) (150) (135)
Amortization:
Net gain on adoption of SFAS No. 87 (23) (24) (24)
Unrecognized net loss (gain) from
experience differences (22) 3 (4) (1)
Prior service cost 19 15 14 6 6 6
Termination, settlement and curtailment 22 251 (22)
----- ----- ----- ----- ----- -----
Net pension cost (income) $(182) $ 189 $ (77) $ 105 $ 108 $ 116
===== ===== ===== ===== ===== =====
</TABLE>
During 1999, 1998 and 1997, the Company instituted early retirement and
workforce reduction programs and, during 1997, the Company also sold
businesses. These actions resulted in additional termination benefits of
$128 million, net of settlement and curtailment gains of $106 million in
1999, additional termination benefits and curtailment losses of $279
million, net of settlement gains of $28 million in 1998 and settlement
gains of $22 million in 1997.
22
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
The changes in benefit obligations and plan assets, as well as the funded
status of the Company's pension plans at December 31, 1999 and 1998 were
as follows:
<TABLE>
<CAPTION>
U.S. Plans Non-U.S. Plans
--------------- ---------------
1999 1998 1999 1998
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
Benefit obligation at January 1 $ 6,220 $ 5,523 $ 3,201 $ 2,701
Service cost 152 156 102 91
Interest cost 436 406 162 165
Benefits paid (693) (396) (155) (129)
Termination, settlement and curtailment 210 305
Actuarial (gains) losses (597) 238 (34) 263
Currency (272) 95
Other 67 (12) 33 15
------- ------- ------- -------
Benefit obligation at December 31 5,795 6,220 3,037 3,201
------- ------- ------- -------
Fair value of plan assets at January 1 8,703 8,085 2,248 2,189
Actual return on plan assets 1,240 973 252 116
Contributions 309 14 88 53
Benefits paid (649) (372) (112) (93)
Currency (194) 39
Actuarial gains (losses) 18 3 90 (56)
------- ------- ------- -------
Fair value of plan assets at December 31 9,621 8,703 2,372 2,248
------- ------- ------- -------
Excess (deficit) of plan assets versus benefit
obligations at December 31 3,826 2,483 (665) (953)
Unrecognized actuarial (gains) losses (2,573) (1,718) (92) 171
Unrecognized prior service cost 148 107 37 37
Unrecognized net transition obligation (34) (58) 10 12
------- ------- ------- -------
Net prepaid pension asset (liability) $ 1,367 $ 814 $ (710) $ (733)
======= ======= ======= =======
</TABLE>
The combined domestic and foreign pension plans resulted in a net prepaid
pension asset of $657 million and $81 million at December 31, 1999 and
1998, respectively. These amounts were recognized in the Company's
consolidated balance sheets at December 31, 1999 and 1998 as other assets
of $2.2 billion and $1.9 billion, respectively, for those plans in which
plan assets exceeded their accumulated benefit obligations and as other
liabilities of $1.5 billion and $1.8 billion, respectively, for those
plans in which the accumulated benefit obligations exceeded their plan
assets.
For domestic plans with accumulated benefit obligations in excess of plan
assets, the projected benefit obligation, accumulated benefit obligation
and fair value of plan assets were $305 million, $242 million and $25
million, respectively, as of December 31, 1999 and $1,484 million, $1,374
million and $1,123 million, respectively, as of December 31, 1998. For
foreign plans with accumulated benefit obligations in excess of plan
assets, the projected benefit obligation, accumulated benefit obligation
and fair value of plan assets were $1,020 million, $917 million and $97
million, respectively, as of December 31, 1999 and $1,111 million, $996
million and $155 million, respectively, as of December 31, 1998.
23
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
The following weighted-average assumptions were used to determine the
Company's obligations under the plans:
U.S. Plans Non-U.S. Plans
----------- --------------
1999 1998 1999 1998
---- ---- ---- ----
Discount rate 7.75% 7.00% 5.58% 5.37%
Expected rate of return on plan assets 9.00 9.00 7.95 7.63
Rate of compensation increase 4.50 4.50 3.71 3.73
The Company and certain of its subsidiaries sponsor deferred
profit-sharing plans covering certain salaried, non-union and union
employees. Contributions and costs are determined generally as a
percentage of pre-tax earnings, as defined by the plans. Certain other
subsidiaries of the Company also maintain defined contribution plans.
Amounts charged to expense for defined contribution plans totaled $198
million, $201 million and $200 million in 1999, 1998 and 1997,
respectively.
Postretirement Benefit Plans
Net postretirement health care costs consisted of the following for the
years ended December 31, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
(in millions)
Service cost $ 56 $ 56 $ 54
Interest cost 188 182 182
Amortization:
Unrecognized net gain from experience
differences (3) (3) (3)
Unrecognized prior service cost (12) (12) (12)
Other expense 23 30
----- ----- -----
Net postretirement health care costs $ 252 $ 253 $ 221
===== ===== =====
During 1999, 1998 and 1997, the Company instituted early retirement and
workforce reduction programs. These actions resulted in curtailment losses
of $23 million in 1999 and additional postretirement health care costs of
$20 million and curtailment losses of $10 million in 1998, all of which
are included in other expense above.
24
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
The Company's postretirement health care plans currently are not funded.
The changes in the benefit obligations of the plans at December 31, 1999
and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
(in millions)
<S> <C> <C>
Accumulated postretirement benefit obligation at January 1 $ 2,771 $ 2,627
Service cost 56 56
Interest cost 188 182
Benefits paid (142) (135)
Termination, settlement and curtailment 45 107
Plan amendments (8) 1
Actuarial gains (381) (67)
------- -------
Accumulated postretirement benefit obligation at December 31 2,529 2,771
Unrecognized actuarial gains (losses) 159 (201)
Unrecognized prior service cost 90 96
------- -------
Accrued postretirement health care costs $ 2,778 $ 2,666
======= =======
</TABLE>
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation for U.S. plans was 7.5% in 1998, 7.0% in
1999 and 6.5% in 2000, gradually declining to 5.0% by the year 2003 and
remaining at that level thereafter. For Canadian plans, the assumed health
care cost trend rate was 12.0% in 1998, 11.0% in 1999 and 10.0% in 2000,
gradually declining to 4.0% by the year 2005 and remaining at that level
thereafter. A one-percentage-point increase in the assumed health care
cost trend rates for each year would increase the accumulated
postretirement benefit obligation as of December 31, 1999 and
postretirement health care cost (service cost and interest cost) for the
year then ended by approximately 11.9% and 13.9%, respectively. A
one-percentage-point decrease in the assumed health care cost trend rates
for each year would decrease the accumulated postretirement benefit
obligation as of December 31, 1999 and postretirement health care cost
(service cost and interest cost) for the year then ended by approximately
9.8% and 11.1%, respectively.
The accumulated postretirement benefit obligations for U.S. plans at
December 31, 1999 and 1998 were determined using assumed discount rates of
7.75% and 7.0%, respectively. The accumulated postretirement benefit
obligation at December 31, 1999 and 1998 for Canadian plans was determined
using assumed discount rates of 7.0% and 6.50%, respectively.
25
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Postemployment Benefit Plans
The Company and certain of its affiliates sponsor postemployment benefit
plans covering substantially all salaried and certain hourly employees.
The cost of these plans is charged to expense over the working life of the
covered employees. Net postemployment costs consisted of the following for
the years ended December 31, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
(in millions)
Service cost $ 24 $ 25 $ 26
Amortization of unrecognized net loss 2 5 17
Other expense 161 30 288
---- ---- ----
Net postemployment costs $187 $ 60 $331
==== ==== ====
The Company instituted workforce reduction programs in its tobacco and
North American food operations in 1999, in its domestic tobacco operations
in 1998 and in its international food operations in 1997. These actions
resulted in incremental postemployment costs, which are shown as other
expense above.
The Company's postemployment plans are not funded. The changes in the
benefit obligations of the plans at December 31, 1999 and 1998 were as
follows:
1999 1998
---- ----
(in millions)
Accumulated benefit obligation at January 1 $ 602 $ 743
Service cost 24 25
Benefits paid (149) (196)
Other expense 161 30
----- -----
Accumulated benefit obligation at December 31 638 602
Unrecognized actuarial gains 5 11
----- -----
Accrued postemployment costs $ 643 $ 613
===== =====
The accumulated benefit obligation was determined using an assumed
ultimate annual turnover rate of 0.3% in 1999 and 1998, assumed
compensation cost increases of 4.5% in 1999 and 1998, and assumed benefits
as defined in the respective plans or historical experience of the plan
sponsors. Postemployment costs in excess of actuarially determined
benefits are charged to expense when incurred.
26
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 13. Additional Information:
For the years ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(in millions)
Research and development expense $ 522 $ 506 $ 533
======= ======= =======
Advertising expense $ 2,301 $ 2,416 $ 2,530
======= ======= =======
Interest and other debt expense, net:
Interest expense $ 1,100 $ 1,144 $ 1,184
Interest income (305) (254) (132)
------- ------- -------
$ 795 $ 890 $ 1,052
======= ======= =======
Interest expense of financial services
operations included in cost of sales $ 89 $ 77 $ 67
======= ======= =======
Rent expense $ 467 $ 429 $ 443
======= ======= =======
Note 14. Financial Instruments:
Derivative financial instruments
The Company operates internationally, with manufacturing and sales
facilities in various locations around the world. Derivative financial
instruments are used by the Company for purposes other than trading,
principally to reduce exposures to market risks resulting from
fluctuations in interest rates and foreign exchange rates by creating
offsetting exposures. The Company is not a party to leveraged derivatives.
The Company has foreign currency and related interest rate swap agreements
that were executed to reduce the Company's borrowing costs and serve as
hedges of the Company's net assets in foreign subsidiaries, principally
those denominated in Swiss francs. At December 31, 1999 and 1998, the
notional principal amounts of those agreements were $3.4 billion and $3.3
billion, respectively. Aggregate maturities at December 31, 1999 were as
follows (in millions): 2000, $1,015; 2002, $155; 2003, $129; 2004, $162;
2006, $876; and 2008, $1,054. The local currency notional amount is used
to calculate interest payments that are exchanged over the life of the
swap transaction and is equal to the amount of foreign currency or dollar
principal exchanged at maturity.
Forward foreign exchange contracts and foreign currency options are used
by the Company to reduce the effect of fluctuating foreign currencies on
foreign currency denominated intercompany and third party transactions. At
December 31, 1999 and 1998, the Company had option and forward foreign
exchange contracts, principally for the Japanese yen, British pound and
the euro, with an aggregate notional amount of $3.8 billion and $8.1
billion, respectively, for both the purchase and/or sale of foreign
currencies.
27
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Credit exposure and credit risk
The Company is exposed to credit loss in the event of nonperformance by
counterparties. However, the Company does not anticipate nonperformance
and such exposure was not material at December 31, 1999.
Fair value
The aggregate fair value, based on market quotes, of the Company's total
debt at December 31, 1999 was $14.1 billion as compared to its carrying
value of $14.5 billion. The aggregate fair value of the Company's total
debt at December 31, 1998 was $15.6 billion as compared to its carrying
value of $14.7 billion.
The carrying values of the foreign currency and related interest rate swap
agreements, the forward foreign currency contracts and the currency option
contracts, which did not differ materially from their fair values, were
not material.
See Notes 5 and 6 for additional disclosures of fair value for short-term
borrowings and long-term debt.
Note 15. 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., the Company's
domestic tobacco subsidiary, 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, (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. Damages claimed in some of the smoking and health class actions,
health care cost recovery cases and asbestos contribution cases range into
the billions of dollars. Plaintiffs' theories of recovery and the defenses
raised in the smoking and health and health care cost recovery cases are
discussed below.
As of December 31, 1999, there were approximately 380 smoking and health
cases filed and served on behalf of individual plaintiffs in the United
States against PM Inc. and, in some cases, the
28
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Company, compared with approximately 510 such cases on December 31, 1998,
and approximately 375 such cases on December 31, 1997. Approximately 13 of
the individual cases involve allegations of various personal injuries
allegedly related to exposure to environmental tobacco smoke ("ETS"). In
January 2000, approximately 300 additional individual cases were filed in
Florida by current and former flight attendants claiming personal injuries
allegedly related to ETS. The flight attendants were members of an ETS
smoking and health class action which was settled in 1998. The terms of
the court-approved settlement in that case allowed class members to file
individual lawsuits seeking compensatory damages, but prohibited them from
seeking punitive damages.
In addition, as of December 31, 1999, there were approximately 50 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 60 such cases on December 31, 1998, and
approximately 50 such cases on December 31, 1997. Many 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 December 31, 1999, there were approximately 60 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 95 health care cost recovery cases pending on December 31,
1998, and 105 cases on December 31, 1997.
There are also a number of tobacco-related actions pending outside the
United States against PMI and its affiliates and subsidiaries, including
approximately 55 smoking and health cases initiated by one or more
individuals (Argentina (38), Brazil (2), Canada (1), Germany (3), Hong
Kong (1), Ireland (1), Italy (1), Japan (1), the Philippines (1), Poland
(2), Scotland (1), Spain (1) and Turkey (2)), compared with approximately
27 such cases on December 31, 1998. In addition, there are 10 smoking and
health putative class actions pending outside the United States (Australia
(2), Brazil (3), Canada (3), Israel (1) and Nigeria (1)), compared with
six in December 1998. 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, Guatemala (dismissed, as discussed below), Panama, Nicaragua,
Thailand (voluntarily dismissed), Ukraine, Venezuela and the States of
Goias and Rio de Janeiro, Brazil.
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, the
Medicare Secondary Payer 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 injunction prohibiting
29
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
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. In December 1999, the Company and PM Inc. filed a motion to
dismiss this lawsuit on numerous grounds, including that the statutes
invoked by the government do not provide a basis for the relief sought.
The Company and PM Inc. believe that they have a number of valid defenses
to the lawsuit and will vigorously defend it.
Industry Trial Results
There have been several jury verdicts in tobacco-related litigation during
the past three years. In July 1999, a Louisiana jury returned a verdict in
favor of defendants in an individual smoking and health case against other
cigarette manufacturers. Also in July 1999, the jury in the Engle smoking
and health class action pending in Florida returned a verdict against PM
Inc. and several other tobacco companies in "Phase One" of the trial,
which concerned certain issues determined by the trial court to be
"common" to the causes of action of the plaintiff class. Liability and
damages in relation to any individual class member were not decided in
Phase One (see "Engle Trial", below, for a more detailed discussion of the
Phase One verdict and certain other developments in this case). 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.
In March 1999, an Oregon jury awarded $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 $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., on all counts in a union health care cost recovery action brought
on behalf of approximately 114 employer-employee trust funds in Ohio.
Previously, juries had returned verdicts for defendants in three
individual smoking and health cases and in one individual ETS smoking and
health case. In January 1999, a Florida court set aside a jury award
totaling approximately $1 million in a smoking and health case against
another United States cigarette manufacturer and ordered a new trial in
the case. In June 1998, a Florida appeals court reversed a $750,000 jury
verdict awarded in August 1996 against another United States cigarette
manufacturer, and the Florida Supreme Court has heard oral arguments on
this ruling. In 1997, a court in Brazil awarded plaintiffs in a smoking
and health case the Brazilian currency equivalent of $81,000, attorneys'
fees and a monthly annuity for 35 years equal to two-thirds of the
deceased smoker's last monthly salary. In March 1999, an appeals court
reversed the trial court's award and dismissed the case. Neither the
Company nor its affiliates were parties to that action.
In December 1999, a French court in an action brought on behalf of a
deceased smoker, found that another
30
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
cigarette manufacturer had a duty to warn him about risks associated with
smoking prior to 1976, when the French government required warning labels
on cigarettes 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
Trial in this Florida smoking and health class action case began in July
1998. The plaintiff class seeks compensatory and punitive damages, each in
excess of $100 billion, as well as attorneys' fees and court costs. 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."
On July 7, 1999, the jury returned a verdict against defendants in Phase
One of the three-phase trial plan. The Phase One verdict concerned 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 and/or the
addictive nature of smoking cigarettes and agreed to misrepresent and
conceal the health effects 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."
Liability and damages in relation to any individual class member were not
decided in Phase One. Phase Two of the trial commenced on November 1,
1999. During this phase, the claims of three of the named plaintiffs are
being adjudicated in a consolidated trial before the same jury that
returned the verdict in Phase One. Under the trial plan, the jury in Phase
Two will determine issues of specific causation, reliance, affirmative
defenses, and other individual-specific issues related to the claims of
the named plaintiffs and their entitlement to damages, if any.
Phase Three of the trial plan would 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.
By order dated July 30, 1999, and supplemented on August 2, 1999
(together, the "order"), the trial judge amended the trial plan in respect
of the manner of determining punitive damages, if any. The order provides
that the jury in Phase Two will determine punitive damages, if any, on a
dollar-amount basis for the entire qualified class. By order of September
3, 1999, the Third District Court of Appeal quashed the July 30, 1999 and
August 2, 1999 orders of the trial judge and stated that both compensatory
and punitive damages must be tried on an individual as opposed to
class-wide basis. On September 17, 1999, the Third District Court of
Appeal, on its own motion, vacated its September 3 order, and, on October
20, 1999, ruled that defendants could not challenge the trial plan for
determining punitive damages at this stage of the proceedings; the ruling
expressly declined to address the merits of whether a class-wide
determination of punitive damages is permissible but deferred the court's
review of that issue for any appropriate subsequent appeal. Defendants
sought review by the Florida Supreme Court of the Third District Court of
Appeal's ruling. In December 1999, the Florida Supreme Court denied
defendants' petition for review,
31
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
noting that it did so without prejudicing defendants' rights to raise the
same issues in subsequent appeals.
It is unclear how the trial court's order will be implemented. The order
provides that the punitive damage amount, if any, should be standard as to
each class member and acknowledges that the actual size of the class will
not be known until the last case has withstood appeal, i.e., the punitive
damage amount, if any, determined for the entire qualified class, would be
divided equally among those plaintiffs who are ultimately successful. The
order does not address whether defendants would be required to pay the
punitive damage award, if any, prior to a determination of claims of all
class members, a process that could take years to conclude. PM Inc. and
the Company do not believe that an adverse class-wide punitive damage
award in Phase Two would permit entry of a judgment at that time that
would require the posting of a bond to stay its execution pending appeal
or that any party would be entitled to execute on such a judgment in the
absence of a bond. However, in a worst case scenario, it is possible that
a judgment for punitive damages could be entered in an amount not capable
of being bonded, resulting in an execution of the judgment before it could
be set aside on appeal. PM Inc. and the Company believe that such a result
would be unconstitutional and would also violate Florida laws. 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 has a serious medical condition of a type
that the plaintiffs claim, and the jury has now found, is caused by
smoking, making him financially interested in the result of the case and,
under plaintiffs' theory of the case, a potential member of the plaintiff
class. The Third District Court of Appeal denied defendants' petition to
disqualify the trial judge. The defendants filed motions seeking
reconsideration of this decision and to supplement the record with the
deposition testimony of an expert witness. The Third District Court of
Appeal denied defendants' motions.
PM Inc. and the Company remain of the view that the Engle case should not
have been certified as a class action. That 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. PM Inc. intends to challenge the class certification, as well
as numerous other reversible errors that it believes occurred during the
Phase One trial, at the earliest time that an appeal of these issues is
permissible under Florida law. In any event, PM Inc. believes it would be
able to raise these issues in an appeal following any verdict in favor of
an individual named or absent class member plaintiff. PM Inc. and the
Company believe that such an appeal should prevail.
Upcoming Trial Dates
In addition to the Engle trial, trial in an individual smoking and health
case in which PM Inc. is a defendant commenced in California in January
2000. Additional cases against PM Inc. and, in some cases, the Company as
well, are scheduled for trial through the end of 2000. These cases include
five health care cost recovery actions that are scheduled for trial in May
(New York), June (New York), October (the Marshall Islands and California)
and December (Minnesota); three asbestos contribution cases (discussed
below) that are scheduled for trial in New York in April, September and
October; two cases under the California Business and Professions Code
(discussed below) that are scheduled for trial in June (California); and
approximately 11 other individual smoking and health cases that are
32
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
scheduled for trial in March (Massachusetts), May (New York), June (Iowa
and Puerto Rico), July (New Jersey), August (Iowa), October (Iowa,
Louisiana, New Hampshire and South Carolina) and November (Alabama). Cases
against other tobacco companies are also scheduled for trial during this
period. 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; and, thereafter, $9.4 billion. In addition, the domestic
tobacco industry is required to pay settling plaintiffs' attorneys' fees,
subject to an annual cap of $500 million, as well as additional amounts as
follows: 2000, $416 million; and 2001 through 2002, $250 million. These
payment obligations are the several and not joint obligations of each
settling defendant. For the year ended December 31, 1998, PM Inc. recorded
settlement charges of $3.081 billion, which represented its share of
up-front payments required under the settlement agreements. For periods
subsequent to December 31, 1998, 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.
The State Settlement Agreements also include provisions 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.
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
December 31, 1999, 46 jurisdictions had obtained final judicial approval
of the MSA.
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
33
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
payments, prior to application of various adjustments, scheduled to total
$5.15 billion. PM Inc. has charged $300 million of payments into the trust
against 1998 operating companies income. Future industry payments (in
2000, $280 million; 2001, $400 million; 2002 through 2008, $500 million;
2009 and 2010, $295 million) are subject to adjustments 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.
In 1999, the State Settlement Agreements materially adversely affected the
volumes of PM Inc. and the Company believes that the State Settlement
Agreements may materially adversely affect the business, volume, results
of operations, cash flows or financial position of PM Inc. and the Company
in future 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 has arisen out of the State Settlement Agreements,
including the actions described below.
In December 1998, a putative class action was filed against PM Inc. and
certain other domestic tobacco manufacturers on behalf of a class
consisting of citizens of the United States who consume tobacco products
manufactured by defendants. One count of the complaint alleged that
defendants conspired to raise the prices of their tobacco products in
order to pay the costs of the MSA in violation of federal antitrust laws.
The other two counts alleged that the actions of defendants amount to an
unconstitutional deprivation of property without due process of law and an
unlawful burdening of interstate trade. The complaint sought unspecified
damages (to be trebled under the antitrust count), injunctive and
declaratory relief, costs and attorneys' fees. In April 1999, the court
granted defendants' motions for summary judgment, and plaintiffs have
appealed.
In February 1999, a putative class action was filed on behalf of tobacco
consumers in the United States against the States of California and Utah,
other public entity defendants, certain domestic tobacco manufacturers,
including PM Inc., and others, challenging the MSA. Plaintiffs are
seeking, among other things, an order (i) prohibiting the states from
collecting any monies under the MSA, (ii) restraining the domestic tobacco
manufacturers from further collection of price increases related to the
MSA and compelling them to reimburse to plaintiffs all monies paid by
plaintiffs in the form of price increases related to the MSA, and (iii)
declaring the MSA "unfair, discriminatory, unconstitutional and
unenforceable." In January 2000, the court granted defendants' motion to
dismiss the complaint.
In April 1999, a putative class action was filed on behalf of all firms
that directly buy cigarettes in the United States from defendant tobacco
manufacturers. The complaint alleges violation of antitrust law, based in
part on the MSA. Plaintiffs seek treble damages computed as three times
the difference between current prices and the price plaintiffs would have
paid for cigarettes in the absence of an alleged conspiracy to restrain
and monopolize trade in the domestic cigarette market, together with
attorneys' fees. Plaintiffs also seek injunctive relief against certain
aspects of the MSA and against PM Inc.'s acquisition of the U.S. rights to
manufacture and market three cigarette trademarks, L&M, Lark and
Chesterfield.
34
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
In June 1999, a putative class action was filed on behalf of certain
native American tribes against PM Inc. and other cigarette manufacturers
challenging the MSA. The complaint alleged that defendants, by entering
into the MSA, violated certain constitutional and civil rights of the
tribes. The complaint was dismissed by the trial court, and the tribes
have appealed.
In August 1999, five companies that import cigarettes or that are involved
in the re-importation of cigarettes into U.S. markets filed suit seeking
to invalidate the MSA and the 1998 Texas State Settlement Agreement on
various grounds, including violation of antitrust laws. Plaintiffs also
seek monetary relief, including treble damages in an unspecified amount
and disgorgement of profits.
In August 1999, after New York obtained final judicial approval of the
MSA, four alleged smokers in New York sought leave to intervene in
litigation concerning the MSA, alleging violations of antitrust laws and
seeking injunctive relief, including invalidating the settlements. The
trial court denied the motion as untimely, and they have appealed.
A description of the smoking and health litigation, health care cost
recovery litigation and certain other proceedings pending against the
Company and/or its subsidiaries and affiliates follows.
Smoking and Health Litigation
Plaintiffs' allegations of liability in smoking and health cases are based
on various theories of recovery, including negligence, gross negligence,
strict liability, fraud, misrepresentation, design defect, failure to
warn, breach of express and implied warranties, breach of special duty,
conspiracy, concert of action, violations of deceptive trade practice laws
and consumer protection statutes, and claims under the federal 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 December 31, 1999,
smoking and health putative class actions were pending in Alabama,
Arizona, California, the District of Columbia, Hawaii, Illinois, Indiana,
Iowa, Louisiana, Maryland, Massachusetts, Missouri, Nevada, New Jersey,
New Mexico, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, South
Carolina, Tennessee, Texas, Utah and West Virginia, as well as in
Australia, Brazil, Canada, Israel and Nigeria. Class certification has
been denied or reversed by courts in 19 smoking and health class actions
involving PM Inc. in Arkansas, the District of Columbia, Illinois, Kansas,
Louisiana, Michigan, Minnesota, New Jersey (6), New York (2), Ohio,
Pennsylvania, Puerto Rico, and Wisconsin, while classes remain certified
in three cases in Florida, Louisiana and Maryland. A number of these class
certification decisions are on appeal. In October 1999, the State of New
York's
35
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
highest court affirmed without dissent the decertification and dismissal
of a class action suit. 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.
Class certification motions are pending in a number of the putative
smoking and health class actions. As mentioned 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, taxpayers and others, are seeking reimbursement of health
care cost expenditures 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 and, in some
cases, the class was certified by the court. In one health care cost
recovery case, private citizens seek recovery of alleged tobacco-related
health care expenditures incurred by the federal Medicare program. In
another, Blue Cross subscribers seek reimbursement of increased medical
insurance premiums allegedly caused by tobacco products. In the native
American cases, claims are also asserted for alleged lost productivity of
tribal government employees. Other relief sought by some but not all
plaintiffs includes punitive damages, treble/multiple damages and other
statutory damages and penalties, injunctions prohibiting alleged marketing
and sales to minors, disclosure of research, disgorgement of profits,
funding of anti-smoking programs, disclosure of nicotine yields, and
payment of attorney and expert witness fees.
The claims asserted in these health care cost recovery actions include the
equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to
smoking, the equitable claim of indemnity, common law claims of
negligence, strict liability, breach of express and implied warranty,
violation of a voluntary undertaking or special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under federal and
state statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under federal and state RICO
statutes.
Defenses raised include 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 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 payor of medical costs (such as an insurer) can seek recovery
of health care costs from a third party solely by "standing in the shoes"
of the injured party. Defendants argue that plaintiffs should be required
to bring any actions as subrogees of individual health care recipients and
should be subject to all defenses available against the injured party.
Excluding the cases covered by the MSA, as of December 31, 1999, there
were approximately 60 health care cost recovery cases pending in the
United States against PM Inc. and, in some cases, the Company, of which
approximately 40 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
36
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
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,
Guatemala, Panama, Nicaragua, Thailand (voluntarily dismissed), Ukraine,
Venezuela and the States of Goias and Rio de Janeiro, Brazil. The actions
brought by Bolivia, Guatemala, Nicaragua, Ukraine, Venezuela and the State
of Goias, Brazil, have been consolidated for pre-trial purposes and
transferred to the United States District Court for the District of
Columbia. Other foreign entities and others have stated that they are
considering filing health care cost recovery actions.
Five federal appeals courts have issued rulings in health care cost
recovery actions that were favorable to the tobacco industry. The United
States Courts of Appeals for the Second, Third, Fifth, Seventh and Ninth
Circuits, relying primarily on grounds that the 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 denied plaintiffs' petitions for writs of certiorari
in the cases decided by the Court of Appeals for the Second, Third and
Ninth Circuits, effectively refusing to allow plaintiffs' appeals.
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 United States
District Court for the District of Columbia dismissed a lawsuit filed by
Guatemala, ruling that the claimed injuries were too remote. 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 has been 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 trust funds seeking reimbursement of health care
expenditures allegedly caused by tobacco products. Defendants are seeking
to appeal this decision.
Certain Other Tobacco-Related Litigation
Asbestos Contribution Cases: As of December 31, 1999, 11 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. On November 2, 1999, one of these cases was dismissed
by the federal district court in the Eastern District of New York although
the case was subsequently refiled. Trials in these cases are scheduled to
begin in New York in April, September and October 2000.
Marlboro Light/Ultra Light and Virginia Slims Light Cases: As of December
31, 1999, there were nine putative class actions pending against PM Inc.
and the Company, in Arizona, Florida, Massachusetts, New Jersey, Ohio,
Pennsylvania, Tennessee, and Washington, D.C., on behalf of individuals
who purchased and consumed Marlboro Lights and, in one case, Marlboro
Ultra Lights, and, in another case, Virginia Slims Lights, as well. These
cases allege, in connection with the use of the term "Lights" and/or
"Ultra Lights," among other things, deceptive and unfair trade practices
and unjust enrichment, and seek injunctive and equitable relief, including
restitution.
Retail Leaders Case: Three domestic tobacco manufacturers have filed suit
against PM Inc. seeking to
37
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
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 four 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., and requiring those outlets to allocate a percentage of
cigarette-related permanent signage to PM Inc. greater than PM Inc.'s
market share, or prohibiting retail outlets from advertising or conducting
promotional programs of cigarette manufacturers other than PM Inc. The
preliminary injunction applies only to certain accounts and does not
affect any other aspect or level 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. The claims of ten plaintiffs are
set for trial in November 2000; the claims of remaining plaintiffs have
been stayed pending disposition of those claims 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. The
defendants' motions to dismiss were denied in both of these cases. In
October 1999, plaintiffs' motion for a preliminary injunction was also
denied. In January 2000, defendants' motion for summary judgment was
granted in part, and plaintiffs' "Proposition 65" claim was dismissed.
Trial on the remaining claims in these cases is scheduled to begin in June
2000.
Certain Other Actions
National Cheese Exchange Cases: Since 1996, seven putative class actions
have been filed alleging that Kraft Foods, Inc., 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 are appealing those dismissals. 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.
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 $2.4 billion. In
addition, the Italian lira equivalent of $3.4 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
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Italian administrative tax court in Milan has overturned 149 of the
assessments. The decisions to overturn 73 assessments have been appealed
by the tax authorities. In a separate proceeding in Naples, in October
1997, a court dismissed charges of criminal association against certain
present and former officers and directors of affiliates of the Company,
but permitted charges of tax evasion to remain pending. In February 1998,
the tax evasion charges were dismissed by the criminal court in Naples
following a determination that jurisdiction was not proper, and the case
file was transmitted to the public prosecutor in Milan, who is
investigating the matter and will determine whether to bring charges, in
which case a preliminary investigations judge will make a new finding as
to whether there should be
38
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
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. Two 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, and an unfavorable verdict has been
returned in the first phase of the Engle smoking and health class action
trial underway in Florida. It is possible that additional cases could be
decided unfavorably and that there could be further adverse developments
in the Engle case. An unfavorable outcome or settlement of a pending
smoking and health or health care cost recovery case could encourage the
commencement of additional similar litigation. There have also been a
number of adverse legislative, regulatory, political and other
developments concerning cigarette smoking and the tobacco industry that
have received widespread media attention. These developments may
negatively affect the perception of potential triers of fact with respect
to the tobacco industry, possibly to the detriment of certain pending
litigation, and may prompt the commencement of additional similar
litigation.
Management is unable to make a meaningful estimate of the amount or range
of loss that could result from an unfavorable outcome of pending
litigation. The present legislative and litigation environment is
substantially uncertain, and it is possible that the Company's business,
volume, results of operations, cash flows or financial position could be
materially affected by an unfavorable outcome or settlement of certain
pending litigation or by the enactment of federal or state tobacco
legislation. The Company and each of its subsidiaries named as a defendant
believe, and each has been so advised by counsel handling the respective
cases, that it has a number of valid defenses to all litigation pending
against it. All such cases are, and will continue to be, vigorously
defended. However, the Company and its subsidiaries may enter into
discussions in an attempt to settle particular cases if they believe it is
in the best interests of the Company's stockholders to do so.
39
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
Note 16. Quarterly Financial Data (Unaudited):
1999 Quarters
-------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions, except per share data)
Operating revenues $19,497 $19,810 $19,878 $19,411
======= ======= ======= =======
Gross profit $ 7,874 $ 8,080 $ 8,041 $ 8,195
======= ======= ======= =======
Net earnings $ 1,787 $ 2,030 $ 2,001 $ 1,857
======= ======= ======= =======
Per share data:
Basic EPS $ 0.74 $ 0.84 $ 0.84 $ 0.79
======= ======= ======= =======
Diluted EPS $ 0.73 $ 0.84 $ 0.84 $ 0.79
======= ======= ======= =======
Dividends declared $ 0.44 $ 0.44 $ 0.48 $ 0.48
======= ======= ======= =======
Market price - high $ 55.56 $ 43.00 $ 41.19 $ 35.50
- low $ 34.00 $ 33.13 $ 33.81 $ 21.25
Basic and diluted EPS are computed independently for each of the periods
presented. Accordingly, the sum of the quarterly earnings per share amounts may
not agree to the total for the year.
During 1999, the Company recorded pre-tax charges primarily for voluntary early
retirement and separation programs ("VERS"), a factory closure and related
capacity reduction in Brazil and asset impairments in the beer segment.
1999 Quarters
-------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions)
VERS $ 287 $ 45 $ 8
Brazil factory closure 136
Beer asset impairments $ 29
------- ------- ------- -------
$ 287 $ 45 $ 144 $ 29
======= ======= ======= =======
40
<PAGE>
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
----------
1998 Quarters
-----------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions, except per share data)
Operating revenues $ 18,383 $ 18,978 $ 18,587 $ 18,443
======== ======== ======== ========
Gross profit $ 7,449 $ 7,903 $ 7,842 $ 7,799
======== ======== ======== ========
Net earnings $ 1,382 $ 1,736 $ 1,980 $ 274
======== ======== ======== ========
Per share data:
Basic EPS $ 0.57 $ 0.72 $ 0.81 $ 0.11
======== ======== ======== ========
Diluted EPS $ 0.57 $ 0.71 $ 0.81 $ 0.11
======== ======== ======== ========
Dividends declared $ 0.40 $ 0.40 $ 0.44 $ 0.44
======== ======== ======== ========
Market price - high $ 47.88 $ 41.56 $ 48.13 $ 59.50
- low $ 39.06 $ 34.75 $ 38.06 $ 45.00
During 1998, the Company recorded pre-tax charges for tobacco and shareholder
litigation settlements, VERS and severance.
1998 Quarters
-----------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in millions)
Tobacco settlements $ 806 $ 199 $ 111 $ 2,265
Shareholder settlement 116
VERS and severance 95 232 10
-------- -------- -------- --------
$ 901 $ 431 $ 121 $ 2,381
======== ======== ======== ========
41
