-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SQ+3uIQiC9HSfEK0U5ZjWbqYTri0vF1U969Adca1MHPhZfHL9+dbZSEbALRrLcJO ffBevYVCDy3h50thfuULWw== 0000950109-96-007546.txt : 19961118 0000950109-96-007546.hdr.sgml : 19961118 ACCESSION NUMBER: 0000950109-96-007546 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHILIP MORRIS COMPANIES INC CENTRAL INDEX KEY: 0000764180 STANDARD INDUSTRIAL CLASSIFICATION: FOOD & KINDRED PRODUCTS [2000] IRS NUMBER: 133260245 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08940 FILM NUMBER: 96662990 BUSINESS ADDRESS: STREET 1: 120 PARK AVE CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 212-880-3870 MAIL ADDRESS: STREET 1: 120 PARK AVE CITY: NEW YORK STATE: NY ZIP: 10017 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-8940 Philip Morris Companies Inc. ________________________________________________________________________________ (Exact name of registrant as specified in its charter) Virginia 13-3260245 ________________________________________________________________________________ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 120 Park Avenue, New York, New York 10017 ________________________________________________________________________________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 880-5000 ______________________________ ________________________________________________________________________________ Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ________ ________ At October 31, 1996, there were 814,399,021 shares outstanding of the registrant's common stock, par value $1 per share. PHILIP MORRIS COMPANIES INC. TABLE OF CONTENTS
Page No. PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited). Condensed Consolidated Balance Sheets at September 30, 1996 and December 31, 1995 3 - 4 Condensed Consolidated Statements of Earnings for the Nine Months Ended September 30, 1996 and 1995 5 Three Months Ended September 30, 1996 and 1995 6 Condensed Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 1995 and for the Nine Months Ended September 30, 1996 7 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1996 and 1995 8 - 9 Notes to Condensed Consolidated Financial Statements 10 - 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 24 - 38 PART II - OTHER INFORMATION Item 1. Legal Proceedings. 39 Item 6. Exhibits and Reports on Form 8-K. 39 Signature 40
-2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (in millions of dollars) (Unaudited)
September 30, December 31, 1996 1995 ------------- ------------ ASSETS CONSUMER PRODUCTS Cash and cash equivalents $ 459 $ 1,138 Receivables, net 5,105 4,508 Inventories: Leaf tobacco 3,483 3,332 Other raw materials 1,964 1,721 Finished product 3,154 2,809 ------- ------- 8,601 7,862 Other current assets 1,215 1,371 ------- ------- Total current assets 15,380 14,879 Property, plant and equipment, at cost 19,493 18,601 Less accumulated depreciation 8,081 7,485 ------- ------- 11,412 11,116 Goodwill and other intangible assets (less accumulated amortization of $4,275 and $3,873) 18,764 19,319 Other assets 3,378 2,866 ------- ------- Total consumer products assets 48,934 48,180 FINANCIAL SERVICES AND REAL ESTATE Finance assets, net 5,205 4,991 Real estate held for development and sale 326 339 Other assets 256 301 ------- ------- Total financial services and real estate assets 5,787 5,631 ------- ------- TOTAL ASSETS $54,721 $53,811 ======= =======
See notes to condensed consolidated financial statements. -3- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (continued) (in millions of dollars) (Unaudited)
September 30, December 31, 1996 1995 ------------- ------------ LIABILITIES CONSUMER PRODUCTS Short-term borrowings $ 320 $ 122 Current portion of long-term debt 1,755 1,926 Accounts payable 2,457 3,364 Accrued marketing 2,112 2,114 Accrued taxes, except income taxes 1,485 1,075 Other accrued liabilities 3,394 3,701 Income taxes 1,318 1,137 Dividends payable 982 834 ------- ------- Total current liabilities 13,823 14,273 Long-term debt 13,093 12,324 Deferred income taxes 562 356 Accrued postretirement health care costs 2,356 2,273 Other liabilities 5,466 5,643 ------- ------- Total consumer products liabilities 35,300 34,869 FINANCIAL SERVICES AND REAL ESTATE Short-term borrowings 221 671 Long-term debt 1,140 783 Deferred income taxes 3,505 3,382 Other liabilities 180 121 ------- ------- Total financial services and real estate liabilities 5,046 4,957 ------- ------- Total liabilities 40,346 39,826 Contingencies (Note 2) STOCKHOLDERS' EQUITY Common stock, par value $1.00 per share (935,320,439 shares issued) 935 935 Earnings reinvested in the business 21,976 19,779 Currency translation adjustments 282 467 ------- ------- 23,193 21,181 Less cost of repurchased stock (119,876,150 and 104,150,433 shares) 8,818 7,196 ------- ------- Total stockholders' equity 14,375 13,985 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $54,721 $53,811 ======= =======
See notes to condensed consolidated financial statements. -4- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions of dollars, except per share data) (Unaudited)
For the Nine Months Ended September 30, ------------------------- 1996 1995 ------- ------- Operating revenues $52,414 $50,335 Cost of sales 20,001 20,345 Excise taxes on products 11,232 9,943 ------- ------- Gross profit 21,181 20,047 Marketing, administration and research costs 11,724 11,498 Amortization of goodwill 443 443 ------- ------- Operating income 9,014 8,106 Interest and other debt expense, net 824 916 ------- ------- Earnings before income taxes and cumulative effect of accounting changes 8,190 7,190 Provision for income taxes 3,358 2,984 ------- ------- Earnings before cumulative effect of accounting changes 4,832 4,206 Cumulative effect of changes in method of accounting (Note 3) (28) ------- ------- Net earnings $ 4,832 $ 4,178 ======= ======= Weighted average number of shares 824 844 ======= ======= Per share data: Earnings before cumulative effect of accounting changes $ 5.87 $ 4.98 Cumulative effect of changes in method of accounting (.03) ------- ------- Net earnings $ 5.87 $ 4.95 ======= ======= Dividends declared $ 3.20 $ 2.65 ======= =======
See notes to condensed consolidated financial statements. -5- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions of dollars, except per share data) (Unaudited)
For the Three Months Ended September 30, -------------------------- 1996 1995 ------- ------- Operating revenues $17,414 $16,689 Cost of sales 6,596 6,565 Excise taxes on products 3,726 3,360 ------- ------- Gross profit 7,092 6,764 Marketing, administration and research costs 3,871 3,876 Amortization of goodwill 150 149 ------- ------- Operating income 3,071 2,739 Interest and other debt expense, net 281 290 ------- ------- Earnings before income taxes 2,790 2,449 Provision for income taxes 1,144 1,016 ------- ------- Net earnings $ 1,646 $ 1,433 ======= ======= Weighted average number of shares 818 839 ======= ======= Per share data: Net earnings $ 2.01 $ 1.71 ======= ======= Dividends declared $ 1.20 $ 1.00 ======= =======
See notes to condensed consolidated financial statements. -6- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 1995 and for the Nine Months Ended September 30, 1996 (in millions of dollars, except per share data) (Unaudited)
Earnings Total Reinvested Currency Cost of Stock- Common in the Translation Repurchased holders' Stock Business Adjustments Stock Equity ------ ---------- ----------- ----------- -------- Balances, January 1, 1995 $935 $17,489 $ (47) $(5,591) $12,786 Net earnings 5,450 5,450 Exercise of stock options and issuance of other stock awards (77) 470 393 Cash dividends declared ($3.65 per share) (3,065) (3,065) Redemption of stock rights (9) (9) Currency translation adjustments 514 514 Stock repurchased (2,075) (2,075) Net unrealized depreciation on securities (9) (9) ---- ------- ----- ------- ------- Balances, December 31, 1995 935 19,779 467 (7,196) 13,985 Net earnings 4,832 4,832 Exercise of stock options and issuance of other stock awards (25) 463 438 Cash dividends declared ($3.20 per share) (2,631) (2,631) Currency translation adjustments (185) (185) Stock repurchased (2,085) (2,085) Net unrealized appreciation on securities 21 21 ---- ------- ----- ------- ------- Balances, September 30, 1996 $935 $21,976 $ 282 $(8,818) $14,375 ==== ======= ===== ======= =======
See notes to condensed consolidated financial statements. -7- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (in millions of dollars) (Unaudited)
For the Nine Months Ended September 30, ------------------------- 1996 1995 ------- ------ CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net earnings - Consumer products $ 4,744 $ 4,101 - Financial services and real estate 88 77 ------- ------- Net earnings 4,832 4,178 Adjustments to reconcile net earnings to operating cash flows: CONSUMER PRODUCTS Depreciation and amortization 1,259 1,283 Deferred income tax provision 220 87 Gains on sales of businesses (68) (19) Cumulative effect of accounting changes 46 Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net (630) (791) Inventories (617) 281 Accounts payable (915) (1,364) Income taxes 334 490 Other working capital items (240) (98) Other 207 95 FINANCIAL SERVICES AND REAL ESTATE Deferred income tax provision 110 186 Decrease in real estate receivables 24 33 Decrease in real estate held for development and sale 13 55 Other 67 ------- ------- Operating cash flow before income taxes on sales of businesses 4,596 4,462 Income taxes on sales of businesses (74) (25) ------- ------- Net cash provided by operating activities 4,522 4,437 ------- ------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES CONSUMER PRODUCTS Capital expenditures (1,108) (1,054) Purchases of businesses, net of acquired cash (515) (96) Proceeds from sales of businesses 154 1,177 Other 12 (92) FINANCIAL SERVICES AND REAL ESTATE Investments in finance assets (306) (398) Proceeds from finance assets 154 105 ------- ------- Net cash used in investing activities (1,609) (358) ------- ------- Net cash provided by operating and investing activities $ 2,913 $ 4,079 ------- -------
See notes to condensed consolidated financial statements. -8- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (continued) (in millions of dollars) (Unaudited)
For the Nine Months Ended September 30, -------------------------- 1996 1995 ------- ------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES CONSUMER PRODUCTS Net issuance of short-term borrowings $ 329 $ 49 Long-term debt proceeds 1,966 530 Long-term debt repaid (1,487) (420) FINANCIAL SERVICES AND REAL ESTATE Net repayment of short-term borrowings (450) (121) Long-term debt proceeds 363 Repurchase of outstanding stock (2,097) (1,513) Dividends paid (2,483) (2,101) Issuance of shares 341 208 Stock rights redemption (9) Other (31) (16) ------- ------- Net cash used in financing activities (3,549) (3,393) Effect of exchange rate changes on cash and cash equivalents (43) 8 ------- ------- Cash and cash equivalents: (Decrease) increase (679) 694 Balance at beginning of period 1,138 184 ------- ------- Balance at end of period $ 459 $ 878 ======= =======
See notes to condensed consolidated financial statements. -9- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1. Accounting Policies: _____________________________ The interim condensed consolidated financial statements of Philip Morris Companies Inc. (the "Company") are unaudited. It is the opinion of the Company's management that all adjustments necessary for a fair statement of the interim results presented have been reflected therein. All such adjustments were of a normal recurring nature. Operating revenues and net earnings for any interim period are not necessarily indicative of results that may be expected for the entire year. These statements should be read in conjunction with the consolidated financial statements and related notes which appear in the Company's annual report to stockholders and which are incorporated by reference into the Company's Annual Report on Form 10-K for the year ended December 31, 1995. Balance sheet accounts are segregated by two broad types of business. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services and real estate assets and liabilities are unclassified, in accordance with respective industry practices. -10- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Note 2. Contingencies: - ----------------------- Legal proceedings covering a wide range of matters are pending in various U.S. and foreign jurisdictions against the Company and its subsidiaries, including Philip Morris Incorporated ("PM Inc."), a wholly-owned subsidiary of the Company. In certain of the proceedings pending against PM Inc. and, in some cases, the Company and/or certain of its other subsidiaries, plaintiffs allege injury resulting from cigarette smoking, "addiction" to cigarette smoking or exposure to environmental tobacco smoke ("ETS") and seek compensatory and, in some cases, punitive damages. As of September 30, 1996, there were 240 such smoking and health cases pending in the United States. Of these cases, 153 were filed in the state of Florida and served between April 28, 1995 and September 30, 1996. Two hundred nineteen of the smoking and health cases pending as of September 30, 1996, involve allegations of various injuries allegedly related to cigarette smoking. There are 15 purported class actions that have been served involving allegations of various injuries allegedly related to cigarette smoking. Ten of the smoking and health cases that have been served, including one that purports to be a class action, involve allegations of various personal injuries allegedly related to exposure to ETS. Twenty three cases currently pending involve state and local governments and others that have commenced actions seeking reimbursement for Medicaid and other health care expenditures allegedly caused by cigarette smoking. In addition, a purported class action involving allegations of various personal injuries allegedly related to cigarette smoking is pending in Canada against, among others, an entity in which the Company has a 40% indirect ownership interest, and another such action is pending in Brazil against a subsidiary of the Company, among others. There are also three lawsuits pending, including one which purports to be a class action, in which plaintiffs have alleged that PM Inc. failed to manufacture a fire-safe cigarette. In California individuals purportedly acting as "private attorneys general" have filed two suits seeking, among other things, injunctive relief, restitution and disgorgement of profits for alleged violations of California's consumer protection statutes. In August 1996, a jury awarded a former smoker and his spouse $750,000 in a smoking and health case against another leading United States cigarette manufacturer (Carter v. American Tobacco Co., et al.). Neither PM Inc. nor the Company was a party to that litigation. The defendant in that action has filed a motion for judgment notwithstanding the verdict. Later that month, a jury returned a verdict for the defendants in a smoking and health case in Indiana against leading United States cigarette manufacturers, including PM Inc. (Rogers v. R.J. Reynolds Tobacco Company, et al.) Plaintiff has appealed the verdict. During 1997, a number of individual smoking and health cases against the industry and PM Inc. are scheduled to go to trial. In addition, the Broin class action discussed below, and three Medicaid recovery actions are scheduled to go to trial in 1997. Two individual smoking and health cases against the industry, including PM Inc., and the Mississippi Medicaid recovery suit discussed below are scheduled to go to trial during the first quarter of 1997. Trial dates, however, are subject to change. -11- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) A description of certain pending class action and Medicaid and health care recovery litigation follows. SMOKING AND HEALTH CLASS ACTION LITIGATION ------------------------------------------ The plaintiffs' allegations of liability in those cases in which individuals seek recovery for personal injuries allegedly caused by cigarette smoking are based on various theories of recovery, including negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, breach of express and implied warranties, conspiracy, concert of action, violations of deceptive trade practice laws, consumer protection laws and antitrust statutes. Plaintiffs also seek punitive damages in many of these cases. Defenses raised by defendants in these cases include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, statutes of limitations or repose, and preemption by the Federal Cigarette Labeling and Advertising Act, as amended (the "Labeling Act"). In June 1992, the United States Supreme Court held that the Labeling Act, as enacted in 1965, does not preempt common law damage claims but that the Labeling Act, as amended in 1969, preempts claims arising after 1969 against cigarette manufacturers "based on failure to warn and the neutralization of federally mandated warnings to the extent that those claims rely on omissions or inclusions in advertising or promotions." The Court also held that the 1969 Labeling Act does not preempt claims based on express warranty, fraudulent misrepresentation or conspiracy. The Court also held that claims for fraudulent concealment were preempted except "insofar as those claims relied on a duty to disclose...facts through channels of communication other than advertising or promotion." (The Court did not consider whether such common law damage claims were valid under state law.) The Court's decision was announced by a plurality opinion. The effect of the decision on pending and future cases will be the subject of further proceedings in the lower federal and state courts. Additional similar litigation could be encouraged if legislation to eliminate the federal preemption defense, proposed in Congress in recent years, were to be enacted. It is not possible to predict whether any such legislation will be enacted. In 1991, a purported class action was filed in Florida state court against the leading United States cigarette manufacturers, in which certain flight attendants, claiming to represent a class of approximately 60,000 individuals, alleged personal injury caused by exposure to ETS aboard aircraft. Broin, et al. v. Philip Morris Incorporated, et al., Circuit of the Eleventh Judicial Circuit in and for Dade County Florida, Case No. 91-49738-CA-20. In December 1994, the trial court certified a class consisting of "all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from diseases and disorders caused by their exposure to second hand cigarette smoke in airline cabins." Various challenges to the trial court's class certification decision have been denied by the Florida Third District Court of Appeal and the Florida Supreme Court. This case is currently set for trial in June 1997. In May 1994, an action was filed in Florida state court against the leading United States cigarette manufacturers and others, by plaintiffs alleging injury and purporting to represent a class of certain smokers, certain former smokers and their heirs. Engle, et al. v. R.J. Reynolds Tobacco Company, et al., Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida, Case No. 94-08273-CA-20. In October 1994, the trial court granted plaintiffs' motion for class certification. The class, as certified, comprises "all United States citizens and residents and their survivors who have...suffered, presently suffer, or who have died from diseases and medical conditions caused by their addiction to cigarettes that contain nicotine." In January 1996, the Florida Third District Court of Appeal affirmed the trial court's class certification order, with the modification that the subject class -12- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) be restricted to Florida citizens and residents rather than United States citizens and residents. A motion by defendants requesting that the Florida Supreme Court exercise its discretionary authority to review the lower court's class certification decision was denied in October 1996. Plaintiffs have notified the trial court that they believe that the case is ready to be set for trial. In March 1994, an action was filed in Alabama state court against three leading United States cigarette manufacturers, including PM Inc. Defendants subsequently removed the case to federal court. Lacey, et al. v. Lorillard Tobacco Company, Inc. et al., United States District Court, Northern District of Alabama, Jasper Division, Civil Action No. CV94-B-0901-J. Plaintiffs, claiming to represent all smokers who have smoked or are smoking cigarettes sold by defendants in the State of Alabama, seek compensatory and punitive damages not to exceed $48,500 per each class member as well as injunctive relief arising from defendants' alleged failure to disclose additives used in their cigarettes. In August 1996, the judge orally granted the defendants' motion for summary judgment on the grounds that the suit is preempted by the Labeling Act. In March 1994, an action was filed in federal court in Louisiana against the leading United States cigarette manufacturers and others, including the Company, seeking certification of a purported class action on behalf of all United States residents who allege that they are addicted, or are the legal survivors of persons who were addicted, to tobacco products. Castano, et al. v. The American Tobacco Company Inc., et al., United States District Court, Eastern District of Louisiana, Case No. 94-1044. Plaintiffs alleged that the cigarette manufacturers concealed and/or misrepresented information regarding the addictive nature of nicotine and manipulated the levels of nicotine in their tobacco products to make such products addictive. In May 1996, the Court of Appeals reversed the district court's earlier certification of the class and remanded the case with instructions that the district court dismiss the class allegations. Summary judgment motions against the two remaining named plaintiffs in this case are pending. Since the announcement of the Court of Appeals' class decertification decision in Castano, purported statewide class action suits based on claims similar to those in Castano (a "nicotine-dependence class action") and, in some cases, claims of physical injury as well (a "physical injury class action") have been filed in several states as described below. Lawyers for the plaintiffs in Castano announced that they intend to file similar class actions and actions on behalf of individual plaintiffs in other state courts. Immediately prior to the Court of Appeals' decision in the Castano case, a purported nicotine-dependence class action suit was filed in Indiana state court against the leading United States cigarette manufacturers and others. In June 1996, defendants removed the case to federal court. Norton, et al. v. RJR Nabisco Holdings Corporation, et al., United States District Court for the Southern District of Indiana, Case No. IP96-0798-C-M/S. Plaintiffs' motion to remand the case to state court is pending. In May 1996, a purported physical injury class action suit was filed in Maryland state court against the leading United States cigarette manufacturers and others, including the Company. The case was removed by defendants to federal court and plaintiffs have moved to remand the case to state court. Richardson, et al., v. Philip Morris Incorporated, et al., United States District Court, District of Maryland, Civil Action No. CCB-96-1963. In May 1996, a purported nicotine-dependence class action suit was filed in Louisiana state court against four leading United States cigarette manufacturers and others, including the Company. The case was removed by defendants to the United States District Court for the Eastern District of Louisiana in June 1996 and was subsequently remanded to state court. Scott, et al. v. The American Tobacco Company, -13- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Inc., et al., Civil District Court for the Parish of Orleans, State of Louisiana, Docket No. 96-8461. In June 1996, a purported nicotine-dependence class action suit was filed in New York state court against PM Inc., the Company, the Tobacco Institute and the Council for Tobacco Research--U.S.A., Inc. Frosina, et al. v. Philip Morris Inc., et al., Supreme Court of the State of New York, County of New York, Case No. 96110950. In June 1996, a purported physical injury class action suit was filed in the Superior Court of the District of Columbia against the leading United States cigarette manufacturers and others, including the Company. Reed v. Philip Morris Incorporated, et al., Superior Court of the District of Columbia, Case No. CA- 05070-96. A hearing on whether plaintiff can pursue a class action has been scheduled for June 1997. In August 1996, a purported nicotine-dependence class action suit was filed in Pennsylvania state court against the leading United States cigarette manufacturers and others, including the Company. The case was subsequently removed by defendants to federal court. Arch, et al., v. American Tobacco Company Inc. et al., United States District Court for the Eastern District of Pennsylvania, Case No. 96-5903-CN. In August 1996, a purported nicotine-dependence class action suit was filed in Alabama state court, on behalf of Alabama and North Carolina residents, against four leading United States cigarette manufacturers and others, including the Company. In September 1996, the case was removed by defendants to federal court. Lyons, et al. v. The American Tobacco Co., Inc., et al., United States District Court for the Southern District of Alabama, Southern Division, Civil Action No. 96-0881-BH-S. Plaintiffs' motion to remand the case to state court is pending. In August 1996, a purported nicotine-dependence class action suit was filed in Ohio state court against the leading United States cigarette manufacturers and others, including the Company. The case was removed by defendants to federal court. Chamberlain, et al. v. The American Tobacco Co., et al., United States District Court, Northern District of Ohio, Case No. 1:96CV2005. Plaintiffs' motion to remand the case to state court is pending. In August 1996, a purported physical injury class was filed in Florida state court against the leading United States cigarette manufacturers, and others. Walters, et al. v. Brown & Williamson Tobacco Corp., et al., Circuit Court, Fourth Judicial District, Duval County, Florida. In September 1996, a purported nicotine-dependence class action suit was filed in Minnesota state court against four leading United States cigarette manufacturers and others, including the Company. The case was removed by defendants to United States District Court for the District of Minnesota in September 1996. Masepohl, et al. v. The American Tobacco Co., Inc., et al., United States District Court, District of Minnesota, Third Division, Case No. CV3-96-888. Plaintiff has filed a motion to remand the case to the state court. In October 1996, a purported nicotine-dependence class action suit was filed in New Mexico state court against four leading United States cigarette manufacturers and others, including the Company. Connor, et al. v. The American Tobacco Co., et al., Second Judicial District Court, County of Bernalillo, State of New Mexico, Case No. CV-96-9422. A similar action captioned Connor, et al. v. The American Tobacco Co., et al., which was filed in September 1996, was voluntarily dismissed by plaintiffs in October 1996. In October 1996, a purported nicotine-dependence class action suit was filed in federal court in Puerto Rico against four leading United States cigarette manufacturers and others. Ruiz v. The American Tobacco Co., -14- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) et al., United States District Court for the District of Puerto Rico, Civil Action No. 96-2300. In November 1996, a purported nicotine-dependence class action was filed in federal court in Arkansas against the leading United States cigarette manufacturers, and others, including the Company. McGinty, et al., v. The American Tobacco Co., et al., United States District Court for the Eastern District of Arkansas, Case No. LRC 96-881. In February 1995, Rothmans, Benson & Hedges, Inc. (in which the Company, through subsidiaries, owns a 40% interest) was served with a statement of claim commencing a purported class action in the Ontario Court of Justice, Toronto, Canada, against Imperial Tobacco Limited, RJR-MacDonald Inc., and Rothmans, Benson & Hedges. LeTourneau v. Rothmans et al., Ontario Court of Justice, Toronto, Canada. Court File No. 95-CU-82186 (now captioned Caputo v. Imperial Tobacco Limited, et al.). The lawsuit seeks damages in the amount of $1,000,000 (Canadian) per class member and punitive and exemplary damages and an order requiring the funding of rehabilitation centers. Plaintiffs seek certification of a class of persons who have suffered loss as a result of their alleged nicotine addiction and their estates and persons with related Family Law Act claims. Defendants' request for a more particular statement of claim prior to delivering their statement of defense was partially granted and partially denied in April 1996. Defendants have appealed that order. In July 1995, a purported class action on behalf of all Brazilian smokers and former smokers was filed in state court in Sao Paulo, Brazil, naming Philip Morris Marketing, S.A. ("PM Marketing") as a co-defendant. The Smoker Health Defense Association, et al. v. Souza Cruz, S.A. and Philip Morris Marketing, S.A., 19th Lower Civil Court of the Central Courts of the Judiciary District of Sao Paulo, Brazil. Plaintiffs allege that defendants failed to warn that smoking is "addictive" and engaged in misleading advertising. Plaintiffs have obtained an order, which was upheld on appeal, reversing the burden of proof and placing the burden on defendants. Pro se prisoners have filed two purported class actions against the leading United States cigarette manufacturers and others seeking, in one case, class certification on behalf of prisoners in two Mississippi prisons based on alleged exposure to ETS (Lyle, et al. v. Brown & Williamson Tobacco Corporation, et al., United States District Court for the Northern District of Mississippi, Civil Action No. 3:96-CV-268WS) and, in the other, on behalf of all allegedly nicotine-persons in the United States (Harris, et al. v. Philip Morris Incorporated, et al., United States District Court for the Eastern District of Pennsylvania, Civil Action No. 3:96-CV 652). In October 1996, the court issued an order dismissing the Lyle action. MEDICAID AND HEALTH CARE RECOVERY LITIGATION -------------------------------------------- In certain of the pending proceedings, state and local government entities and others seek reimbursement for Medicaid and other health care expenditures allegedly caused by tobacco products. The claims asserted in these Medicaid recovery actions vary. All plaintiffs assert the equitable claim that the tobacco industry was "unjustly enriched" by plaintiffs' payment of health care costs allegedly attributable to smoking and seek reimbursement of those costs. Other claims made by some but not all plaintiffs include the equitable claim of indemnity, common law claims of negligence, strict liability, breach of express and implied warranty, violation of a voluntary undertaking or special duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims under state and federal statutes governing consumer fraud, antitrust, deceptive trade practices and false advertising, and claims under the Federal Racketeer Influenced and Corrupt Organization Act ("RICO"). -15- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Each plaintiff seeks reimbursement of Medicaid and/or other health care costs. Other relief sought by some but not all plaintiffs includes punitive damages, treble damages for alleged antitrust law violations, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti-smoking programs, disclosure of nicotine yields and payment of attorneys and expert witness fees. Defenses raised by defendants include failure to state a valid claim, lack of benefit, adequate remedy at law, "unclean hands" (namely, that plaintiffs cannot recover because they participated in, and benefited from, the sale of cigarettes), lack of antitrust injury, federal preemption, lack of proximate cause and statute of limitations. In addition, defendants argue that they should be entitled to "set-off" any alleged damages to the extent a state benefits economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that all of 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 or a state) can seek recovery of health care costs from a third party solely by "standing in the shoes" of the injured party. Defendants argue that plaintiffs should be required to bring an action on behalf of each individual Medicaid recipient and should be subject to all defenses available against the injured party. In certain of these cases, defendants have also challenged the ability of the plaintiffs to use contingency fee counsel to prosecute these actions. Further, certain cigarette companies, including PM Inc., have filed related declaratory judgment actions in several states seeking to block the Medicaid recovery actions in those states and/or to prevent the state from hiring contingency fee counsel. The following is a summary of certain developments in each of the Medicaid and health care recovery suits pending against PM Inc. and, in some cases, the Company and the related declaratory judgment actions filed by tobacco companies. Florida -- In May 1994, the State of Florida enacted a statute which purports, - ------- among other things, to abolish affirmative defenses in Medicaid recovery actions. In June 1994, PM Inc. and others filed suit in Florida state court challenging the constitutionality of the statute. Associated Industries of Florida, Inc., et al. v. State of Florida Agency for Health Care Administration, et al., Circuit Court of the Second Judicial Circuit in and for Leon County, Florida, Case No. 94-3128. In June 1996, the Florida Supreme Court, by a 4 to 3 plurality opinion, ruled that the provisions of the statute that permitted the state to pursue its action without identifying individual Medicaid recipients violated defendants' due process rights under the Florida constitution and that defendants may rebut the state's claims of causation and damages on a recipient- by-recipient basis. The court held constitutional on its face the statutory provision abolishing affirmative defenses normally available to a third party, including assumption of the risk. However, the court stated that while this provision is constitutional on its face, it might be unconstitutional as applied in the state's case. The court also held that the state's independent cause of action created by statutory amendment could apply only to Medicaid costs paid after the amendment became effective in July 1994, that defendants could be held individually liable under a market share theory, that the state could use statistical evidence to present its case, and that the agency charged with enforcing the statute was constitutionally established. In September 1996, plaintiffs' petition for rehearing on the Florida Supreme Court's rulings on abrogation of affirmative defenses and application of the statute to conduct occurring before July 1994 was denied. In February 1995, the State of Florida filed a Medicaid recovery action under the statute in Florida state court. The State of Florida, et al. v. The American Tobacco Company, et al., Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida, Case No. CL 95 1466 AO. In September 1996, the trial court dismissed all of the state's claims except for its negligence and strict liability counts arising from Medicaid payments made after July 1, 1994, and its -16- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) count for injunctive relief. The court also ordered the state to disclose the identity of the Medicaid recipients within 30 days of its order. The state has filed a notice of appeal of the court's order. In October 1996, the state filed a coded listing (without names) for all Medicaid recipients with alleged smoking-related illnesses. Defendants' motion to strike the state's list for noncompliance with the Florida Supreme Court's order was denied and PM Inc., as a party in the Associated Industries case described above, filed a petition with the Florida Supreme Court challenging the sufficiency of the state's purported identification of Medicaid recipients. The trial in this case is scheduled to begin in August 1997. Mississippi -- In May 1994, the Attorney General of Mississippi filed a Medicaid - ----------- recovery action in Mississippi state court. Moore v. The American Tobacco Company, et al., Chancery Court of Jackson County, Mississippi, Case No. 94- 1429. In February 1995, the court granted plaintiff's motion to strike certain of defendants' challenges to the sufficiency of the complaint and denied defendants' motion for judgment on the pleadings. The court subsequently denied defendants' motion for partial summary judgment, which asserted that the Attorney General lacked the authority to bring those claims seeking Medicaid reimbursement. In July 1995, plaintiff filed a motion seeking to preclude defendants from asserting their "set off" defenses. That motion is pending. In April 1996, the Mississippi Supreme Court directed the Attorney General to respond to the Governor of Mississippi's petition requesting that the court issue a writ requiring the Attorney General to cease and desist from actions for recovery of Medicaid funds on the grounds the Attorney General has no authority to pursue such an action. Pursuant to the Supreme Court's order, the Attorney General responded to defendants' petition which requested that the Mississippi Supreme Court instruct the trial judge to dismiss those portions of the Attorney General's lawsuit that seek recovery of Medicaid funds due to lack of authority to bring such an action. The Mississippi Supreme Court heard arguments on both petitions in September 1996, but has not issued a decision on either petition. The trial has been scheduled to begin in March 1997. Minnesota -- In August 1994, the Attorney General of Minnesota and Blue Cross - --------- and Blue Shield of Minnesota filed a Medicaid recovery action in Minnesota state court. Minnesota, et al. v. Philip Morris Incorporated, et al., Minnesota District Court, Second Judicial District, County of Ramsey, Case No. C1-94-8565. In July 1996, the Minnesota Supreme Court ruled that Blue Cross did not have standing to pursue its tort claims against defendants, but that it could proceed against defendants for claims brought under antitrust and consumer protection statutes. The Supreme Court also held that Blue Cross could pursue directly its equitable claims, but only for injunctive (not monetary) relief. The case is scheduled to go to trial in 1998, but a specific date has not yet been set. West Virginia -- In September 1994, the Attorney General of West Virginia filed - ------------- a Medicaid recovery action in West Virginia state court. McGraw v. The American Tobacco Company, et al., Circuit Court of Kanawha County, West Virginia, Case No. 94-1707. In October 1995, the court issued a final order dismissing eight of ten counts of the complaint on the grounds that the Attorney General did not have standing to assert the common law counts of the complaint. The court also granted defendants' motion to prohibit prosecution of this case pursuant to a contingent fee agreement with private counsel. In June 1996, the Attorney General filed an amended complaint adding the Public Employees' Insurance Agency as a party plaintiff. In July 1996, defendants filed motions to dismiss all of the counts of the second amended complaint. Hearings on these motions are set for December 1996 and February 1997. In November 1996, plaintiffs filed a third amended complaint which added the West Virginia Department of Health and Human Resources as a plaintiff, and three law firms as defendants, and which asserts additional counts under theories of indemnity, negligent misrepresentation, negligence, and strict product liability. Texas -- In November 1995, PM Inc., the other leading United States cigarette - ----- manufacturers and the Tobacco Institute filed a lawsuit in state court in Texas seeking a declaration that the Attorney General cannot pursue a Medicaid recovery -17- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) action, which the Attorney General subsequently brought, as discussed below. Philip Morris Incorporated, et al. v. Dan Morales, Attorney General of the State of Texas, et al., District Court of Travis County, Texas, No. 94-14807. The complaint asserts that the lawsuit violates the United States Constitution and federal law as well as the Texas Constitution and Texas statutory and common law, and includes a request for a declaration that the Attorney General has no authority to enter into contingent fee agreements with private attorneys. In February 1996, plaintiffs filed a motion for partial summary judgment seeking a declaration that the Attorney General has no authority under Texas law to seek reimbursement of Medicaid expenditures from plaintiffs outside of the subrogation remedy provided by statute and that subrogation is the exclusive remedy for recovery of Medicaid expenditures from third parties. In June 1996, the court denied the Attorney General's challenge to the court's jurisdiction, but decided to hold the state court action in abeyance pending the action filed by the Attorney General in federal court in March 1996. The State of Texas v. The American Tobacco Company, et al., United States District Court, Eastern District of Texas, Civil No. 5-96CV91. In June 1996, defendants filed a number of motions, including a motion to dismiss the RICO claims of the complaint. The trial is set for September 1997. Massachusetts -- In November 1995, PM Inc., along with four other tobacco - ------------- manufacturers, commenced an action in federal court in Massachusetts against the Attorney General of Massachusetts seeking declaratory and injunctive relief in connection with the constitutionality of two recently enacted Massachusetts statutory provisions (as construed by the Attorney General). Philip Morris Incorporated, et al. v. Scott Harshbarger, United States District Court, District of Massachusetts, Case No. 95-12574-GAO. The complaint alleges that the Attorney General of Massachusetts had threatened to bring a Medicaid recovery action, which was subsequently brought, as discussed below. The complaint asserts claims based upon the United States Constitution and federal law, as well as certain Massachusetts state constitutional, statutory and common law claims. In July, 1996, oral argument was heard on the Attorney General's motion to dismiss the complaint, which is still pending. In December 1995, the Commonwealth of Massachusetts filed a Medicaid recovery suit in Massachusetts state court. Commonwealth of Massachusetts v. Philip Morris Inc., et al., Superior Court, Middlesex County, Civil Action No. 95-7378. In October 1996, defendants in the state court action moved to dismiss the Commonwealth's complaint. Maryland -- In January 1996, PM Inc., four other leading United States cigarette - -------- manufacturers, the Tobacco Institute and a local retailer, commenced an action in Maryland state court seeking a declaration that, under Maryland law, any contingent fee contract between the Attorney General and private attorneys to be appointed assistant counsel for the State and compensated in such a manner is invalid. Philip Morris Incorporated, et al. v. Parris N. Glendening, Governor of the State of Maryland, et al., Circuit Court for Talbot County, Maryland, Case No. CG 2829. The action was commenced in response to threats by the Governor and Attorney General to file a Medicaid recovery action, which was subsequently brought, as discussed below. In August 1996, the court denied plaintiffs' motion for summary judgment, granted defendants' motion for summary judgment and dismissed the case. Plaintiffs have appealed the Circuit Court's decision. In May 1996, the State of Maryland filed a Medicaid recovery action in Maryland state court. State of Maryland v. Philip Morris Incorporated, et al., Circuit Court for Baltimore County, Maryland, Case No. 96-122017/CL211017. In September 1996, defendants filed a motion to dismiss the state's complaint. Louisiana -- In March 1996, the Attorney General of Louisiana filed a Medicaid - --------- recovery action in Louisiana state court. Ieyoub, et al. v. The American Tobacco Company, et al., 14th Judicial District Court, Parish of Calcasieu, Louisiana, Case No. 96-1204. A hearing on defendants' argument that the Attorney General lacks capacity to bring this action is scheduled for December 1996. -18- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) San Francisco -- This action for recovery of health care expenses was filed in - ------------- June 1996 by the City and County of San Francisco in California federal court and was since joined by ten other California counties. City and County of San Francisco, et al. v. Philip Morris, Inc. et al., United States District Court, Northern District of California, Civil No. C 96-2090. Defendants have filed a motion to dismiss the complaint and a motion to disqualify contingency-fee counsel for plaintiffs. In September 1996, plaintiffs in the federal court action, joined by several medical associations and one other California county, filed an action in California state court seeking, among other things, injunctive relief and disgorgement of profits for alleged violations of California's consumer protection statutes. People of the State of California, et al. v. Philip Morris, Inc. et al., San Francisco Superior Court, County of San Francisco, Case No. 980864. Washington -- This Medicaid recovery action was filed in June 1996 by the - ---------- Attorney General of the State of Washington in Washington state court. State of Washington v. American Tobacco Co., Inc., et al., Superior Court of Washington, King County, No. 96-2-15056-8. Defendants' motion to dismiss several causes of action in the complaint, including those alleging violations of Washington's antitrust laws and equitable claims of unjust enrichment and breach of a special duty, was argued before the court in September 1996 and is still pending. The trial is scheduled for September 1998. Connecticut -- In June 1996, PM Inc., along with three other tobacco - ----------- manufacturers, commenced an action in federal court in Connecticut against the Attorney General of Connecticut seeking declaratory and injunctive relief. Philip Morris Inc., et al. v. Richard Blumenthal, United States District Court, District of Connecticut, Case No. 396CV01221 (PCD). The complaint alleges that the Attorney General threatened to bring a Medicaid recovery action, which was subsequently brought, as discussed below. The complaint asserts claims based upon the United States Constitution and federal law, as well as certain Connecticut state constitutional, statutory and common law claims. In July 1996, the Attorney General moved to dismiss the complaint, which motion was denied without prejudice. Also in July 1996, the State of Connecticut filed a Medicaid recovery action in Connecticut state court. Defendants subsequently removed the case to federal court. In October 1996, the case was remanded to state court, whereupon the Attorney General renewed his motion to dismiss the federal action. State of Connecticut v. Philip Morris Inc., et al., Superior Court, Judicial District of Litchfield, Case No. CV-96-01534405. In October 1996, defendants moved to have portions of the complaint or the entire complaint deleted, subject to proper repleading under Connecticut rules. Utah -- In July 1996, PM Inc. and the other leading United States cigarette - ---- manufacturers filed a lawsuit in state court in Utah seeking a declaration that the Attorney General of the State of Utah is not authorized by Utah law to hire special counsel and compensate them on a contingent fee basis for bringing a Medicaid recovery action. Philip Morris Incorporated, et al. v. Janet C. Graham, Attorney General of the State of Utah, et al., Third Judicial District Court of Salt Lake County, Utah, No. 960904948CV. The suit also challenges the right of the Attorney General to bring the threatened lawsuit, which was subsequently filed, as discussed below, as a matter of federal constitutional law and statutes and under the Utah constitution and Utah statutes and common law. In September 1996, the Utah Attorney General filed a Medicaid recovery action in federal court in Utah. State of Utah v. R.J. Reynolds Tobacco Company, et al., United States District Court, District of Utah, Case No. 2:96CV 0829W. As a result of this filing, the parties have agreed that the state court action will be stayed with the exception of defendants' claim regarding the Attorney General's retention of attorneys on a contingent fee basis. Los Angeles -- This action for the recovery of health care expenses was filed in - ----------- August 1996 by the County of Los Angeles in California state court. County of Los Angeles v. R.J. Reynolds Tobacco Company, et al., Superior Court of California, Los Angeles County, Case No. BC155068. -19- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Alabama -- This Medicaid recovery action was filed in Alabama state court in - ------- August 1996 as a putative class action on behalf of taxpayers of the State of Alabama. In August 1996, following local rules, the state court entered an order conditionally certifying the class. This action was subsequently removed by defendants to federal court. Crozier, et al. v. The American Tobacco Company, et al., United States District Court for the Middle District of Alabama, Case No. 96-A-1403-N. Plaintiffs' motion to remand to state court is pending. Kansas -- In August 1996, the Attorney General of Kansas filed a Medicaid - ------ recovery action in Kansas state court. State of Kansas, ex rel. Carla J. Stovall, Attorney General v. R.J. Reynolds Tobacco Co., et al., District Court of Shawnee County, Kansas, Case No. 96-CV-919. In November 1996, defendants moved to dismiss this case. Michigan -- This Medicaid recovery action was filed in August 1996 by the - -------- Attorney General of Michigan in Michigan state court. Frank J. Kelley, Attorney General, ex rel. State of Michigan v. Philip Morris Incorporated, et al., Circuit Court for the 30th Judicial Circuit, Ingham County, Michigan, Case No. 96-84281-CZ. In October 1996, defendants moved to dismiss certain counts of the complaint and to strike claims for compensatory and punitive damages. Oklahoma -- In August 1996, the Attorney General of Oklahoma filed a Medicaid - -------- recovery action in Oklahoma state court. State of Oklahoma, et al. v. R.J. Reynolds Tobacco Co., et al., District Court for Cleveland County, Oklahoma, Case No. CJ-96-1499-L. Arizona -- In August 1996, the Attorney General of Arizona filed a Medicaid - ------- recovery action in Arizona state court. State of Arizona, et al. v. American Tobacco Co., Inc., et al., Superior Court, Maricopa County, Arizona, No. CV 96- 14769. The Governor of Arizona has instructed the Attorney General to dismiss the case. Subsequently, the Attorney General filed an amended complaint that abandons the claims for Medicaid payments, but seeks recovery of other health care costs as well as other damages and forms of relief. Hawaii -- In August 1996, PM Inc. and three other cigarette manufacturers filed - ------ suit against the Hawaii Attorney General in federal district court in Hawaii seeking declaratory and injunctive relief invalidating a threatened Medicaid reimbursement action by Hawaii on the grounds that it would violate federal law. Philip Morris Inc., et al. v. Margery Bronster, U.S. District Court, Hawaii, Civ. No. 96-00722 HG. Ohio -- In September 1996, two Ohio local officials filed a Medicaid recovery - ---- action in Ohio state court, purportedly on behalf of the State of Ohio and all Ohio taxpayers. Defendants removed the case to federal court in Ohio. State ex rel. Coyne, Jr., et al. v. The American Tobacco Co., et al., United States District Court, Northern District of Ohio, Case No. 96-2247. New Jersey -- In August 1996, PM Inc., along with three other tobacco - ---------- manufacturers, commenced an action in New Jersey state court, seeking a declaration that New Jersey law does not authorize and in fact prohibits the retention of special counsel who will be compensated on a contingency fee basis for bringing the state's Medicaid recovery action. Philip Morris Incorporated, et al. v. Peter Verniero, Attorney General of the State of New Jersey, et al., Superior Court of New Jersey, Chancery Division, Mercer County, Case No. MER-C- 000114-96. The suit also challenges the right of the Attorney General to bring the threatened Medicaid reimbursement lawsuit, which was subsequently filed, as discussed below, as a matter of federal constitutional law and statutes and under the New Jersey constitution, statutes and common law. In October 1996, defendants in this action moved to dismiss the complaint. In September 1996, the State of New Jersey filed its Medicaid recovery action in New Jersey state court. The State of New Jersey, v. R.J. Reynolds Tobacco Company, et al., Chancery Court, Middlesex County, Case No. C-254-96. New York City -- This action for the recovery of health care expenses (including - ------------- Medicaid) was filed in October 1996 by the City of New York and the New York City Health and Hospitals Corporation in New York state court. City of New York, et al. v. -20- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) The Tobacco Institute, et al., Supreme Court of the State of New York, County of New York, Case No. 406225/96. Illinois -- In November 1996, the Attorney General of Illinois filed a -------- Medicaid recovery action in Illinois state court. People of the State of Illinois v. Philip Morris, Inc., et al., Circuit Court of Cook County, Illinois, Case No. 96 L 13146. Other state and local government entities have announced that they are considering similar proceedings to those discussed above. OTHER TOBACCO RELATED CLASS ACTION LITIGATION --------------------------------------------- In May 1995, PM Inc. announced a recall of certain of its products and in June and July four purported class actions relating to the recall were filed. Three of these cases have been dismissed. In September 1995, plaintiffs in the remaining action, Tijerina, et al., v. Philip Morris, Inc., et al., United States District Court, Northern District of Texas, Amarillo Division, Case No. 2-95-CV-120, filed an amended complaint alleging that PM Inc. has, for many years, knowingly manufactured filtered products that are defective because they contain "defective filters." Plaintiffs purport to bring this action on behalf of all persons who "are Texas residents and who have smoked Philip Morris filtered cigarettes manufactured with Hoechst Celanese filter materials" and who have suffered adverse health effects. Plaintiffs allege that the filters in these products contain hazardous chemicals and that cellulose acetate fibers break away from the filters and are inhaled and ingested by the consumer when the filtered products are used. Plaintiffs further allege that they relied on PM Inc.'s false and fraudulent misrepresentations, made through advertising, regarding the safety of the use of the filters. Motions to dismiss certain of plaintiffs' claims and motions for summary judgment are pending. In October 1996, the court denied plaintiffs' motion for class certification. In June 1995, an action was filed in federal court in Maryland against PM Inc. seeking certification of a purported class consisting of "all persons and estates injured as a result of the defendant's alleged failure to manufacture a fire safe cigarette since 1987." Sacks, et al. v. Philip Morris Inc., United States District Court, District of Maryland, Case No. WMN-95-1840. Plaintiffs alleged in their complaint that PM Inc. intentionally withheld and suppressed material information relating to technology to produce a cigarette less likely to cause fires and failed to design and sell its cigarettes using the alleged technology. Compensatory and punitive damages were sought. In September 1996, an order was entered denying plaintiffs' motion for leave to file an amended complaint and granting defendant's motion to dismiss. Plaintiffs have appealed the order. In September 1996, a purported class action was filed in Tennessee state court against four leading United States cigarette manufacturers and others, on behalf of all individuals and entities in the United States who have paid premiums to a Blue Cross or Blue Shield organization for medical insurance. The complaint alleges that defendants' actions have resulted in increased medical insurance premiums for all class members and seeks recovery under various consumer protection statutes as well as under theories of breach of special duty and unjust enrichment. Perry, et al. v. Philip Morris Incorporated, et al., The Circuit Court for Coffee County, Tennessee, Civil Action No. 27,960. OTHER CLASS ACTION LITIGATION ----------------------------- In April 1994, the Company, PM Inc. and certain officers and directors were named as defendants in a complaint filed as a purported class action in federal court in New York. Lawrence, et al. v. Philip Morris Companies Inc., et al., United States District Court, Eastern District of New York, Case No. 94 Civ. 1494 (JG). Plaintiffs allege that defendants violated the federal securities laws by maintaining artificially high levels of profitability through an inventory management practice pursuant to which defendants allegedly shipped more inventory to customers than was necessary to satisfy market demand. In August 1995, the court granted plaintiffs' -21- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) motion for class certification, certifying this action as a class action on behalf of all persons (other than persons associated with defendants) who purchased common stock of the Company during the period July 10, 1991 through April 1, 1993, inclusive, and who held such stock at the close of business on April 1, 1993. In February 1996, the Company filed a Petition for Writ of Mandamus with the United States Court of Appeals for the Second Circuit requesting the Court of Appeals to direct the trial court to withdraw its order granting class certification. In July 1996, an alleged class member moved to intervene in the action and to be named a class representative. In September 1996, the United States Court of Appeals for the Second Circuit denied defendants' Petition for Writ of Mandamus. In April 1994, the Company, PM Inc. and certain officers and directors were named as defendants in several purported class actions that were consolidated in the United States District Court in the Southern District of New York. Kurzweil, et al. v. Philip Morris Companies Inc., et al., United States District Court for the Southern District of New York, Case Nos. 94 Civ. 2373 (MBM) and 94 Civ. 2546 (MBM) and State Board of Administration of Florida, et al. v. Philip Morris Companies Inc., et al., United States District Court for the Southern District of New York, Case No. 94 Civ. 6399 (MBM). In those cases, plaintiffs asserted that defendants violated federal securities laws by, among other things, making allegedly false and misleading statements regarding the allegedly "addictive" qualities of cigarettes. In each case, plaintiffs claimed to have been misled by defendants' knowing and intentional failure to disclose material information. In September 1995, the court granted defendants' motion to dismiss the two complaints in their entirety. The court granted plaintiff in the State Board action leave to replead one of its claims. In April 1996, the court entered an order stipulating the dismissal of the State Board claims. In August 1996, the court entered judgment dismissing the claims in Kurzweil. In September 1996, the Kurzweil plaintiffs filed a motion in the district court to vacate the judgment and for leave to amend their complaint. Also in September 1996, the Kurzweil plaintiffs filed an appeal from the judgment in the United States Court of Appeals for the Second Circuit. Both the motion and the appeal are pending. In March 1995, an antitrust action was filed in California state court against four leading United States cereal manufacturers, including the Post Division of Kraft Foods, Inc. ("Kraft"), by plaintiffs purporting to represent all California residents who purchased defendants' cereal products during the four years preceding the date upon which the complaint was filed. McIver, et al. v. General Mills, Inc., et al., Superior Court of the State of California, County of Santa Barbara, Case No. 206666. Plaintiffs seek treble damages and the return of profits resulting from defendants' alleged conspiracy to fix and raise prices of cereal products sold to California consumers. In April 1995, a second purported class action similar to the earlier action was filed in the same court. In August 1995, the two cases were consolidated. In September 1995, the court granted defendants' motions for summary judgment. In December 1995, plaintiffs filed an appeal of that decision with the California Court of Appeals. In April 1996, an antitrust action was filed in federal court in Wisconsin against Kraft as a purported class action. Stuart, et al. v. Kraft Foods, Inc., et al., United States District Court, Eastern District of Wisconsin, Case No. 96-C-391. An amended complaint filed in July 1996, named two other leading dairy products manufacturers and the National Cheese Exchange as defendants. Plaintiff purports to represent all persons and entities in the United States (excluding governmental entities and political subdivisions) that sold milk and/or bulk cheese directly to Kraft or any of its alleged co-conspirators at any time since January 1, 1988. Plaintiff alleges that defendants engaged in a conspiracy to fix and depress the prices of bulk cheese and milk through their trading activity on the National Cheese Exchange and failed to deal in good faith with their bulk cheese and milk suppliers by paying them prices based on the National Cheese Exchange opinion. Plaintiff seeks injunctive and equitable relief and treble damages. Plaintiffs' motion for class certification and defendants' motion to dismiss plaintiffs' action are pending. -22- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) In September 1996, a second antitrust action was filed in federal court in Wisconsin against Kraft as a purported class action. Sheeks, et al. v. Kraft Foods, Inc., et al., United States District Court, Eastern District of Wisconsin, Case No. 96-C-1100. Plaintiffs are dairy farmers and assert virtually identical claims to those in the Stuart case discussed above. Plaintiffs are seeking to consolidate this action with the Stuart case. The Company and each of its subsidiaries named as a defendant believes, 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. It is not possible to predict the outcome of this litigation. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case, such as the Carter case discussed above, could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry. These developments generally receive widespread media attention. The Company is not able to evaluate the effect of these developing matters on pending litigation and the possible commencement of additional litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of all pending litigation. It is possible that the Company's results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially affected by an ultimate unfavorable outcome of certain pending litigation. Management believes, however, that the ultimate outcome of all pending litigation should not have a material adverse effect on the Company's financial position. Note 3. Recent Financial Accounting Pronouncements: - ---------------------------------------------------- Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed of." This statement requires that certain assets be reviewed for impairment and, if necessary, remeasured at fair value, whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The adoption of SFAS No. 121 at January 1, 1996 and its application during 1996, had no material impact on the Company's financial position or results of operations for the three and nine months ended September 30, 1996. Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which allows companies either to measure compensation cost in connection with employee stock compensation plans using a fair value based method or to continue to use an intrinsic value based method. The Company will continue to use the intrinsic value based method, which generally does not result in compensation cost. Effective January 1, 1995, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," for its non-U.S. retiree benefit plans and SFAS No. 116, "Accounting for Contributions Received and Contributions Made." The adoption of these Statements reduced 1995 net earnings by $21 million ($.02 per share) and $7 million ($.01 per share), respectively. In October 1996, the AICPA's Accounting Standards Executive Committee issued Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities," which requires adoption by the Company as of January 1, 1997. The Company is currently evaluating SOP 96-1 and has not yet estimated the impact of adoption, if any. -23- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. ________________________________________________________________________ CONSOLIDATED OPERATING RESULTS - ------------------------------
For the Nine Months Ended September 30, --------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------- ------- ------ ------ Tobacco $27,837 $24,704 $6,356 $5,523 Food 20,888 21,950 2,909 2,834 Beer 3,418 3,396 392 398 Financial services and real estate 271 285 139 120 Amortization of goodwill (443) (443) Unallocated corporate expenses (339) (326) ------- ------- ------ ------ Total $52,414 $50,335 $9,014 $8,106 ======= ======= ====== ======
For the Three Months Ended September 30, ---------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------- ------- ------ ------ Tobacco $ 9,497 $ 8,433 $2,226 $1,921 Food 6,710 7,001 941 921 Beer 1,118 1,163 117 119 Financial services and real estate 89 92 49 39 Amortization of goodwill (150) (149) Unallocated corporate expenses (112) (112) ------- ------- ------ ------ Total $17,414 $16,689 $3,071 $2,739 ======= ======= ====== ======
-24- 1996 COMPARED WITH 1995 Operating revenues for the first nine months of 1996 increased $2.1 billion (4.1%) and operating income for the first nine months increased $908 million (11.2%) over the comparable 1995 period. Operating revenues for the third quarter increased $725 million (4.3%) and operating income for the third quarter increased $332 million (12.1%) over the comparable 1995 period. Operating revenues increased in the first nine months and third quarter over the comparable 1995 periods due primarily to increases in tobacco revenues partially offset by the impact of divestitures of food businesses. Operating income increased in the first nine months and third quarter over the comparable 1995 periods due primarily to increases in the tobacco and food segments. Excluding the results of divested North American food businesses (discussed below in Food--Business Environment), operating revenues and operating income increased $4.0 billion (8.3%) and $1.0 billion (12.7%), respectively, in the first nine months over the comparable 1995 period and increased $1.2 billion (7.3%) and $380 million (14.1%), respectively, in the third quarter over the comparable 1995 period. Currency movements, primarily the Japanese yen, decreased operating income by $109 million and $74 million in the first nine months and third quarter of 1996, respectively, versus the comparable 1995 periods. Although the Company cannot predict future movements in currency rates, it currently estimates that currency movements, primarily the Japanese yen, will continue to have an unfavorable impact on 1996 operating income and, at current rates, will continue to unfavorably impact operating income in 1997. Excluding the cumulative effect of accounting changes discussed below, net earnings increased by $626 million (14.9%) in the first nine months of 1996 over the comparable 1995 period due to increased operating income ($908 million) and lower interest expense ($92 million), partially offset by a higher income tax provision ($374 million). Net earnings increased $213 million (14.9%) in the third quarter of 1996 over the comparable 1995 period due to increased operating income ($332 million) and lower interest expense ($9 million), partially offset by a higher income tax provision ($128 million). Excluding the cumulative effect of accounting changes discussed below, earnings per share of $5.87 in the first nine months of 1996 increased by 17.9% over the comparable 1995 period, due to an increase in earnings and fewer shares outstanding. Similarly, net earnings per share of $2.01 in the third quarter of 1996 increased 17.5% as compared to the prior year. As a result of the Company's share repurchase program, the weighted average number of shares outstanding decreased to 824 million in the first nine months of 1996 from 844 million in the first nine months of 1995. The weighted average number of shares outstanding decreased to 818 million in the third quarter of 1996 from 839 million in the third quarter of 1995. Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," for its non-U.S. retiree benefit plans and SFAS No. 116, "Accounting for Contributions Received and Contributions Made." The adoption of these Statements reduced 1995 net earnings by $21 million ($.02 per share) and $7 million ($.01 per share), respectively. As described in Note 3 to the Condensed Consolidated Financial Statements, effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and SFAS No. 123, "Accounting for Stock-Based Compensation." The adoption and application of SFAS No. 121 and SFAS No. 123 as of January 1, 1996 had no impact on the Company's financial position or results of operations for the three and nine months ended September 30, 1996. -25- In October 1996, the AICPA's Accounting Standards Executive Committee issued Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities," which requires adoption by the Company as of January 1, 1997. The Company is currently evaluating SOP 96-1 and has not yet estimated the impact of adoption, if any. OPERATING RESULTS BY BUSINESS SEGMENT _____________________________________ TOBACCO _______ BUSINESS ENVIRONMENT As discussed below, the tobacco industry, including PM Inc., the Company's domestic tobacco subsidiary, and Philip Morris International Inc. ("PMI"), the Company's international tobacco subsidiary, have faced, and continue to face, a number of issues which may adversely affect volume, operating revenues and operating income. In the United States, these issues include proposed federal regulatory controls (including, as discussed below, the issuance of final regulations by the United States Food and Drug Administration (the "FDA") which purport to regulate tobacco products as "drugs" or "medical devices"); actual and proposed excise tax increases; federal, state and local governmental and private restrictions on smoking (including restrictions imposed by airlines); new and proposed restrictions on tobacco manufacturing, marketing, advertising (including decisions by certain companies to limit or not accept tobacco advertising) and sales; new and proposed regulations to ban or severely restrict smoking in workplaces and in buildings permitting public access, to require substantial additional health warning and product content information on cigarette packages and in advertising, and to eliminate the tax deductibility of tobacco advertising and promotional costs; increased assertions of adverse health effects associated with both smoking and exposure to environmental tobacco smoke; legislation or other governmental action seeking to ascribe to the industry responsibility and liability for the purported adverse health effects associated with both smoking and exposure to environmental tobacco smoke; the diminishing social acceptance of smoking; increased pressure from anti-smoking groups; unfavorable press reports; governmental and grand jury investigations; private plaintiff class action litigation; and actions by states and local governments seeking Medicaid and health care reimbursement and existing and proposed laws to help facilitate such recoveries. See Note 2 to the Condensed Consolidated Financial Statements regarding certain litigation in which the Company and/or its subsidiaries (including PM Inc.) are defendants. In August 1996, the FDA issued final regulations purportedly designed to prevent minors from smoking. In the regulations, the FDA asserted that it has jurisdiction over nicotine as a "drug" and purports to regulate cigarettes as a "medical device" (a "nicotine delivery system") under the provisions of the Food, Drug and Cosmetic Act. The final regulations include severe restrictions on the distribution, marketing and advertising of cigarettes and would require the industry to comply with a wide range of labeling, reporting, recordkeeping, manufacturing and other requirements applicable to medical devices and their manufacturers. For the most part, the regulations are scheduled to become effective on August 28, 1997. The FDA's assertion of jurisdiction, if not reversed by judicial or legislative action, could lead to more expansive FDA- imposed restrictions on cigarette operations than those set forth in the final regulations and could adversely affect the volume, operating revenues and operating income of PM Inc. in amounts that cannot be determined. PM Inc. and other domestic cigarette manufacturers and an advertising firm have sued the FDA, seeking a judicial declaration that the FDA has no authority to regulate cigarettes and asking the court to permanently enjoin the FDA from enforcing its regulations. Similar suits have been filed against the FDA by manufacturers of -26- smokeless tobacco products, by a trade association of cigarette retailers and by advertising agency associations. A hearing on plaintiffs' motion for summary judgment has been scheduled for February 1997. The outcome of the litigation challenging the FDA regulations cannot be predicted. In August 1996, the Governor of Massachusetts signed legislation that would require cigarette manufacturers to disclose, for cigarettes sold in the Common- wealth, the flavorings and other ingredients used in each brand of such cigarettes, and to provide "nicotine-yield ratings" for their products based on standards to be established by the Massachusetts Department of Public Health. PM Inc. and PMI believe that enforcement of the statute could require the disclosure of valuable proprietary information concerning their brands. PM Inc. and three other domestic cigarette manufacturers have filed suit in federal district court in Boston challenging the ingredient-disclosure provision of the legislation as preempted by the Federal Cigarette Labeling and Advertising Act and as violating the commerce, full faith and credit, due process and takings clauses of the U.S. Constitution. A hearing on plaintiffs' motion for summary judgment has been scheduled for December 3, 1996. The outcome of this lawsuit cannot be predicted. The enactment of this legislation may encourage efforts in other states to enact similar legislation. Some foreign countries have also taken steps to restrict or prohibit cigarette advertising and promotion, to increase taxes on cigarettes, to control prices, to restrict imports, to propose disclosure of product ingredients, to impose maximum constituent levels and to discourage cigarette smoking. It is not possible to predict what, if any, other foreign or domestic governmental legislation or regulations will be adopted relating to the manufacturing, advertising, sale or use of cigarettes or to the tobacco industry generally. In June 1995, PM Inc. announced that it had voluntarily undertaken a program to limit minors' access to cigarettes. Elements of the program include discontinuing free cigarette sampling to consumers in the United States, discontinuing the distribution of cigarettes by mail to consumers in the United States, placing a notice on cigarette cartons and packs for sale in the United States stating "Underage Sale Prohibited," working with others in support of state legislation to prevent youth access to tobacco products, taking measures to encourage retailer compliance with minimum-age laws, and independent auditing of the program. In May 1996, PM Inc. proposed that comprehensive federal legislation be enacted to respond to concerns by the President and others regarding the use of tobacco products by minors. The proposed legislation would establish a federal minimum age of 18 for the sale of tobacco products and would ban, restrict or otherwise limit the following among other things: cigarette vending machines; tobacco product brand names, logos, characters and selling messages on non- tobacco-related items such as hats or T-shirts; tobacco product sponsorship of events with significant youth audiences; outdoor advertisements for tobacco products within 1,000 feet of any playground or elementary or secondary school, including outward-facing window display advertising; advertisements for tobacco products in or on trains, buses, subways and taxis, and in terminals, stations, platforms or stops for these vehicles; and advertisements for tobacco products in youth-oriented publications. The proposed legislation would restrict youth access to tobacco products by calling for a ban on the sale of single cigarettes or packs with fewer than 20 cigarettes; requiring all tobacco sales to be face- to-face, where proof of age can be verified for anyone appearing to be under age 21; mandating that tobacco products in retail establishments be displayed within the control or line of sight of an employee; banning sampling except in locations where minors are denied access; and requiring retailers and their employees to certify that they understand and will comply with minimum-age laws. To ensure compliance, the proposed legislation calls for penalties of up to $50,000 for violations by a tobacco manufacturer. The proposed legislation also calls for a $250 million contribution from the tobacco industry (based on market share) over a five-year period to assist the government and others in implementation and enforcement. The proposed legislation would preclude the FDA from regulating tobacco products. As of the date of this filing, this legislation has not been introduced in either house of Congress. -27- PM Inc. has received requests for information (including, in some cases, grand jury subpoenas or Civil Investigative Demands) in connection with governmental investigations of the tobacco industry, and is cooperating with respect to such requests. Certain present and former employees of PM Inc. have testified or have been asked to testify in connection with certain of these matters. The investigations are as follows: An investigation by the United States Department of Justice relating to the possibility of alleged joint activity to restrain competition in the manufacture and sale of cigarettes, including possible joint activity to restrict research and development or product innovations; An investigation by the United States Attorney for the Eastern District of New York relating to The Council for Tobacco Research-U.S.A., Inc., a research organization of which PM Inc. is a sponsor; An investigation by the United States Attorney for the Eastern District of Virginia relating to Healthy Buildings International, Inc.; and An investigation by the United States Department of Justice relating to issues raised in testimony provided by tobacco industry executives before Congress. PM Inc. has been informed that an investigation by the United States Attorney for the Southern District of New York, which had been initiated following the publication of an article in The New York Times that made allegations about PM Inc. documents and supposedly secret research relating to nicotine, has been consolidated with the United States Department of Justice investigation discussed immediately above. While the outcomes of these investigations cannot be predicted, PM Inc. believes it has acted lawfully. In July 1996, PMI learned of a criminal investigation of certain employees and officers of certain affiliates of PMI by the Criminal Prosecutors Office in Naples, Italy, regarding an alleged conspiracy to avoid the payment of taxes. Subsequently, PMI's Italian affiliate, Intertaba, s.p.a. ("Intertaba"), was served with tax assessments relating to value added taxes on royalties paid to affiliates of PMI by Amministrazione Autonoma Dei Monopoli di Stato, the Italian state cigarette monopoly, for the years 1989 to 1994. The aggregate amount of taxes alleged to be due, together with interest and penalties, is $104.5 million. PMI anticipates that Intertaba may receive further value added tax assessments for 1995 and 1996, as well as income tax assessments, the aggregate amount of which could be substantial. However, PMI and its affiliates believe they have complied with applicable Italian tax laws and intend to vigorously contest the assessments. Also in July 1996, an affiliate of PMI received a request for information from the Competition Directorate of the European Commission concerning the relationship of certain affiliates of PMI with the Italian state cigarette monopoly. PMI and its affiliates believe that they have acted in accordance with European Community law. In March 1996, Liggett Group, Inc., a United States manufacturer and seller of cigarettes ("Liggett"), announced an agreement to settle the Castano case described in Note 2 to the Condensed Consolidated Financial Statements. The agreement is subject to court approval. Liggett also announced an agreement to settle the Medicaid reimbursement actions brought by the states of Florida, Louisiana, Massachusetts, Mississippi and West Virginia. As part of each settlement, Liggett agreed to comply with certain aspects of the regulations proposed by the FDA, to make certain payments and to cooperate in limited ways with otherwise adverse parties in certain investigations and lawsuits. The terms of the settlements would be available to any other defendant that has a share of the United States domestic cigarette market of less than 30% if it acquires or is acquired by Liggett, and each settlement can be terminated by Liggett upon the -28- occurrence of specified events. Liggett's sales account for approximately 2% of the United States domestic cigarette market. The major cigarette manufacturers in the United States, including PM Inc., have stated that they do not intend to settle any smoking and health litigation and that they will continue to defend all such actions vigorously. Press reports have discussed a proposal to forge a comprehensive legislative solution to smoking and health claims against the tobacco industry. The Company did not initiate the proposal and believes it is unrealistic. The Company believes that any such legislation would involve significant and perhaps insurmountable difficulties in reconciling the views of many competing interests. However, the Company will explore all reasonable measures that may be in the best interests of its shareholders. A recent issue of the journal Science reported the results of a study that ------- suggest that a metabolite of a chemical found in cigarette smoke may be involved in a cellular mechanism leading to lung cancer. The Company believes that the study merits careful review. In addition to the foregoing, there is litigation pending against the Company and its subsidiaries which is discussed in Note 2 to the Condensed Consolidated Financial Statements. The Company's position with regard to this litigation is set forth therein. 1996 COMPARED WITH 1995
For the Nine Months Ended September 30, --------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------- ------- ------ ------ Domestic tobacco $ 9,251 $ 8,504 $3,131 $2,797 International tobacco 18,586 16,200 3,225 2,726 ------- ------- ------ ------ Total $27,837 $24,704 $6,356 $5,523 ======= ======= ====== ======
DOMESTIC TOBACCO. During the first nine months of 1996, PM Inc.'s operating revenues increased 8.8% over the comparable 1995 period, due to higher volume ($382 million), pricing ($305 million) and improved product mix ($60 million). Operating income for the first nine months of 1996 increased 11.9% over 1995, due to price increases, net of product cost increases ($253 million), higher volume ($238 million), improved product mix ($53 million) and lower fixed manufacturing expense ($88 million, due primarily to the costs of a product recall in the second quarter of 1995), partially offset by higher marketing, administration and research expense ($298 million). The premium and discount segments (based on shipments) accounted for approximately 71.5% and 28.5%, respectively, of domestic cigarette industry volume in the first nine months of 1996, versus approximately 69.7% for the premium segment and 30.3% for the discount segment in the first nine months of 1995. PM Inc.'s volume (based on shipments) for the first nine months of 1996 was 172.2 billion units, an increase of 4.6% over 1995, compared with an industry increase of 0.5%, over the comparable period in 1995. While 1996 industry volume increased, due in part to one extra shipping day in 1996, PM Inc. estimates that, over the long-term, industry shipments should continue to decline at their historical average of 1% to 2% per annum. PM Inc.'s market share (based on shipments) for the first nine months of 1996 was 47.6%, an increase of 1.8 share points from the first nine months of 1995. In the premium segment, volume in PM Inc.'s brands increased 6.7%, compared with a -29- 3.1% increase for the industry, resulting in a premium segment share of 56.1%, an increase of 1.9 share points from the first nine months of 1995. Marlboro volume was up 9.3 billion units (8.7%) for a 32.1% share of the total industry, an increase of 2.4 share points from 1995. In the discount segment, PM Inc.'s shipments decreased 5.6%, to 27.2 billion units, in the first nine months of 1996 compared with an industry decline of 5.4%, resulting in a discount segment share of 26.4%, unchanged from the first nine months of 1995. Retail sales data (compiled by the A.C. Nielsen Company) indicate PM Inc. and Marlboro market shares of 49.3% and 33.2%, respectively, in the first nine months of 1996, compared with 47.1% and 30.4%, respectively, in the first nine months of 1995. The market share for PM Inc.'s other premium brands as a group was 9.0% in 1996, up slightly from the comparable period in 1995. In the discount segment, Basic increased its segment share to 17.3%, an increase of 1.8 share points from the first nine months of 1995. PM Inc. cannot predict change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, market share (based on shipments) or retail market share. During the second quarter of 1996, PM Inc. implemented a $2.00 per thousand cigarettes increase in the price of its domestic premium and discount brands. PM Inc. previously increased the price of its domestic brands by $1.50 per thousand cigarettes in the second quarter of 1995. INTERNATIONAL TOBACCO. During the first nine months of 1996, tobacco operating revenues of PMI increased 14.7%, due primarily to higher foreign excise taxes ($1.2 billion, including those for previously unconsolidated and newly acquired subsidiaries), favorable volume/mix ($831 million) and pricing ($308 million), and the impact of previously unconsolidated and newly acquired subsidiaries ($240 million, excluding excise taxes), partially offset by unfavorable currency movements ($204 million). Operating income increased 18.3%, due primarily to favorable volume/mix ($416 million) and pricing ($308 million), partially offset by unfavorable currency movements ($121 million) and higher marketing, administration and research costs. Total international volume grew 54.1 billion units (11.7%) in the first nine months of 1996 over the comparable 1995 period to 517.8 billion units. Volume includes local brands manufactured by ZPT-Krakow, a Polish cigarette manufacturer, in which PMI acquired a controlling interest during the first quarter of 1996. Volume advanced in most major markets, including Germany, Italy, Spain, the Benelux countries, Eastern Europe, the Middle East, Turkey, Japan, Korea, Singapore and Argentina. Volume continued to decline in Mexico, as consumers continued to trade down to lower-priced brands. PMI's market shares also rose in most major markets, with significant increases recorded in Germany, Italy, Spain, the Benelux countries, Switzerland, Turkey, Japan, Korea, Singapore and Hong Kong. -30-
For the Three Months Ended September 30, ---------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------ ------ ------ ------ Domestic tobacco $3,284 $2,928 $1,098 $ 972 International tobacco 6,213 5,505 1,128 949 ------ ------ ------ ------ Total $9,497 $8,433 $2,226 $1,921 ====== ====== ====== ======
DOMESTIC TOBACCO. During the third quarter of 1996, PM Inc.'s operating revenues increased 12.2% over the comparable 1995 period, due to higher volume ($221 million), pricing ($111 million) and improved product mix ($24 million). Operating income for the 1996 third quarter increased 13.0% from 1995, due to higher volume ($139 million), price increases, net of product cost increases ($91 million) and improved product mix ($20 million), partially offset by higher marketing, administration and research costs ($108 million) and higher fixed manufacturing expense ($16 million). The premium and discount segments (based on shipments) accounted for approximately 71.9% and 28.1%, respectively, of domestic cigarette industry volume in the third quarter of 1996, versus approximately 69.8% for the premium segment and 30.2% for the discount segment in the third quarter of 1995. PM Inc.'s volume (based on shipments) for the third quarter of 1996 was 60.4 billion units, an increase of 7.8% over 1995, compared with an industry increase of 2.1%, from the comparable period in 1995. A portion of the volume gain was due to a favorable comparison against 1995's third quarter, when three major factors reduced volume: wholesalers shifted a portion of 1995 third quarter shipments to the second quarter in advance of an extended July 4th holiday weekend; distributor buying patterns resulted in lower 1995 third quarter-end wholesaler inventories; and the 1995 third quarter had one less shipping day. While industry volume grew in the third quarter of 1996 from the comparable 1995 period, due primarily to the previously-discussed favorable comparison, PM Inc. estimates that, over the long-term, industry shipments should continue to decline at their historical average of 1% to 2% per annum. PM Inc.'s market share (based on shipments) for the third quarter of 1996 was 48.1%, an increase of 2.5 share points from the third quarter of 1995. In the premium segment, volume in PM Inc.'s brands increased 10.7%, compared with a 5.1% increase for the industry, resulting in a premium segment share of 56.6%, an increase of 2.8 share points from the third quarter of 1995. Marlboro volume was up 4.7 billion units (13.0%) for a 32.8% share of the total industry, an increase of 3.2 share points from 1995. In the discount segment, PM Inc.'s shipments decreased 5.9%, to 9.3 billion units, in the third quarter of 1996 compared with an industry decline of 4.9%, resulting in a discount segment share of 26.3%, a decrease of 0.3 share points from the third quarter of 1995. Retail sales data (compiled by the A.C. Nielsen Company) indicate PM Inc. and Marlboro market shares of 49.7% and 33.7%, respectively, in the third quarter of 1996, compared with 47.1% and 30.6%, respectively, in the third quarter of 1995. The market share for PM Inc.'s other premium brands as a group was 9.0% in 1996, up slightly from the comparable period in 1995. In the discount segment, Basic increased its segment share 1.8 points, to 17.7%, in the third quarter of 1996. -31- PM Inc. cannot predict change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, market share (based on shipments) or retail market share. INTERNATIONAL TOBACCO. During the third quarter of 1996, tobacco operating revenues of PMI increased 12.9%, due to higher foreign excise taxes ($325 million, including those for previously unconsolidated and newly acquired subsidiaries), favorable volume/mix ($299 million) and pricing ($162 million), and the impact of previously unconsolidated and newly acquired subsidiaries ($75 million, excluding excise taxes), partially offset by unfavorable currency movements ($153 million). Operating income increased 18.9% due primarily to favorable pricing ($162 million) and volume/mix ($140 million), partially offset by unfavorable currency movements ($72 million) and higher marketing, administration and research costs. Total international volume grew 15.8 billion units (9.8%) in the third quarter of 1996 over the comparable 1995 period to 177.1 billion units. Volume includes local brands manufactured by ZPT-Krakow, a Polish cigarette manufacturer, in which PMI acquired a controlling interest during the first quarter of 1996. Volume advanced in virtually all major markets, including Germany, Italy, Spain, the Benelux countries, Eastern Europe, the Middle East, Turkey, Japan and Argentina. Volume continued to decline in Mexico, as consumers continued to trade down to lower-priced brands. PMI's market shares rose in most major markets, with significant increases in Germany, Italy, Spain, the Benelux countries, Switzerland, Turkey, Japan, Korea, Singapore and Hong Kong. FOOD ____ BUSINESS ENVIRONMENT Several steps have been taken to build the value of premium brands, reduce costs and increase profitability in the food businesses. Effective January 1995, the North American food business was reorganized to combine the operations of Kraft USA and General Foods USA. The combined organization, named Kraft Foods, Inc. ("Kraft"), has streamlined operations and improved effectiveness and customer response. In December 1995, the international food business, Kraft Foods International, Inc. ("KFI"), was realigned to capitalize on future growth opportunities and reorganized into separate regional units: Western Europe; Northern Europe; Central and Eastern Europe, Middle East and Africa; and Asia/Pacific. In Latin America, where certain subsidiaries and affiliates of PMI manufacture and market a wide variety of food products, PMI acquired nearly all of the remaining voting shares of Industrias de Chocolate Lacta S.A. ("Lacta"), a Brazilian chocolate confectionery company, in the second quarter of 1996. Kraft and KFI have sold certain non-strategic businesses. In 1995, Kraft sold its bakery and margarine businesses during the fourth quarter, its specialty oils, marshmallows and caramels businesses during the third quarter and substantially all of the distribution businesses of Kraft Foodservice during the first quarter. In addition, KFI sold several smaller international food businesses in 1995. During 1996, Kraft and KFI have continued to realign their portfolios of businesses and focus on higher-margin premium products. During the third quarter of 1996, KFI recorded gains of $70 million, primarily on the sales of its margarine businesses in the U.K. and Italy. KFI also recorded a charge for cost reduction initiatives during the quarter. The net impact of these items was immaterial to 1996 third quarter results of operations. KFI has also negotiated an agreement to sell Malaco, a Scandinavian sugar confectionery business, subject to government approval; the sale may be completed in the fourth quarter of 1996. In addition, Kraft and KFI have sold several smaller food businesses in 1996. These divestitures are not expected to have a material effect on their 1996 or future results of operations. -32- Both Kraft and KFI have been affected by green coffee bean cost volatility, which began with frosts in Brazil in 1994. Throughout 1995, green coffee bean prices remained volatile, significantly affecting consumer buying patterns and leading to intense price competition among coffee companies in some markets. In 1996, intense competition has continued as green coffee bean prices declined. The green coffee bean price decline has lowered 1996 operating revenues as prices charged to consumers have been reduced. Kraft has also been affected by record high cheese commodity costs, as well as other higher dairy commodity costs, arising from low U.S. milk production. The increased commodity costs have led to an increase in prices charged to consumers. Additionally, Kraft's cereal business has been affected by intense price competition from low-priced brands. In response, Kraft implemented price reductions and simplified couponing of its cereal products. Several competitors followed with similar pricing strategies. 1996 COMPARED WITH 1995
For the Nine Months Ended September 30, --------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------- ------- ------ ------ North American food $12,509 $13,913 $2,062 $2,022 International food 8,379 8,037 847 812 ------- ------- ------ ------ Total $20,888 $21,950 $2,909 $2,834 ======= ======= ====== ======
NORTH AMERICAN FOOD. During the first nine months of 1996, operating revenues decreased 10.1% from the comparable 1995 period, due to the impact of divestitures ($1.9 billion), product mix ($93 million) and pricing ($56 million), partially offset by volume increases in on-going operations ($608 million) and the impact of acquisitions ($46 million). Operating income increased 2.0% over the comparable 1995 period due primarily to volume increases in on-going operations ($337 million), partially offset by net price reductions and net cost increases ($135 million), the impact of divestitures ($107 million) and product mix ($71 million). The effect of pricing on 1996 operating revenues was due primarily to price reductions in coffee and cereals, partially offset by price increases in cheese. The effect of net price reductions on 1996 operating income was due primarily to price reductions in cereals. The effect of net cost increases on 1996 operating income was due primarily to higher cheese commodity costs. Excluding operating results of the divested businesses discussed above, North American food operating revenues and operating income increased 4.5% and 7.7%, respectively, in the first nine months of 1996 compared with the comparable 1995 period. Significant volume gains were achieved in beverages, on the strength of ready-to-drink and powdered products; desserts, due to strength in packaged and refrigerated products, as well as the acquisition of a shelf-stable pudding product line in the fourth quarter of 1995; and frozen pizza, helped by new product introductions and geographic market expansion. Volume also increased in coffee, aided by sales of premium-priced line extensions, and processed meats, with growth in lunch combinations, driven by product introductions. Volume increased in cereals in the first nine months of 1996, due primarily to product introductions and Kraft's implementation of price reductions and simplified couponing in the second quarter. -33- INTERNATIONAL FOOD. Operating revenues for the first nine months of 1996 increased 4.3% over the first nine months of 1995, due to higher volume ($121 million, reflecting an additional selling week in 1996) and the consolidation of previously unconsolidated operations in emerging markets ($448 million), the impact of acquisitions ($31 million), partially offset by pricing ($175 million, primarily coffee) and the impact of divestitures ($77 million). Operating income during the first nine months of 1996, which included the results from an extra selling week, increased 4.3% over the comparable 1995 period reflecting higher volume ($60 million), cost decreases, net of price reductions ($35 million), and the consolidation of previously unconsolidated operations in emerging markets ($30 million), partially offset by higher marketing, administration and research costs ($97 million, primarily higher marketing costs partially offset by lower administration costs). During the first nine months of 1996, several small international businesses were sold, and margarine businesses in the U.K. and Italy were sold at gains. In addition, a charge was recorded for cost reduction initiatives. The net impact of these items was not material to operating income. Higher international food volume was due primarily to the consolidation of previously unconsolidated businesses, an extra selling week in the first quarter and growth in a number of developing markets. KFI's coffee volume increased in all regions during the first nine months of 1996 over the first nine months of 1995, particularly in several key markets such as Germany and France, KFI's largest coffee markets. Although volume gains in coffee were realized during the first nine months of 1996, volume related earnings gains were not realized due to continued intense competition and higher coffee margins in 1995. KFI's confectionery volume increased, especially in the emerging markets of Central and Eastern Europe but volume declined in several Western and Northern European markets. KFI's cheese and grocery volumes were down, due to divestitures of businesses, lower sliced beef sales in Italy and the effects of a peanut butter recall in Australia. Price competition remains intense in all international food categories and may continue to have an unfavorable impact on volume and operating income during 1996. Latin America volume was higher on strong sales of powdered soft drinks throughout the region.
For the Three Months Ended September 30, ---------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1996 1995 1996 1995 ------ ------ ---- ---- North American food $4,062 $4,366 $642 $635 International food 2,648 2,635 299 286 ------ ------ ---- ---- Total $6,710 $7,001 $941 $921 ====== ====== ==== ====
NORTH AMERICAN FOOD. During the third quarter of 1996, operating revenues decreased 7.0% from the comparable 1995 period, due primarily to the impact of divestitures ($465 million), product mix ($41 million) and pricing ($6 million), partially offset by volume increases in on-going operations ($172 million), the impact of acquisitions ($24 million) and currency movements ($12 million). Operating income increased 1.1% over the comparable 1995 period, due primarily to volume increases in on-going operations ($95 million) and lower marketing, administrative and research expenses ($65 million), partially offset by net price reductions and net cost increases ($90 million), the impact of divestitures ($48 million) and product mix ($22 million). The effect of pricing on 1996 operating revenues was due primarily to -34- price reductions in coffee and cereals, partially offset by price increases on cheese. The effect of net price reductions on 1996 operating income was due primarily to price reductions in cereals. The effect of net cost increases on 1996 operating income was due primarily to higher cheese commodity costs. Excluding operating results of divested businesses, discussed above, North American food operating revenues and operating income increased 4.1% and 9.4%, respectively, in the third quarter of 1996 compared with the comparable 1995 period. Significant volume gains were achieved in beverages, on the strength of ready-to-drink products; desserts, due to refrigerated desserts, frozen toppings and the acquisition of a shelf-stable pudding product line in the fourth quarter of 1995; and frozen pizza, helped by new product introductions and geographic market expansion. Volume gains were also realized in processed meats, driven by hot dogs and lunch combinations, which were aided by new product introductions, coffee, aided by sales of premium-priced line extensions and meals, benefiting from dinners and sales from Taco Bell grocery products, acquired in the third quarter of 1996. Volume also increased in the cereals business, as consumers responded to price reductions and new product introductions. Cheese volume was down slightly for the quarter, reflecting weakness in the process cheese category as a result of commodity-driven price increases. INTERNATIONAL FOOD. Operating revenues for the third quarter of 1996 increased 0.5% compared to the third quarter of 1995, due to the consolidation of previously unconsolidated operations in emerging markets ($86 million), higher volume ($59 million) and the impact of acquisitions ($25 million), partially offset by pricing ($69 million, reflecting lower coffee prices and continued intense price competition in Western Europe), currency movements ($51 million) and the impact of divestitures ($37 million). Operating income increased 4.5% over the comparable 1995 period reflecting higher volume ($20 million) and cost decreases, net of price reductions ($8 million), partially offset by higher marketing, administration and research costs ($8 million, primarily higher marketing costs partially offset by lower administration costs), currency movements ($4 million) and the impact of divestitures ($3 million). During the third quarter of 1996, margarine businesses in the U.K. and Italy were sold at gains. In addition, a charge was recorded for cost reduction initiatives. The net impact of these items was not material to operating income. KFI's coffee volumes increased in the third quarter of 1996 due primarily to higher shipments of premium priced coffee in France and new product introductions in Germany, KFI's largest coffee markets. KFI's confectionery volumes also increased in the third quarter of 1996 reflecting increases in Western Europe. KFI's cheese and grocery volume decreased in the third quarter reflecting the sale of several small international food businesses in 1995, price competition, lower sliced beef volume in Italy and the effect of a peanut butter recall in Australia, partially offset by higher volume in the United Kingdom, China and the Philippines. Volume in Latin America increased in the third quarter of 1996 due to the second quarter acquisition of nearly all of the remaining voting shares, and subsequent consolidation, of Lacta, as discussed above, and on the strength of powdered soft drinks in Argentina, Brazil and Puerto Rico. These increases were partially offset by lower confectionery volume in Argentina and Brazil (excluding Lacta) and lower ice cream volume in Brazil. BEER ____ Nine Months ended September 30 Operating revenues of Miller Brewing Company ("Miller") for the first nine months of 1996 increased $22 million (0.6%) from the comparable 1995 period, due to price/mix improvements ($109 million) and the impact of acquisitions ($6 million), partially offset by lower volume ($93 million). Operating income -35- decreased $6 million (1.5%) from the comparable 1995 period, due to lower volume ($39 million) and unfavorable fixed manufacturing expenses ($16 million), partially offset by price/mix improvements ($28 million) and lower marketing, administration and research costs ($21 million). During the first quarter of 1996, Miller recorded its share of a restructuring charge at 20%-owned Molson Canada. In the second quarter of 1996, Miller realized the benefit of lower than anticipated costs for integrating Molson USA's operations. The net impact of these items was not material to Miller's operating income for the nine months ended September 30, 1996. Miller's 1996 first nine months total shipment volume of 34.5 million barrels decreased 2.6% from the comparable 1995 period, reflecting decreased shipments of premium-priced and budget-priced brands. Shipments of premium-priced beers accounted for 82.6% of shipments in the first nine months of 1996 compared with 81.8% in the first nine months of 1995. Lower volume was due to continued intense competition, softness in most of Miller's major brands and unseasonably cool weather during the second quarter in Miller's key northern United States markets. Miller currently estimates that shipments for the full year will be lower than 1995 shipments. Quarter Ended September 30 Operating revenues of Miller for the third quarter of 1996 decreased $45 million (3.9%) from the comparable 1995 period, due primarily to volume decreases ($77 million), partially offset by price/mix improvements ($30 million). Operating income decreased by $2 million (1.7%) from the comparable 1995 period, due to lower volume ($32 million) and unfavorable fixed manufacturing expenses ($5 million), partially offset by price/mix improvements ($3 million) and lower marketing, administration and research costs ($32 million). During the third quarter, Miller took a number of actions intended to restore growth and streamline its organization. These included the announced elimination of approximately 500 salaried positions, to take effect in November. The Company's accrued liability for postemployment benefits is adequate to provide for this workforce reduction. Miller's 1996 third quarter total shipment volume of 11.4 million barrels decreased 6.5% from the comparable 1995 period, reflecting softness in most of Miller's major brands and reductions in distributor inventory levels during the quarter. FINANCIAL SERVICES AND REAL ESTATE __________________________________ Nine Months ended September 30 For the first nine months of 1996, operating revenues from financial services and real estate operations decreased 4.9%, and operating income increased 15.8% from the first nine months of 1995, reflecting growth from the financial services operations of Philip Morris Capital Corporation ("PMCC") partially offset by lower results from the real estate operations of Mission Viejo Company ("MVC"). Higher financial services operating revenues and operating income reflect the continued growth and profitability of PMCC's leasing and structured finance portfolio. Operating revenues and income from real estate operations decreased from 1995 levels, due primarily to reduced residential land sales, partially offset by improved business properties sales volume. Quarter Ended September 30 For the third quarter of 1996, operating revenues from financial services and real estate operations decreased 3.3% from the third quarter of 1995, and operating income increased 25.6% from the third quarter of 1995, reflecting growth from PMCC's financial services and MVC's real estate operations. Higher financial services operating revenues and operating income reflect growth and profitability from continuing and new investments in PMCC's leasing and structured finance -36- portfolio. Operating income from real estate operations increased from 1995 levels, due primarily to higher land sales volume. FINANCIAL REVIEW ________________ Net Cash Provided by Operating Activities _________________________________________ During the first nine months of 1996, cash provided by operating activities was $4.5 billion, $85 million higher than during the first nine months of 1995. The increase was due primarily to higher net earnings, partially offset by increased investments in working capital. Net Cash Used in Investing Activities _____________________________________ During the first nine months of 1996, cash used in investing activities was $1.6 billion, compared with $358 million used during the comparable 1995 period. The change is due primarily to cash used for the acquisitions in 1996 (primarily for controlling interests in ZPT-Krakow, a Polish cigarette manufacturer, and Lacta, a Brazilian chocolate confectionery company) compared with cash received in 1995 from the sales of North American food businesses. Net Cash Used in Financing Activities _____________________________________ During the first nine months of 1996, the Company's net cash used in financing activities was $3.5 billion, compared with $3.4 billion used during the comparable 1995 period. In the first nine months of 1996 and 1995, cash was used to repurchase and pay dividends on common stock. In 1996, increases in stock repurchases and dividends paid were partially offset by net proceeds from debt. Debt ____ The Company's total debt was $16.5 billion and $15.8 billion at September 30, 1996 and December 31, 1995, respectively. Total consumer products debt increased $796 million in the first nine months of 1996, due primarily to the net issuance of long-term debt. At September 30, 1996, short-term borrowings of $2.8 billion were reclassified as long-term debt based upon the Company's intent and ability to refinance such debt under an $8 billion revolving bank credit agreement that expires in 2000. The Company may continue to refinance long-term and short-term debt and the proportionate amount of each can be expected to vary as a result of future business requirements, market conditions and other factors. The Company operates internationally, with manufacturing and sales facilities in various locations around the world. The Company continually evaluates its foreign currency net asset exposure (primarily the Swiss franc, German mark, Swedish krona, Canadian dollar and Norwegian krone) based on current market conditions and business strategies. It acts to manage such exposure, when deemed prudent, through various hedging transactions. The Company has entered into currency and related interest rate swap agreements to manage exposure to currency movements. The aggregate notional principal amounts of these agreements outstanding was $2.0 billion at September 30, 1996 and December 31, 1995, of which $1.1 billion and $1.5 billion related to consumer products debt at September 30, 1996 and December 31, 1995, respectively. The Company enters into forward exchange contracts, for purposes other than trading, to reduce the effects of fluctuating foreign currency on foreign currency denominated assets, liabilities, commitments and short-term intercompany transactions. At September 30, 1996 and December 31, 1995, the Company had forward exchange contracts, with maturities of less than one year, of $2.1 billion and $1.2 billion, respectively. -37- Equity and Dividends ____________________ During the first nine months of 1996, the Company repurchased 21.7 million shares of its common stock at an aggregate cost of $2.1 billion. These purchases were made pursuant to the Company's repurchase program, announced in 1994, to purchase up to $6 billion of its common stock in the open market. These repurchases, net of 6.0 million shares issued under the Company's stock option and stock awards plan in the first nine months of 1996, resulted in lower average shares outstanding. Through September 30, 1996, cumulative purchases under the program totaled 57.2 million shares at a cost of $4.6 billion. At September 30, 1996, the ratio of consumer products debt to total equity was 1.06, compared with 1.03 at December 31, 1995. The Company's ratio of total debt to total equity at September 30, 1996 was 1.15 compared with 1.13 at December 31, 1995. The increase in these ratios primarily reflects net issuance of short-term borrowings and long-term debt, partially offset by an increase in stockholders' equity, due primarily to net earnings partially offset by share repurchases, dividends declared and currency translation adjustments. Dividends paid in the first nine months of 1996 were 18.2% higher than in the first nine months of 1995, reflecting an increase in dividends declared, partially offset by fewer shares outstanding. On August 28, 1996, the Board of Directors increased the Company's quarterly dividend rate to $1.20 per share, a 20.0% increase, resulting in an annualized dividend rate of $4.80 per share. Cash and Cash Equivalents _________________________ Cash and cash equivalents, primarily representing cash earned and retained outside of North America, was $459 million at September 30, 1996, compared with $1.1 billion at December 31, 1995. Cash earned and retained outside of North America is used for new investments, normal working capital requirements, the payment of foreign excise taxes and dividend repatriation. The decrease in cash and cash equivalents primarily reflects these uses of cash during the quarter. At September 30, 1996, PMI had not received payment of certain cigarette- related invoices from the Italian state cigarette monopoly, which distributes cigarettes in Italy. Payment of the overdue invoices was received in October, bringing the monopoly current in its financial obligation to PMI and its affiliates for their shipments. Contingencies _____________ See Note 2 to the Condensed Consolidated Financial Statements for discussion of contingencies. Reference is made to Item 1 (c) "Other Matters - Forward- Looking and Cautionary Statements" of the Company's 1995 Annual Report on Form 10-K regarding important factors that could cause actual results to differ materially from those contained in any forward-looking statement made by or on behalf of the Company, including forward-looking statements contained in Item 2 of this Form 10-Q. -38- Part II -- OTHER INFORMATION Item 1. Legal Proceedings. Reference is made to Note 2, "Contingencies," of the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report, and to "Tobacco--Business Environment," of the Management's Discussion and Analysis of Financial Condition and Results of Operations included in Part I, Item 2 of this report. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 3.2 By-Laws, as amended, of the Company. 12 Statement regarding computation of ratios of earnings to fixed charges. 27 Financial Data Schedule. (b) Reports on Form 8-K. During the quarter for which this report is filed, the Registrant filed a Current Report on Form 8-K, dated September 20, 1996. The Form 8-K incorporated by reference a Prospectus and Prospectus Supplement each dated September 19, 1996 (Registration Statement No. 33-49195). The Prospectus and Prospectus Supplement were filed in connection with the Registrant's offering of $650 million aggregate principal amount of its 7 1/4% Notes Due 2001. ___________ -39- Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHILIP MORRIS COMPANIES INC. BY /s/ Louis C. Camilleri Louis C. Camilleri, Senior Vice President and Chief Financial Officer DATE November 13, 1996 -40- EX-3.2 2 BY-LAWS EXHIBIT 3.2 BY-LAWS OF PHILIP MORRIS COMPANIES INC. ARTICLE I MEETING OF STOCKHOLDERS SECTION 1. ANNUAL MEETINGS. - The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting, and any postponement or adjournment thereof, shall be held on such date and at such time as the Board of Directors may in its discretion determine. SECTION 2. SPECIAL MEETINGS. - Unless otherwise provided by law, special meetings of the stockholders may be called by the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, an executive vice president or by order of the Board of Directors, whenever deemed necessary. SECTION 3. PLACE OF MEETINGS. - All meetings of the stockholders shall be held at such place in the Commonwealth of Virginia as from time to time may be fixed by the Board of Directors. SECTION 4. NOTICE OF MEETINGS. - Written notice, stating the place, day and hour and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given by mail not less than ten nor more than sixty days before the date of the meeting (except as a different time is specified herein or by law), to each stockholder of record having voting power in respect of the business to be transacted thereat, at his or her address as it appears on the stock transfer books of the Corporation. Notice of a stockholders' meeting to act on an amendment of the Articles of Incorporation, a plan of merger or share exchange, a proposed sale of all, or substantially all of the Corporation's assets, otherwise than in the usual and regular course of business, or the dissolution of the Corporation shall be given, in the manner provided above, not less than twenty-five nor more than sixty days before the date of the meeting and shall be accompanied, as appropriate, by a copy of the proposed amendment, plan of merger or share exchange or sale agreement. November 1, 1996 -1- Notwithstanding the foregoing, a written waiver of notice signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A stockholder who attends a meeting shall be deemed to have (i) waived objection to lack of notice or defective notice of the meeting, unless at the beginning of the meeting he or she objects to holding the meeting or transacting business at the meeting, and (ii) waived objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless he or she objects to considering the matter when it is presented. SECTION 5. QUORUM. - At all meetings of the stockholders, unless a greater number or voting by classes is required by law, a majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum. If a quorum is present, action on a matter is approved if the votes cast favoring the action exceed the votes cast opposing the action, unless the vote of a greater number or voting by classes is required by law or the Articles of Incorporation, and except that in elections of directors those receiving the greatest number of votes shall be deemed elected even though not receiving a majority. Less than a quorum may adjourn. SECTION 6. ORGANIZATION AND ORDER OF BUSINESS. - At all meetings of the stockholders, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the most senior executive vice president, shall act as chairman. In the absence of all of the foregoing officers or, if present, with their consent, a majority of the shares entitled to vote at such meeting, may appoint any person to act as chairman. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary at all meetings of the stockholders. In the event that neither the secretary nor any assistant secretary is present, the chairman may appoint any person to act as secretary of the meeting. The chairman shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts and things as are necessary or desirable for the proper conduct of the meeting, including, without limitation, the establishment of procedures for the dismissal of business not properly presented, the maintenance of order and safety, limitations on the time allotted to questions or comments on the affairs of the Corporation, restrictions on entry to such meeting after the time prescribed for the commencement thereof and the opening and closing of the voting polls. At each annual meeting of stockholders, only such business shall be conducted as shall have been properly brought before the meeting (a) by or at the direction of the Board of Directors or (b) by any stockholder of the Corporation who shall be entitled to vote at such meeting and who complies with the notice -2- procedures set forth in this Section 6. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation. To be timely, a stockholder's notice must be given, either by personal delivery or by United States certified mail, postage prepaid, and received at the principal executive offices of the Corporation (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of stockholders or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting. A stockholder's notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting, including the complete text of any resolutions to be presented at the annual meeting, and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder proposing such business, (c) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to bring the business before the meeting specified in the notice, (d) the class and number of shares of stock of the Corporation beneficially owned by the stockholder and (e) any material interest of the stockholder in such business. Notwithstanding anything in the By-Laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 6. The chairman of an annual meeting shall, if the facts warrant, determine that the business was not brought before the meeting in accordance with the procedures prescribed by this Section 6. If the chairman should so determine,he or she shall so declare to the meeting and the business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 6, a stockholder seeking to have a proposal included in the Corporation's proxy statement shall comply with the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended (including, but not limited to, Rule 14a-8 or its successor provision). The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. SECTION 7. VOTING. - A stockholder may vote either in person or by proxy executed in writing by the stockholder or by his or her duly authorized attorney-in-fact. No stockholder may authorize more than four persons to act for him or her, and any proxy shall be delivered to the secretary of the meeting at or prior to the time designated by the chairman or in the order of business for so delivering such proxies. No proxy shall be valid after eleven months from its date, unless otherwise provided in the proxy. Each holder of record of stock of any class shall, as to all -3- matters in respect of which stock of such class has voting power, be entitled to such vote as is provided in the Articles of Incorporation for each share of stock of such class standing in the holders's name on the books of the Corporation. Unless required by statute or determined by the chairman to be advisable, the vote on any questions need not be by ballot. On a vote by ballot, each ballot shall be signed by the stockholder voting or by such stockholder's proxy, if there be such proxy. SECTION 8. INSPECTORS. - At every meeting of the stockholders for election of directors, the proxies shall be received and taken in charge, all ballots shall be received and counted and all questions touching the qualifications of voters, the validity of proxies, and the acceptance or rejection of votes shall be decided, by two inspectors. Such inspectors shall be appointed by the chairman of the meeting. They shall be sworn faithfully to perform their duties and shall in writing certify to the returns. No candidate for election as director shall be appointed or act as inspector. ARTICLE II BOARD OF DIRECTORS SECTION 1. GENERAL POWERS. - The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. SECTION 2. NUMBER. - The number of directors shall be thirteen (13). SECTION 3. TERM OF OFFICE AND QUALIFICATION. - Each director shall serve for the term for which he or she shall have been elected and until a successor shall have been duly elected. SECTION 4. NOMINATION AND ELECTION OF DIRECTORS. - At each annual meeting of stockholders, the stockholders entitled to vote shall elect the directors. No person shall be eligible for election as a director unless nominated in accordance with the procedures set forth in this Section 4. Nominations of persons for election to the Board of Directors may be made by the Board of Directors or any committee designated by the Board of Directors or by any stockholder entitled to vote for the election of directors at the applicable meeting of stockholders who complies with the notice procedures set forth in this Section 4. Such nominations, other than those made by the Board of Directors or any committee designated by the Board of Directors, may be made only if written notice of a stockholder's intent to nominate one or more persons for election as directors at the applicable meeting of stockholders has been given,either by personal delivery or by United States certified mail, postage prepaid, to the secretary of the Corporation and received (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of -4- stockholders, or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting, or (iii) with respect to any special meeting of stockholders called for the election of directors, not later than the close of business on the seventh day following the date on which notice of such meeting is first given to stockholders. Each such stockholder's notice shall set forth (a) as to the stockholder giving the notice, (i) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder, (ii) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to nominate the person or persons specified in the notice, (iii) the class and number of shares of stock of the Corporation beneficially owned by such stockholder, and (iv) a description of all arrangements or understandings between such stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by such stockholder; and (b) as to each person whom the stockholder proposes to nominate for election as a director, (i) the name, age, business address and, if known, residence address of such person, (ii) the principal occupation or employment of such person, (iii) the class and number of shares of stock of the Corporation which are beneficially owned by such person, (iv) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors or is otherwise required by the rules and regulations of the Securities and Exchange Commission promulgated under the Securities Exchange Act of 1934, as amended, and (v) the written consent of such person to be named in the proxy statement as a nominee and to serve as a director if elected. The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. Any person nominated for election as director by the Board of Directors or any committee designated by the Board of Directors shall, upon the request of the Board of Directors or such committee, furnish to the secretary of the Corporation all such information pertaining to such person that is required to be set forth in a stockholder's notice of nomination. The chairman of the meeting of stockholders shall, if the facts warrant, determine that a nomination was not made in accordance with the procedures prescribed by this Section 4. If the chairman should so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded. SECTION 5. ORGANIZATION. - At all meetings of the Board of Directors, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any),the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the senior most executive vice president, shall act as chairman of the meeting. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary of meetings of the Board of Directors. In the event that neither the -5- secretary nor any assistant secretary shall be present at such meeting, the chairman of the meeting shall appoint any person to act as secretary of the meeting. SECTION 6. VACANCIES. - Any vacancy occurring in the Board of Directors, including a vacancy resulting from amending these By-Laws to increase the number of directors by thirty percent or less, may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors. SECTION 7. PLACE OF MEETING. - Meetings of the Board of Directors, regular or special, may be held either within or without the Commonwealth of Virginia. SECTION 8. ORGANIZATIONAL MEETING. - The annual organizational meeting of the Board of Directors shall be held immediately following adjournment of the annual meeting of stockholders and at the same place, without the requirement of any notice other than this provision of the By-Laws. SECTION 9. REGULAR MEETINGS: NOTICE. - Regular meetings of the Board of Directors shall be held at such times and places as it may from time to time determine. Notice of such meetings need not be given if the time and place have been fixed at a previous meeting. SECTION 10. SPECIAL MEETINGS. - Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) or of the president (if any) or of two of the directors. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each director, addressed to his or her residence or usual place of business, at least two days before the day on which the meeting is to be held, or shall be sent to such place by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held SECTION 11. WAIVER OF NOTICE. - Whenever any notice is required to be given to a director of any meeting for any purpose under the provisions of law, the Articles of Incorporation or these By-Laws, a waiver thereof in writing signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A director's attendance at or participation in a meeting waives any required notice to him or her of the meeting unless at the beginning of the meeting or promptly upon the director's arrival, he or she objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. SECTION 12. QUORUM AND MANNER OF ACTING. - Except where otherwise -6- provided by law, a majority of the directors fixed by these By-Laws at the time of any regular or special meeting shall constitute a quorum for the transaction of business at such meeting, and the act of a majority of the directors present at any such meeting at which a quorum is present shall be the act of the Board of Directors. In the absence of a quorum, a majority of those present may adjourn the meeting from time to time until a quorum be had. Notice of any such adjourned meeting need not be given. SECTION 13. ORDER OF BUSINESS. - At all meetings of the Board of Directors business may be transacted in such order as from time to time the Board of Directors may determine. SECTION 14. COMMITTEES. - In addition to the executive committee authorized by Article III of these By-Laws, other committees, consisting of two or more directors, may be designated by the Board of Directors by a resolution adopted by the greater number of (i) a majority of all directors in office at the time the action is being taken or (ii) the number of directors required to take action under Article II, Section 12 hereof. Any such committee, to the extent provided in the resolution of the Board of Directors designating the committee, shall have and may exercise the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, except as limited by law. ARTICLE III EXECUTIVE COMMITTEE SECTION 1. HOW CONSTITUTED AND POWERS. - The Board of Directors, by resolution adopted pursuant to Article II, Section 14 hereof, may designate, in addition to the chairman of the Board of Directors, one or more directors to constitute an executive committee, who shall serve during the pleasure of the Board of Directors. The executive committee, to the extent provided in such resolution and permitted by law, shall have and may exercise all of the authority of the Board of Directors. SECTION 2. ORGANIZATION, ETC. - The executive committee may choose a chairman and secretary. The executive committee shall keep a record of its acts and proceedings and report the same from time to time to the Board of Directors. SECTION 3. MEETINGS. - Meetings of the executive committee may be called by any member of the committee. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each member of the committee, addressed to his or her residence or usual place of business, at least two days before the day on which the meeting is to be held or shall be sent to such place -7- by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held. SECTION 4. QUORUM AND MANNER OF ACTING. - A majority of the executive committee shall constitute a quorum for transaction of business, and the act of a majority of those present at a meeting at which a quorum is present shall be the act of the executive committee. The members of the executive committee shall act only as a committee, and the individual members shall have no powers as such. SECTION 5. REMOVAL. - Any member of the executive committee may be removed, with or without cause, at any time, by the Board of Directors. SECTION 6. VACANCIES. - Any vacancy in the executive committee shall be filled by the Board of Directors. ARTICLE IV OFFICERS SECTION 1. NUMBER. - The officers of the Corporation shall be a chairman of the Board of Directors, a deputy chairman of the Board of Directors (if elected by the Board of Directors), the president (if elected by the Board of Directors), one or more vice chairmen of the Board of Directors (if elected by the Board of Directors), one or more vice presidents (one or more of whom may be designated executive vice president or senior vice president), a treasurer, a controller, a secretary, one or more assistant treasurers, assistant controllers and assistant secretaries and such other officers as may from time to time be chosen by the Board of Directors. Any two or more offices may be held by the same person. SECTION 2. ELECTION, TERM OF OFFICE AND QUALIFICATIONS. - All officers of the Corporation shall be chosen annually by the Board of Directors, and each officer shall hold office until a successor shall have been duly chosen and qualified or until the officer resigns or is removed in the manner hereinafter provided. The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) and the vice chairmen of the Board of Directors (if any) shall be chosen from among the directors. SECTION 3. VACANCIES. - If any vacancy shall occur among the officers of the Corporation, such vacancy shall be filled by the Board of Directors. -8- SECTION 4. OTHER OFFICERS, AGENTS AND EMPLOYEES - THEIR POWERS AND DUTIES. - - The Board of Directors may from time to time appoint such other officers as the Board of Directors may deem necessary, to hold office for such time as may be designated by it or during its pleasure, and the Board of Directors or the chairman of the Board of Directors may appoint, from time to time, such agents and employees of the Corporation as may be deemed proper, and may authorize any officers to appoint and remove agents and employees. The Board of Directors or the chairman of the Board of Directors may from time to time prescribe the powers and duties of such other officers, agents and employees of the Corporation. SECTION 5. REMOVAL. - Any officer, agent or employee of the Corporation may be removed, either with or without cause, by a vote of a majority of the Board of Directors or, in the case of any agent or employee not appointed by the Board of Directors, by a superior officer upon whom such power of removal may be conferred by the Board of Directors or the chairman of the Board of Directors. SECTION 6. CHAIRMAN OF THE BOARD OF DIRECTORS AND CHIEF EXECUTIVE OFFICER. - The chairman of the Board of Directors shall preside at meetings of the stockholders and of the Board of Directors and shall be a member of the executive committee. The chairman shall be the Chief Executive Officer of the Corporation and shall be responsible to the Board of Directors. He or she shall be responsible for the general management and control of the business and affairs of the Corporation and shall see to it that all orders and resolutions of the Board of Directors are implemented. The chairman shall from, time to time, report to the Board of Directors on matters within his or her knowledge which the interests of the Corporation may require be brought to its notice. The chairman shall do and perform such other duties as from time to time the Board of Directors may prescribe. SECTION 7. DEPUTY CHAIRMAN OF THE BOARD OF DIRECTORS. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The deputy chairman shall be responsible to the chairman of the Board of Directors and shall perform such duties as shall be assigned to him or her by the chairman of the Board of Directors. The deputy chairman shall from time to time report to the chairman of the Board of Directors on matters within the deputy chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. SECTION 8. PRESIDENT. - In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The president shall be responsible to the chairman of the Board of Directors. Subject to the authority of the chairman of the Board of Directors, the president shall be devoted to the Corporation's business -9- and affairs under the basic policies set by the Board of Directors and the chairman of the Board of Directors. He or she shall from, time to time, report to the chairman of the Board of Directors on matters within the president's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if any) shall, except as otherwise directed by the Board of Directors, have all of the powers and the duties of the chairman of the Board of Directors. The president (if any) shall do and perform such other duties as from time to time the Board of Directors or the chairman of the Board of Directors may prescribe. SECTION 9. VICE CHAIRMEN OF THE BOARD OF DIRECTORS. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), the vice chairman of the Board of Directors designated for such purpose by the chairman of the Board of Directors (if any) shall preside at meetings of the stockholders and of the Board of Directors. Each vice chairman of the Board of Directors shall be responsible to the chairman of the Board of Directors. Each vice chairman of the Board of Directors shall from time to time report to the chairman of the Board of Directors on matters within the vice chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence or inability to act of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), such vice chairman of the Board of Directors as the chairman of the Board of Directors may designate for the purpose shall have the powers and discharge the duties of the chairman of the Board of Directors. In the event of the failure or inability of the chairman of the Board of Directors to so designate a vice chairman of the Board of Directors, the Board of Directors may designate a vice chairman of the Board of Directors who shall have the powers and discharge the duties of the chairman of the Board of Directors. SECTION 10. VICE PRESIDENTS. - The vice presidents of the Corporation shall assist the chairman of the Board of Directors, the deputy chairman of the Board of Directors, the president (if any) and the vice chairmen (if any) of the Board of Directors in carrying out their respective duties and shall perform those duties which may from time to time be assigned to them. The chief financial officer shall be a vice president of the Corporation (or more senior) and shall be responsible for the management and supervision of the financial affairs of the Corporation. SECTION 11. TREASURER. - The treasurer shall have charge of the funds, securities, receipts and disbursements of the Corporation. He or she shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such banks or trust companies or with such bankers or other depositaries as the Board of Directors may from time to time designate. The treasurer shall render to the Board of Directors, the chairman of the Board of Directors, the deputy chairman -10- of the Board of Directors (if any), the president (if any), the vice chairmen of the Board of Directors (if any), and the chief financial officer, whenever required by any of them, an account of all of his transactions as treasurer. If required, the treasurer shall give a bond in such sum as the Board of Directors may designate, conditioned upon the faithful performance of the duties of the treasurer's office and the restoration to the Corporation at the expiration of his or her term of office or in the case of death, resignation or removal from office, all books, papers, vouchers, money or other property of whatever kind in his or her possession or under his or her control belonging to the Corporation. The treasurer shall perform such other duties as from time to time may be assigned to him or her. SECTION 12. ASSISTANT TREASURERS. - In the absence or disability of the treasurer, one or more assistant treasurers shall perform all the duties of the treasurer and, when so acting, shall have all the powers of, and be subject to all restrictions upon, the treasurer. Assistant treasurers shall also perform such other duties as from time to time may be assigned to them. SECTION 13. SECRETARY. - The secretary shall keep the minutes of all meetings of the stockholders and of the Board of Directors in a book or books kept for that purpose. He or she shall keep in safe custody the seal of the Corporation, and shall affix such seal to any instrument requiring it. The secretary shall have charge of such books and papers as the Board of Directors may direct. He or she shall attend to the giving and serving of all notices of the Corporation and shall also have such other powers and perform such other duties as pertain to the secretary's office, or as the Board of Directors, the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) or any vice chairman of the Board of Directors may from time to time prescribe. SECTION 14. ASSISTANT SECRETARIES. - In the absence or disability of the secretary, one or more assistant secretaries shall perform all of the duties of the secretary and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the secretary. Assistant secretaries shall also perform such other duties as from time to time may be assigned to them. SECTION 15. CONTROLLER. - The controller shall be administrative head of the controller's department. He or she shall be in charge of all functions relating to accounting and the preparation and analysis of budgets and statistical reports and shall establish, through appropriate channels, recording and reporting procedures and standards pertaining to such matters. The controller shall report to the chief financial officer and shall aid in developing internal corporate policies whereby the business of the Corporation shall be conducted with the maximum safety, efficiency and economy. The controller shall be available to all departments of the Corporation for advice and guidance in the interpretation and application of policies which are within the scope of his or her authority. The controller shall perform such other duties as from time to time may be assigned to him or her. -11- SECTION 16. ASSISTANT CONTROLLERS. - In the absence or disability of the controller, one or more assistant controllers shall perform all of the duties of the controller and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the controller. Assistant controllers shall also perform such other duties as from time to time may be assigned to them. ARTICLE V CONTRACTS, CHECKS, DRAFTS, BANK ACCOUNTS, ETC. SECTION 1. CONTRACTS. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the chairman of the Board of Directors may authorize shall have the power to execute any contract or other instrument on behalf of the Corporation; no other officer, agent or employee shall, unless otherwise in these By-Laws provided, have any power or authority to bind the Corporation by any contract or acknowledgement, or pledge its credit or render it liable pecuniarily for any purpose or to any amount. SECTION 2. LOANS. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the Board of Directors may authorize shall have the power to effect loans and advances at any time for the Corporation from any bank, trust company or other institution, or from any corporation, firm or individual, and for such loans and advances may make, execute and deliver promissory notes or other evidences of indebtedness of the Corporation, and, as security for the payment of any and all loans, advances, indebtedness and liability of the Corporation, may pledge, hypothecate or transfer any and all stocks, securities and other personal property at any time held by the Corporation, and to that end endorse, assign and deliver the same. SECTION 3. VOTING OF STOCK HELD. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president or the secretary may from time to time appoint an attorney or attorneys or agent or agents of the Corporation to cast the votes that the Corporation may be entitled to cast as a stockholder or otherwise in any other corporation, any of whose stock or securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other corporation, or to consent in writing to any action by any other such corporation, and may instruct the person or persons so appointed as to -12- the manner of casting such votes or giving such consent, and may execute or cause to be executed on behalf of the Corporation such written proxies, consents, waivers or other instruments as such officer may deem necessary or proper in the premises; or the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president or the secretary may attend in person any meeting of the holders of stock or other securities of such other corporation and thereat vote or exercise any and all powers of the Corporation as the holder of such stock or other securities of such other corporation. ARTICLE VI CERTIFICATES REPRESENTING SHARES Certificates representing shares of the Corporation shall be signed by the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), or the president of the Corporation (if any) and the secretary or an assistant secretary. Any and all signatures on such certificates, including signatures of officers, transfer agents and registrars, may be facsimile. ARTICLE VII DIVIDENDS The Board of Directors may declare dividends from funds of the Corporation legally available therefor. ARTICLE VIII SEAL The Board of Directors shall provide a suitable seal or seals, which shall be in the form of a circle, and shall bear around the circumference the words "Philip Morris Companies Inc." and in the center the word and figures "Virginia, 1985." ARTICLE IX -13- FISCAL YEAR The fiscal year of the Corporation shall be the calendar year. ARTICLE X AMENDMENT The power to alter, amend or repeal the By-Laws of theCorporation or to adopt new By-Laws shall be vested in the Board of Directors, but By-Laws made by the Board of Directors may be repealed or changed by the stockholders, or new By-Laws may be adopted by the stockholders, and the stockholders may prescribe that any By-Laws made by them shall not be altered, amended or repealed by the directors. ARTICLE XI EMERGENCY BY-LAWS If a quorum of the Board of Directors cannot be readily assembled because of some catastrophic event, and only in such event, these By-Laws shall, without further action by the Board of Directors, be deemed to have been amended for the duration of such emergency, as follows: SECTION 1. SECTION 6 OF ARTICLE II SHALL READ AS FOLLOWS: Any vacancy occurring in the Board of Directors may be filled by the affirmative vote of a majority of the directors present at a meeting of the Board of Directors called in accordance with these By-Laws. SECTION 2. THE FIRST SENTENCE OF SECTION 10 OF ARTICLE II SHALL READ AS FOLLOWS: Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors or a deputy chairman (if any),or of the president (if any) or any vice chairman of the Board of Directors (if any) or any director or of any person having the powers and duties of the chairman of the Board of Directors, the -14- deputy chairman, the president or any vice chairman of the Board of Directors. SECTION 3. SECTION 12 OF ARTICLE II SHALL READ AS FOLLOWS: The directors present at any regular or special meeting called in accordance with these By-Laws shall constitute a quorum for the transaction of business at such meeting, and the action of a majority of such directors shall be the act of the Board of Directors, provided, however, that in the event that only one director is present at any such meeting no action except the election of directors shall be taken until at least two additional directors have been elected and are in attendance. -15- EX-12 3 COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) ___________________
Nine Months Ended Three Months Ended September 30, 1996 September 30, 1996 ------------------- ------------------- Earnings before income taxes and cumulative effect of accounting changes $8,190 $2,790 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (154) (52) Dividends from less than 50% owned affiliates 117 22 Fixed charges 1,058 359 Interest capitalized, net of amortization 9 4 ------ ------ Earnings available for fixed charges $9,220 $3,123 ====== ====== Fixed charges: Interest incurred: Consumer products $ 898 $ 307 Financial services and real estate 62 19 ------ ------ 960 326 Portion of rent expense deemed to represent interest factor 98 32 ------ ------ Fixed charges $1,058 $ 358 ====== ====== Ratio of earnings to fixed charges 8.7 8.7 ====== ======
EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) ___________________
Years Ended December 31, ----------------------------------------------- 1995 1994 1993 1992 1991 ------- ------ ------ ------- ------ Earnings before income taxes and cumulative effect of accounting changes $ 9,347 $8,216 $6,196 $ 8,608 $6,971 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (246) (184) (164) (107) (95) Dividends from less than 50% owned affiliates 202 165 151 125 72 Fixed charges 1,495 1,537 1,716 1,736 1,899 Interest capitalized, net of amortization 2 (1) (13) (3) (11) ------- ------ ------ ------- ------ Earnings available for fixed charges $10,800 $9,733 $7,886 $10,359 $8,836 ======= ====== ====== ======= ====== Fixed charges: Interest incurred: Consumer products $ 1,281 $1,317 $1,502 $ 1,525 $1,711 Financial services and real estate 84 78 87 95 83 ------- ------ ------ ------- ------ 1,365 1,395 1,589 1,620 1,794 Portion of rent expense deemed to represent interest factor 130 142 127 116 105 ------- ------ ------ ------- ------ Fixed charges $ 1,495 $1,537 $1,716 $ 1,736 $1,899 ======= ====== ====== ======= ====== Ratio of earnings to fixed charges 7.2 6.3 4.6 6.0 4.7 ======= ====== ====== ======= ======
EX-27 4 FINANCIAL DATA SCHEDULE
5 This schedule contains summary information extracted from Pages 3-5 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 and is qualified in its entirety by reference to such financial statements. 1,000,000 9-MOS DEC-31-1996 SEP-30-1996 459 0 5,277 172 8,601 15,380 19,493 8,081 54,721 13,823 14,233 0 0 935 13,440 54,721 52,414 52,414 20,001 31,233 12,167 0 824 8,190 3,358 4,832 0 0 0 4,832 5.87 5.87
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