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UNITED STATES
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, 2002
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 (917) 663-5000
-----------------------------
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------ ------
At October 31, 2002, there were 2,068,629,270 shares outstanding of the
registrant's common stock, par value $0.33 1/3 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, 2002 and December 31, 2001 3 - 4
Condensed Consolidated Statements of Earnings for the
Nine Months Ended September 30, 2002 and 2001 5
Three Months Ended September 30, 2002 and 2001 6
Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 2001 and the
Nine Months Ended September 30, 2002 7
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2002 and 2001 8 - 9
Notes to Condensed Consolidated Financial Statements 10 - 28
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 29 - 55
Item 4. Controls and Procedures 56
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 57
Item 5. Other Information 57
Item 6. Exhibits and Reports on Form 8-K 57
Signature 58
Certifications 59 - 60
-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,
2002 2001
------------ -----------
ASSETS
Consumer products
Cash and cash equivalents $ 455 $ 453
Receivables (less allowances of
$135 and $193) 5,030 5,148
Inventories:
Leaf tobacco 3,624 3,827
Other raw materials 2,077 1,909
Finished product 3,630 3,187
------- -------
9,331 8,923
Other current assets 2,295 2,751
------- -------
Total current assets 17,111 17,275
Property, plant and equipment, at cost 24,050 25,625
Less accumulated depreciation 9,487 10,488
------- -------
14,563 15,137
Goodwill and other intangible assets, net 37,568 37,548
Other assets 7,992 6,144
------- -------
Total consumer products assets 77,234 76,104
Financial services
Finance assets, net 8,590 8,691
Other assets 161 173
------- -------
Total financial services assets 8,751 8,864
------- -------
TOTAL ASSETS $85,985 $84,968
======= =======
See notes to condensed consolidated financial statements.
Continued
-3-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars, except per share data)
(Unaudited)
September 30, December 31,
2002 2001
------------ -----------
LIABILITIES
Consumer products
Short-term borrowings $ 434 $ 997
Current portion of long-term debt 870 1,942
Accounts payable 2,739 3,600
Accrued liabilities:
Marketing 2,894 2,794
Taxes, except income taxes 1,748 1,654
Employment costs 980 1,192
Settlement charges 4,020 3,210
Other 2,684 2,480
Income taxes 1,936 1,021
Dividends payable 1,340 1,251
------- -------
Total current liabilities 19,645 20,141
Long-term debt 16,274 17,159
Deferred income taxes 5,735 5,238
Accrued postretirement health care costs 3,100 3,315
Minority interest 4,235 4,013
Other liabilities 7,767 7,796
------- -------
Total consumer products liabilities 56,756 57,662
Financial services
Short-term borrowings 512
Long-term debt 2,112 1,492
Deferred income taxes 5,417 5,246
Other liabilities 355 436
------- -------
Total financial services liabilities 7,884 7,686
------- -------
Total liabilities 64,640 65,348
Contingencies (Note 8)
STOCKHOLDERS' EQUITY
Common stock, par value $0.33 1/3 per share
(2,805,961,317 shares issued) 935 935
Additional paid-in capital 4,658 4,503
Earnings reinvested in the business 42,796 37,269
Accumulated other comprehensive losses (including
currency translation of $3,087 and $3,238) (3,276) (3,373)
------- -------
45,113 39,334
Less cost of repurchased stock
(726,258,871 and 653,458,100 shares) (23,768) (19,714)
------- -------
Total stockholders' equity 21,345 19,620
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $85,985 $84,968
======= =======
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,
-------------------------
2002 2001
-------- --------
Net revenues $61,634 $60,997
Cost of sales 24,707 25,430
Excise taxes on products 13,916 13,160
------- -------
Gross profit 23,011 22,407
Marketing, administration and research costs 9,650 9,371
Litigation related expense 500
Amortization of intangibles 5 758
------- -------
Operating income 13,356 11,778
Gain on Miller Brewing Company transaction (2,653)
Interest and other debt expense, net 881 1,165
------- -------
Earnings before income taxes, minority interest and
cumulative effect of accounting change 15,128 10,613
Provision for income taxes 5,370 4,018
------- -------
Earnings before minority interest and cumulative effect of
accounting change 9,758 6,595
Minority interest in earnings and other, net 424 193
------- -------
Earnings before cumulative effect of accounting change 9,334 6,402
Cumulative effect of accounting change (6)
------- -------
Net earnings $ 9,334 $ 6,396
======= =======
Per share data:
Basic earnings per share before cumulative effect of
accounting change $ 4.39 $ 2.92
Cumulative effect of accounting change
------- -------
Basic earnings per share $ 4.39 $ 2.92
======= =======
Diluted earnings per share before cumulative effect of
accounting change $ 4.34 $ 2.89
Cumulative effect of accounting change (0.01)
------- -------
Diluted earnings per share $ 4.34 $ 2.88
======= =======
Dividends declared $ 1.80 $ 1.64
======= =======
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,
--------------------------
2002 2001
-------- --------
Net revenues $19,996 $20,249
Cost of sales 7,674 8,299
Excise taxes on products 4,758 4,350
------- -------
Gross profit 7,564 7,600
Marketing, administration and research costs 3,005 3,141
Amortization of intangibles 1 252
------- -------
Operating income 4,558 4,207
Gain on Miller Brewing Company transaction (2,653)
Interest and other debt expense, net 279 276
------- -------
Earnings before income taxes and minority interest 6,932 3,931
Provision for income taxes 2,461 1,492
------- -------
Earnings before minority interest 4,471 2,439
Minority interest in earnings and other, net 112 111
------- -------
Net earnings $ 4,359 $ 2,328
======= =======
Per share data:
Basic earnings per share $ 2.07 $ 1.07
======= =======
Diluted earnings per share $ 2.06 $ 1.06
======= =======
Dividends declared $ 0.64 $ 0.58
======= =======
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, 2001 and
the Nine Months Ended September 30, 2002
(in millions of dollars, except per share data)
(Unaudited)
Accumulated Other
Comprehensive Losses
----------------------------
Addi- Earnings Total
tional Reinvested Currency Cost of Stock-
Common Paid-in in the Translation Repurchased holders'
Stock Capital Business Adjustments Other Total Stock Equity
----- ------ ------- ----------- ----- ------- -------- -------
Balances, January 1, 2001 $935 $ -- $33,481 $(2,864) $(86) $(2,950) $(16,461) $15,005
Comprehensive earnings:
Net earnings 8,560 8,560
Other comprehensive losses,
net of income taxes:
Currency translation adjustments (753) (753) (753)
Additional minimum pension liability (89) (89) (89)
Change in fair value of derivatives
accounted for as hedges 33 33 33
-------
Total other comprehensive losses (809)
-------
Total comprehensive earnings 7,751
-------
Exercise of stock options and
issuance of other stock awards 138 70 747 955
Cash dividends
declared ($2.22 per share) (4,842) (4,842)
Stock repurchased (4,000) (4,000)
Sale of Kraft Foods Inc. common stock 4,365 379 7 386 4,751
---- ------ ------- ------- ----- ------- -------- -------
Balances, December 31, 2001 935 4,503 37,269 (3,238) (135) (3,373) (19,714) 19,620
Comprehensive earnings:
Net earnings 9,334 9,334
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments 151 151 151
Additional minimum pension liability 18 18 18
Change in fair value of derivatives
accounted for as hedges (72) (72) (72)
-------
Total other comprehensive earnings 97
-------
Total comprehensive earnings 9,431
Exercise of stock options and -------
issuance of other stock awards 155 11 549 715
Cash dividends
declared ($1.80 per share) (3,818) (3,818)
Stock repurchased (4,603) (4,603)
---- ------ ------- ------- ----- ------- -------- -------
Balances, September 30, 2002 $935 $4,658 $42,796 $(3,087) $(189) $(3,276) $(23,768) $21,345
==== ====== ======= ======= ===== ======= ======== =======
Total comprehensive earnings, which represent net earnings and the change in
fair value of derivatives accounted for as hedges, partially offset by currency
translation adjustments, were $4,348 million and $2,368 million, respectively,
for the quarters ended September 30, 2002 and 2001, and $5,899 million for the
first nine months of 2001.
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,
-------------------------------
2002 2001
--------- ---------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 9,180 $ 6,267
- Financial services 154 129
------- -------
Net earnings 9,334 6,396
Adjustments to reconcile net earnings to operating cash flows:
Consumer products
Cumulative effect of accounting change 6
Depreciation and amortization 976 1,724
Deferred income tax provision 1,024 229
Minority interest in Kraft Foods Inc. 396 110
Loss on sale of a North American food factory and
integration costs 119 66
Escrow bond for domestic tobacco litigation (1,200)
Separation programs and asset impairments 223
Gain on Miller Brewing Company transaction (2,653)
Gains on sales of businesses (3) (8)
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (371) (441)
Inventories (262) (346)
Accounts payable (725) (1,068)
Income taxes 1,091 1,932
Accrued liabilities and other current assets 821 744
Other (357) (456)
Financial services
Deferred income tax provision 171 198
Other 148 (4)
------- -------
Net cash provided by operating activities 9,932 7,882
------- -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures (1,349) (1,219)
Purchases of businesses, net of acquired cash (132) (364)
Proceeds from sales of businesses 86 9
Other 87 145
Financial services
Investments in finance assets (443) (511)
Proceeds from finance assets 314 216
------- -------
Net cash used in investing activities (1,437) (1,724)
------- -------
See notes to condensed consolidated financial statements.
Continued
-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,
----------------------------
2002 2001
-------- --------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net repayment of short-term borrowings $(3,442) $(6,991)
Long-term debt proceeds 4,555 68
Long-term debt repaid (1,841) (2,186)
Financial services
Net repayment of short-term borrowings (512) (624)
Long-term debt proceeds 440 557
Repurchase of Philip Morris common stock (4,545) (2,952)
Repurchase of Kraft Foods Inc. common stock (77)
Dividends paid on Philip Morris common stock (3,729) (3,504)
Issuance of Philip Morris common stock 715 662
Issuance of Kraft Foods Inc. common stock 8,435
Other (161) (131)
------- -------
Net cash used in financing activities (8,597) (6,666)
------- -------
Effect of exchange rate changes on cash and
cash equivalents 104 30
------- -------
Cash and cash equivalents:
Increase (decrease) 2 (478)
Balance at beginning of period 453 937
------- -------
Balance at end of period $ 455 $ 459
======= =======
See notes to condensed consolidated financial statements.
-9-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Company Name Change:
- -----------------------------
In April 2002, the stockholders of Philip Morris Companies Inc. (the "Company")
approved changing the Company's name from Philip Morris Companies Inc. to Altria
Group, Inc. The Company's Board of Directors retains the discretion to effect
the name change, and the Company currently anticipates doing so in the first
quarter of 2003.
Note 2. Accounting Policies:
- -----------------------------
The interim condensed consolidated financial statements of 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. Net
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, and management's discussion and analysis of
financial condition and results of operations, 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, 2001 (the
"2001 Form 10-K").
Balance sheet accounts are segregated by two broad types of businesses. Consumer
products assets and liabilities are classified as either current or non-current,
whereas financial services assets and liabilities are unclassified, in
accordance with respective industry practices.
Certain prior year amounts have been reclassified to conform with the current
year's presentation.
Note 3. Recently Adopted Accounting Standards:
- -----------------------------------------------
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets." As a result, the Company stopped recording the
amortization of goodwill and indefinite life intangible assets as a charge to
earnings as of January 1, 2002. The Company estimates that net earnings and
diluted earnings per share ("EPS") would have been as follows for 2001 had the
provisions of the new standards been applied as of January 1, 2001:
Nine Months Ended Three Months Ended
September 30, 2001 September 30, 2001
------------------ ------------------
(in millions, except per share data)
Net earnings, as previously reported $6,396 $2,328
Adjustment for amortization of goodwill 752 250
------ ------
Net earnings, as adjusted $7,148 $2,578
====== ======
Diluted EPS, as previously reported $2.88 $1.06
Adjustment for amortization of goodwill 0.34 0.11
----- -----
Diluted EPS, as adjusted $3.22 $1.17
===== =====
In addition, the Company is required to conduct an annual review of goodwill and
intangible assets for potential impairment. The Company completed its review and
did not have to record a charge to earnings for an impairment of goodwill or
other intangible assets as a result of these new standards.
-10-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
At September 30, 2002, goodwill by segment was as follows (in millions):
International tobacco $ 899
North American food 20,655
International food 4,193
-------
Total goodwill $25,747
=======
Intangible assets as of September 30, 2002 were as follows:
Gross
Carrying Accumulated
Amount Amortization
------ ------------
(in millions)
Non-amortizable intangible assets $11,793
Amortizable intangible assets 55 $27
------- ---
Total intangible assets $11,848 $27
======= ===
Non-amortizable intangible assets substantially comprise brand names purchased
through the Nabisco acquisition. Amortizable intangible assets consist primarily
of certain trademark licenses and non-compete agreements. The pre-tax
amortization expense for intangible assets during the nine months and quarter
ended September 30, 2002 was $5 million and $1 million, respectively. Based upon
the amortizable intangible assets recorded on the balance sheet as of September
30, 2002, amortization expense for each of the next five years is estimated to
be $8 million or less.
The increase in goodwill and other intangible assets, net, at September 30, 2002
from December 31, 2001 of $20 million is due primarily to currency translation,
partially offset by the impact of the Miller Brewing Company ("Miller")
transaction discussed more fully in Note 5.
Effective January 1, 2002, the Company also adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed Of." SFAS No. 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets, expands the scope of a discontinued operation to include a
component of an entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. The adoption of this new
standard did not have a material impact on the Company's financial position,
results of operations or cash flows.
Effective January 1, 2002, the Company adopted Emerging Issues Task Force
("EITF") Issue No. 00-14, "Accounting for Certain Sales Incentives" and EITF
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendor's Products." The adoption of EITF Issues No. 00-14
and No. 00-25 resulted in a reduction of revenues of approximately $7.0 billion
and $2.2 billion in the first nine months and the third quarter of 2001,
respectively. In addition, the adoption reduced marketing, administration and
research costs in the first nine months and the third quarter of 2001 by
approximately $7.6 billion and $2.4 billion, respectively. Cost of sales
increased in the first nine months and the third quarter of 2001 by
approximately $467 million and $160 million, respectively, and excise taxes on
products increased by approximately $171 million and $57 million, respectively.
The adoption of these EITF Issues had no impact on net earnings or basic and
diluted EPS.
Note 4. Financial Instruments:
- -------------------------------
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," and its related amendment, SFAS
No. 138, "Accounting for Certain Derivative
-11-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Instruments and Certain Hedging Activities" (collectively referred to as "SFAS
No. 133"). As of January 1, 2001, the adoption of these new standards resulted
in a cumulative effect of an accounting change that reduced net earnings by $6
million, net of income taxes of $3 million, and decreased accumulated other
comprehensive losses by $15 million, net of income taxes of $8 million.
During the nine months and three months ended September 30, 2002 and 2001,
ineffectiveness related to fair value hedges and cash flow hedges was not
material. The Company is hedging forecasted transactions for periods not
exceeding the next sixteen months. At September 30, 2002, the Company estimates
derivative gains of $3 million, net of income taxes, reported in accumulated
other comprehensive losses will be reclassified to the consolidated statement of
earnings within the next twelve months.
Within currency translation adjustments at September 30, 2002 and 2001, the
Company recorded a loss of $127 million, net of income taxes of $68 million, and
a loss of $26 million, net of income taxes of $14 million, respectively, which
represented effective hedges of net investments.
Hedging activity affected accumulated other comprehensive losses, net of income
taxes, as follows:
For the Nine Months Ended For the Three Months Ended
September 30, September 30,
------------------------- --------------------------
2002 2001 2002 2001
------ ------ ------ ------
(in millions) (in millions)
Gain (loss) at beginning of period $ 33 $ - $(94) $ (4)
Impact of SFAS No. 133 adoption 15
Derivative losses (gains) transferred to earnings 71 (69) (8) (17)
Change in fair value (143) (4) 63 (37)
----- ---- ---- ----
Loss as of September 30 $ (39) $(58) $(39) $(58)
===== ==== ==== ====
Note 5. Acquisitions and Divestitures:
- ---------------------------------------
On May 30, 2002, the Company announced an agreement with South African Breweries
plc ("SAB") to merge Miller into SAB. The transaction closed on July 9, 2002,
and SAB changed its name to SABMiller plc ("SABMiller"). At closing, the Company
received 430 million shares of SABMiller valued at approximately $3.4 billion,
based upon a share price of 5.12 British pounds per share, in exchange for
Miller, which had $2.0 billion of existing debt. The shares in SABMiller owned
by the Company resulted in an initial 36% economic interest in SABMiller and a
24.9% voting interest. The transaction resulted in a pre-tax gain of $2.7
billion or $1.7 billion after-tax. The gain was recorded in the third quarter of
2002. Beginning with the third quarter of 2002, the Company's ownership interest
in SABMiller is being accounted for under the equity method. Accordingly, the
Company's investment in SABMiller is included in the September 30, 2002
condensed consolidated balance sheet as other assets. In addition, the Company
is recording its share of SABMiller's net earnings based on its economic
ownership percentage in minority interest in earnings and other, net.
On October 31, 2002, Kraft Foods International, Inc. ("KFI") sold its Latin
American yeast and industrial bakery ingredients business for approximately $110
million. The resulting gain will be recorded in the fourth quarter of 2002.
During the third quarter of 2002, KFI acquired a snacks company in Turkey and,
during the first quarter of 2002, acquired a biscuits business in Australia.
In addition, during the first half of 2002, Kraft Foods North
-12-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
America, Inc. ("KFNA") sold several small North American food businesses, which
were previously classified as businesses held for sale. The net revenues and
operating results of the businesses held for sale, which were not significant,
were excluded from the Company's condensed consolidated statements of earnings
and no gain or loss was recognized on these sales. The aggregate pre-tax
proceeds received from the sales of these businesses during the first nine
months of 2002 were $86 million.
During 2001, Philip Morris International Inc. ("PMI") increased its interest in
an Argentine tobacco company for an aggregate cost of $255 million. In addition,
KFI purchased coffee businesses in Romania, Morocco and Bulgaria, and also
acquired confectionery businesses in Russia and Poland.
The operating results of the tobacco and food businesses acquired and sold were
not material to the consolidated operating results of the Company in any of the
periods presented.
Note 6. Earnings Per Share:
- ----------------------------
Basic and diluted EPS were calculated using the following:
For the Nine Months Ended
September 30,
-------------------------
2002 2001
------ ------
(in millions)
Earnings before cumulative effect of accounting change $9,334 $6,402
Cumulative effect of accounting change (6)
------ ------
Net earnings $9,334 $6,396
====== ======
Weighted average shares for basic EPS 2,128 2,189
Plus incremental shares from assumed conversions:
Restricted stock and stock rights 2 7
Stock options 20 22
------ ------
Weighted average shares for diluted EPS 2,150 2,218
====== ======
For the Three Months Ended
September 30,
--------------------------
2002 2001
------ ------
(in millions)
Net earnings $4,359 $2,328
====== ======
Weighted average shares for basic EPS 2,104 2,175
Plus incremental shares from assumed conversions:
Restricted stock and stock rights 1 7
Stock options 14 20
------ ------
Weighted average shares for diluted EPS 2,119 2,202
====== ======
The number of shares of common stock excluded from the calculation of weighted
average shares for diluted EPS because their effects were antidilutive was
immaterial for all periods presented.
-13-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 7. Segment Reporting:
- ---------------------------
The products of the Company's subsidiaries include cigarettes, food (consisting
principally of a wide variety of snacks, beverages, cheese, grocery products and
convenient meals) and beer (prior to the merger of Miller into SAB). Another
subsidiary of the Company, Philip Morris Capital Corporation, is primarily
engaged in leasing activities. The products and services of these subsidiaries
constitute the Company's reportable segments of domestic tobacco, international
tobacco, North American food, international food, beer and financial services.
The Company's management reviews operating companies income to evaluate segment
performance and allocate resources. Operating companies income for the segments
excludes general corporate expenses and amortization of intangibles. Interest
and other debt expense, net, and provision for income taxes are centrally
managed at the corporate level and, accordingly, such items are not presented by
segment since they are excluded from the measure of segment profitability
reviewed by the Company's management.
Segment data were as follows:
For the Nine Months Ended
September 30,
-----------------------------
2002 2001
------- -------
(in millions)
Net revenues:
Domestic tobacco $14,921 $14,826
International tobacco 21,817 20,463
North American food 16,087 15,813
International food 5,789 5,875
Beer 2,641 3,699
Financial services 379 321
------- -------
Total net revenues $61,634 $60,997
======= =======
Operating companies income:
Domestic tobacco $ 4,222 $ 3,662
International tobacco 4,489 4,346
North American food 3,770 3,679
International food 851 814
Beer 276 404
Financial services 257 215
------- -------
Total operating companies income 13,865 13,120
Amortization of intangibles (5) (758)
General corporate expenses (504) (584)
------- -------
Total operating income 13,356 11,778
Gain on Miller transaction 2,653
Interest and other debt expense, net (881) (1,165)
------- -------
Total earnings before income taxes, minority interest
and cumulative effect of accounting change $15,128 $10,613
======= =======
-14-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
For the Threee Months Ended
September 30,
-----------------------------
2002 2001
------- -------
(in millions)
Net revenues:
Domestic tobacco $ 5,022 $ 5,144
International tobacco 7,644 6,742
North American food 5,225 5,151
International food 1,991 1,867
Beer 1,235
Financial services 114 110
------- -------
Total net revenues $19,996 $20,249
======= =======
Operating companies income:
Domestic tobacco $ 1,518 $ 1,577
International tobacco 1,522 1,440
North American food 1,303 1,183
International food 300 277
Beer 112
Financial services 82 75
------- -------
Total operating companies income 4,725 4,664
Amortization of intangibles (1) (252)
General corporate expenses (166) (205)
------- -------
Total operating income 4,558 4,207
Gain on Miller transaction 2,653
Interest and other debt expense, net (279) (276)
------- -------
Total earnings before income taxes and minority interest $ 6,932 $ 3,931
======= =======
On May 30, 2002, the Company announced an agreement with SAB to merge Miller
into SAB. The transaction closed on July 9, 2002, and SAB changed its name to
SABMiller. At closing, the Company received 430 million shares of SABMiller
valued at approximately $3.4 billion, based upon a share price of 5.12 British
pounds per share, in exchange for Miller, which had $2.0 billion of existing
debt. The shares in SABMiller owned by the Company resulted in an initial 36%
economic interest in SABMiller and a 24.9% voting interest. The transaction
resulted in a pre-tax gain of $2.7 billion or $1.7 billion after-tax. The gain
was recorded in the third quarter of 2002. Beginning with the third quarter of
2002, the Company's ownership interest in SABMiller is being accounted for
under the equity method. Accordingly, the Company's investment in SABMiller is
included in the September 30, 2002 condensed consolidated balance sheet as
other assets. In addition, the Company is recording its share of SABMiller's
net earnings based on its economic ownership percentage in minority interest
in earnings and other, net.
During 2002, operating companies income for the North American food and
international food segments included pre-tax charges related to the
consolidation of production lines, the closing of a facility and other
consolidation programs. Pre-tax charges of $102 million and $17 million were
recorded in marketing, administration and research costs of the North American
food and international food segment, respectively, for the nine months ended
September 30, 2002. The 2002 integration-related charges of $119 million
included $21 million relating to severance, $82 million relating to asset
write-offs and $16 million relating to other cash exit costs. Cash payments
relating to these charges will approximate $37 million, of which $4 million
has been paid through September 30, 2002. The majority of the remaining
payments are expected to be made throughout the remainder of 2002 and 2003.
During the third quarter of 2002, PMI announced a separation program in the
United Kingdom and approximately 90 employees were terminated. As a result,
pre-tax charges of $27 million, including an asset impairment charge of $8
million and severance of $11 million, were recorded in the third quarter of
2002 in marketing, administration and research costs of the international
tobacco segment.
-15-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
During the second quarter of 2002, PMI announced a separation program in
Germany and approximately 160 employees accepted the benefits offered by this
program. As a result, pre-tax charges of $6 million and $25 million, which
include enhanced severance, pension and postretirement benefits, were recorded
in the third quarter of 2002 and the second quarter of 2002, respectively, in
marketing, administration and research costs of the international tobacco
segment.
During 2001, voluntary early retirement programs were announced for certain
eligible salaried employees in the food and beer businesses. During the first
quarter of 2002, approximately 800 employees accepted the benefits offered by
these programs and elected to retire or terminate employment. Pre-tax charges of
$135 million, $7 million and $23 million were recorded in marketing,
administration and research costs of the North American food, international food
and beer segments, respectively, in the first quarter of 2002 for these
voluntary retirement programs and a beer asset impairment.
As discussed in Note 8. Contingencies, on May 7, 2001, the trial court in the
Engle class action approved a stipulation and agreed order among Philip Morris
Incorporated ("PM Inc."), certain other defendants and the plaintiffs providing
that the execution or enforcement of the punitive damages component of the
judgment in that case will remain stayed through the completion of all judicial
review. As a result of the stipulation, PM Inc. placed $500 million into a
separate interest-bearing escrow account that, regardless of the outcome of the
appeal, will be paid to the court and the court will determine how to allocate
or distribute it consistent with the Florida Rules of Civil Procedure. As a
result, a $500 million pre-tax charge was recorded by the domestic tobacco
business during the first quarter of 2001. In July 2001, PM Inc. also placed
$1.2 billion into an interest-bearing escrow account, which will be returned to
PM Inc. should it prevail in its appeal of the case. The $1.2 billion escrow
account is included in the September 30, 2002 and December 31, 2001 condensed
consolidated balance sheets as other assets. Interest income on the $1.2 billion
escrow account is paid to PM Inc. quarterly and is being recorded as earned in
interest and other debt expense, net, in the condensed consolidated statements
of earnings.
During the third quarter of 2001, KFNA incurred pre-tax integration costs of $37
million related to consolidation programs. In addition, during the first quarter
of 2001, KFNA sold a North American food factory, which resulted in a pre-tax
loss of $29 million.
During the third quarter of 2001, Miller entered into an agreement with Pabst
Brewing Co. modifying the terms of an existing contract brewing agreement. This
modification resulted in a pre-tax charge of $19 million in the Company's beer
segment.
Note 8. Contingencies:
- -----------------------
Legal proceedings covering a wide range of matters are pending or threatened in
various United States and foreign jurisdictions against the Company, its
subsidiaries and affiliates, including PM Inc. and the Company's international
tobacco subsidiary, Philip Morris International Inc. ("PMI"), as well as their
respective indemnitees. Various types of claims are raised in these proceedings,
including product liability, consumer protection, antitrust, tax, contraband
shipments, patent infringement, employment matters, claims for contribution and
claims of competitors and distributors.
Overview of Tobacco-Related Litigation
Types and Number of Cases
Pending claims related to tobacco products generally fall within the following
categories: (i) smoking and health cases alleging personal injury brought on
behalf of individual plaintiffs, (ii) smoking and health cases primarily
alleging personal injury and purporting to be brought on behalf of a class of
individual plaintiffs, (iii) health care cost recovery cases brought by
governmental (both domestic and foreign) and non-governmental plaintiffs seeking
reimbursement for health care expenditures allegedly caused by cigarette smoking
and/or
-16-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
disgorgement of profits, and (iv) other tobacco-related litigation. Other
tobacco-related litigation includes class action suits alleging that the use of
the terms "Lights" and "Ultra Lights" constitutes deceptive and unfair trade
practices, suits by foreign governments seeking to recover damages resulting
from the allegedly illegal importation of cigarettes into various jurisdictions,
suits by former asbestos manufacturers seeking contribution or reimbursement for
amounts expended in connection with the defense and payment of asbestos claims
that were allegedly caused in whole or in part by cigarette smoking, and various
antitrust suits. Damages claimed in some of the smoking and health class
actions, health care cost recovery cases and other tobacco-related litigation
range into the billions of dollars. Plaintiffs' theories of recovery and the
defenses raised in the smoking and health and health care cost recovery cases
are discussed below. Exhibit 99.1 hereto lists the smoking and health class
actions, health care cost recovery and certain other actions pending as of
November 1, 2002, and discusses certain developments in such cases since August
12, 2002.
As of November 1, 2002 there were approximately 1,500 smoking and health cases
filed and served on behalf of individual plaintiffs in the United States against
PM Inc. and, in some instances, the Company, compared with approximately 1,500
such cases on November 1, 2001, and on November 1, 2000. In certain
jurisdictions, individual smoking and health cases have been aggregated for
trial in a single proceeding; the largest such proceeding aggregates 1,250 cases
in West Virginia and is currently scheduled for trial in June 2003. An estimated
14 of the individual cases involve allegations of various personal injuries
allegedly related to exposure to environmental tobacco smoke ("ETS"). In
addition, approximately 2,800 additional individual cases are pending in Florida
by current and former flight attendants claiming personal injuries allegedly
related to ETS. The flight attendants allege that they are members of an ETS
smoking and health class action, which was settled in 1997. The terms of the
court-approved settlement in that case allow class members to file individual
lawsuits seeking compensatory damages, but prohibit them from seeking punitive
damages.
As of November 1, 2002, there were an estimated 25 smoking and health putative
class actions pending in the United States against PM Inc. and, in some cases,
the Company (including two that involve allegations of various personal injuries
related to exposure to ETS), compared with approximately 28 such cases on
November 1, 2001, and approximately 37 such cases on November 1, 2000.
As of November 1, 2002, there were an estimated 43 health care cost recovery
actions, including the suit discussed below under "Federal Government's
Lawsuit," filed by the United States government, pending in the United States
against PM Inc. and, in some instances, the Company, compared with approximately
48 such cases pending on November 1, 2001, and 55 such cases on November 1,
2000. In addition, health care cost recovery actions are pending in Israel, the
Province of British Columbia, Canada, France and Spain.
There are also a number of other tobacco-related actions pending outside the
United States against PMI and its affiliates and subsidiaries, including an
estimated 83 smoking and health cases brought on behalf of individuals
(Argentina (43), Australia (1), Brazil (26), Czech Republic (1), Ireland (1),
Israel (2), Italy (4), Japan (1), the Philippines (1), Scotland (1), and Spain
(2)), compared with approximately 71 such cases on November 1, 2001, and 68 such
cases on November 1, 2000. In addition, as of November 1, 2002, there were nine
smoking and health putative class actions pending outside the United States
(Brazil (1), Canada (4), and Spain (4)), compared with 12 such cases on November
1, 2001 and eight such cases on November 1, 2000.
Pending and Upcoming Trials
Jury selection has been completed and opening arguments have been stayed pending
the resolution of certain appeals in a smoking and health class action in
Louisiana in which PM Inc. is a defendant and in which plaintiffs seek the
creation of funds to pay for medical monitoring and smoking cessation programs.
Trial is underway in an individual smoking and health case in California in
which PM Inc. is a defendant. In addition,
-17-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
trial is scheduled to begin in December in an individual smoking and health case
in California in which PM Inc. is a defendant.
As set forth in Exhibit 99.2 hereto, additional cases against PM Inc. and, in
some instances, the Company, are scheduled for trial through the end of 2003.
They include a class action in New York in which plaintiffs seek punitive
damages for a class of persons residing in the United States who smoke or smoked
cigarettes and have been diagnosed with an enumerated disease during the class
period, a class action in California in which plaintiffs seek restitution under
the California Business and Professions Code for the costs of cigarettes
purchased by class members during the class period, a case in West Virginia that
aggregates 1,250 individual smoking and health cases, two Lights/Ultra Lights
class actions in Illinois and Ohio and a class action in Kansas in which
plaintiffs allege that defendants, including PM Inc., conspired to fix cigarette
prices in violation of antitrust laws. In addition, an estimated 22 individual
smoking and health cases and 8 additional cases brought by flight attendants
seeking compensatory damages for personal injuries allegedly caused by ETS are
scheduled for trial through the end of 2003. Four of the trials in the
individual smoking and health cases are scheduled to begin in January 2003.
Trial is scheduled to begin in one of the cases brought by flight attendants in
January 2003. Cases against other tobacco companies are also scheduled for trial
through the end of 2003. Trial dates, however, are subject to change.
Recent Trial Results
Since January 1999, jury verdicts have been returned in 24 smoking and health
and health care cost recovery cases in which PM Inc. was a defendant. Verdicts
in favor of PM Inc. and other defendants were returned in 14 of the 24 cases.
These 14 cases were tried in Rhode Island, West Virginia, Ohio (2), New Jersey,
Florida (4), New York (2), Mississippi and Tennessee (2). Plaintiffs' appeals or
post-trial motions challenging the verdicts are pending in West Virginia, Ohio
and Florida. In May 2002, a mistrial was declared in a case brought by a flight
attendant claiming personal injuries allegedly caused by ETS, and the case was
subsequently dismissed. In addition, in 2001, a mistrial was declared in New
York in an asbestos contribution case, and plaintiffs subsequently voluntarily
dismissed the case. The chart below lists the verdicts and post-trial
developments in the ten cases that have gone to trial since January 1999 in
which verdicts were returned in favor of plaintiffs.
Location Type of Post-Trial
Date of Court Case Verdict Developments
- ---- -------- ---- ------- ------------
October California Individual $850,000 in compensatory damages PM Inc. has filed post-trial
2002 Smoking & and $28 billion in punitive damages motions challenging the
Health against PM Inc. verdict.
June Florida Flight $5.5 million in compensatory In September 2002, the court
2002 Attendant damages against all defendants, reduced the damages award to
ETS including PM Inc. $500,000; plaintiff and
Litigation defendants have appealed.
June Florida Individual $37.5 million in compensatory Defendants have filed
2002 Smoking and damages against all defendants, post-trial motions
Health including PM Inc. challenging the verdict.
-18-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Location Type of Post-Trial
Date of Court Case Verdict Developments
- ---- -------- ---- ------- ------------
March Oregon Individual $168,500 in compensatory damages In May 2002, the trial court
2002 Smoking and and $150 million in punitive reduced the punitive damages
Health damages against PM Inc. award to $100 million, and
in July 2002, the trial
court denied PM Inc.'s
post-trial motions
challenging the verdict. PM
Inc. has appealed.
June California Individual $5.5 million in compensatory In August 2001, the trial
2001 Smoking and damages, and $3 billion in punitive court reduced the punitive
Health damages against PM Inc. damages award to $100
million; PM Inc. has
appealed.
June New York Health Care $17.8 million in compensatory In February 2002, the trial
2001 Cost Recovery damages against all defendants, court awarded plaintiffs $38
including $6.8 million against PM million in attorneys' fees.
Inc. Defendants have appealed.
July Florida Smoking and $145 billion in punitive damages See "Engle Class Action,"
2000 Health Class against all defendants, including below.
Action $74 billion against PM Inc.
March California Individual $1.72 million in compensatory Defendants have appealed.
2000 Smoking and damages against PM Inc. and another
Health defendant, and $10 million in
punitive damages against PM Inc.
and $10 million in punitive damages
against the other defendant.
March Oregon Individual $800,000 in compensatory damages, The trial court reduced the
1999 Smoking and $21,500 in medical expenses and punitive damages award to
Health $79.5 million in punitive damages $32 million, and PM Inc.
against PM Inc. appealed. In June 2002, the
Oregon Court of Appeals reinstated
the $79.5 million punitive damages
award; PM Inc. has appealed to the
Oregon Supreme Court.
-19-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Location Type of Post-Trial
Date of Court Case Verdict Developments
- ---- -------- ---- ------- ------------
February California Individual $1.5 million in compensatory The trial court reduced the punitive
1999 Smoking and damages and $50 million in punitive damages award to $25 million and PM
Health damages against PM Inc. Inc. appealed. In November 2001, a
California District Court of Appeals
affirmed the trial court's ruling, and
PM Inc. appealed to the California
Supreme Court. In October 2002, the
California Supreme Court vacated the
decision of the District Court of
Appeals and remanded the case back to
the District Court of Appeals for
further consideration.
In addition, since January 1999, jury verdicts have been returned in 13
tobacco-related cases in which neither the Company nor any of its subsidiaries
were defendants. Verdicts in favor of defendants were returned in eight of the
13 cases in cases tried in Connecticut, Texas, South Carolina, Mississippi,
Louisiana, Missouri and Tennessee (2). Plaintiffs' appeal is pending in
Mississippi. Verdicts in favor of plaintiffs were returned in 5 of the 13 cases
in cases tried in Australia, Kansas, Florida (2) and Puerto Rico. Defendants'
appeals or post-trial motions are pending. In October 2002, the court granted
defendants' motion for a new trial in the case in Puerto Rico. In addition, in
a case in France the trial court found in favor of plaintiff; however, the
appellate court reversed the trial court's ruling and dismissed plaintiff's
claim.
Engle Class Action
Verdicts have been returned and judgment has been entered against PM Inc. and
other defendants in the first two phases of this three-phase smoking and health
class action trial in Florida. The class consists of all Florida residents and
citizens, and their survivors, "who have suffered, presently suffer or have died
from diseases and medical conditions caused by their addiction to cigarettes
that contain nicotine."
In July 1999, the jury returned a verdict against defendants in phase one of the
trial concerning certain issues determined by the trial court to be "common" to
the causes of action of the plaintiff class. Among other things, the jury found
that smoking cigarettes causes 20 diseases or medical conditions, that
cigarettes are addictive or dependence-producing, defective and unreasonably
dangerous, that defendants made materially false statements with the intention
of misleading smokers, that defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking cigarettes,
and that defendants were negligent and engaged in extreme and outrageous conduct
or acted with reckless disregard with the intent to inflict emotional distress.
During phase two of the trial, the claims of three of the named plaintiffs were
adjudicated in a consolidated trial before the same jury that returned the
verdict in phase one. In April 2000, the jury determined liability against the
defendants and awarded $12.7 million in compensatory damages to the three named
plaintiffs.
In July 2000, the same jury returned a verdict assessing punitive damages on a
lump sum basis for the entire class totaling approximately $145 billion against
the various defendants in the case, including approximately $74 billion
severally against PM Inc. PM Inc. believes that the punitive damages award was
determined improperly and that it should ultimately be set aside on any one of
numerous grounds. Included among these grounds are the following: under
applicable law, (i) defendants are entitled to have liability and damages for
each plaintiff tried by the same jury, an impossibility due to the jury's
dismissal; (ii) punitive damages cannot be assessed before the jury determines
entitlement to, and the amount of, compensatory damages for all class members;
(iii) punitive damages must bear a reasonable relationship to compensatory
damages, a determination that cannot be made before compensatory damages are
assessed for all class members; and (iv) punitive damages can "punish" but
cannot "destroy" the defendant. In March 2000, at the request of the Florida
legislature, the Attorney General of Florida issued an advisory legal opinion
stating that "Florida law is clear that compensatory damages must be determined
prior to an award of punitive damages" in cases such as Engle. As noted above,
compensatory damages for all but three members of the class have not been
determined.
-20-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Following the verdict in the second phase of the trial, the jury was dismissed,
notwithstanding that liability and compensatory damages for all but three class
members have not yet been determined. According to the trial plan, phase three
of the trial will address other class members' claims, including issues of
specific causation, reliance, affirmative defenses and other individual-specific
issues regarding entitlement to damages, in individual trials before separate
juries.
It is unclear how the trial plan will be further implemented. The trial plan
provides that the punitive damages award should be standard as to each class
member and acknowledges that the actual size of the class will not be known
until the last class member's case has withstood appeal, i.e., the punitive
damages amount would be divided equally among those plaintiffs who, in addition
to the successful phase two plaintiffs, are ultimately successful in phase three
of the trial and in any appeal.
Following the jury's punitive damages verdict in July 2000, defendants removed
the case to federal district court following the intervention application of a
union health fund that raised federal issues in the case. In November 2000, the
federal district court remanded the case to state court on the grounds that the
removal was premature.
The trial judge in the state court, without a hearing, then immediately denied
the defendants' post-trial motions and entered judgment on the compensatory and
punitive damages awarded by the jury. PM Inc. and the Company believe that the
entry of judgment by the trial court is unconstitutional and violates Florida
law. PM Inc. has filed an appeal with respect to the entry of judgment, class
certification and numerous other reversible errors that have occurred during the
trial. PM Inc. has also posted a $100 million bond to stay execution of the
judgment with respect to the $74 billion in punitive damages that has been
awarded against it. The bond was posted pursuant to legislation that was enacted
in Florida in May 2000 that limits the size of the bond that must be posted in
order to stay execution of a judgment for punitive damages in a certified class
action to no more than $100 million, regardless of the amount of punitive
damages ("bond cap legislation").
Plaintiffs had previously indicated that they believe the bond cap legislation
is unconstitutional and might seek to challenge the $100 million bond. If the
bond were found to be invalid, it would be commercially impossible for PM Inc.
to post a bond in the full amount of the judgment and, absent appellate relief,
PM Inc. would not be able to stay any attempted execution of the judgment in
Florida. PM Inc. and the Company will take all appropriate steps to seek to
prevent this worst-case scenario from occurring. In May 2001, the trial court
approved a stipulation (the "Stipulation") among PM Inc., certain other
defendants, plaintiffs and the plaintiff class that provides that execution or
enforcement of the punitive damages component of the Engle judgment will remain
stayed against PM Inc. and the other participating defendants through the
completion of all judicial review. As a result of the Stipulation and in
addition to the $100 million bond it previously posted, PM Inc. placed $1.2
billion into an interest-bearing escrow account for the benefit of the Engle
class. Should PM Inc. prevail in its appeal of the case, both amounts are to be
returned to PM Inc. PM Inc. also placed an additional $500 million into a
separate interest-bearing escrow account for the benefit of the Engle class. If
PM Inc. prevails in its appeal, this amount will be paid to the court, and the
court will determine how to allocate or distribute it consistent with the
Florida Rules of Civil Procedure. In connection with the Stipulation, the
Company recorded a $500 million pre-tax charge in its consolidated statement of
earnings for the quarter ended March 31, 2001.
PM Inc. and the Company remain of the view that the Engle case should not have
been certified as a class action. The certification is inconsistent with the
overwhelming majority of federal and state court decisions that have held that
mass smoking and health claims are inappropriate for class treatment. PM Inc.
has filed an appeal challenging the class certification and the compensatory and
punitive damages awards, as well as numerous other reversible errors that it
believes occurred during the trial to date. The appellate court heard oral
argument on defendants' appeals on November 6, 2002.
-21-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Smoking and Health Litigation
Plaintiffs' allegations of liability in smoking and health cases are based on
various theories of recovery, including negligence, gross negligence, strict
liability, fraud, misrepresentation, design defect, failure to warn, breach of
express and implied warranties, breach of special duty, conspiracy, concert of
action, violations of deceptive trade practice laws and consumer protection
statutes, and claims under the federal and state RICO statutes. In certain of
these cases, plaintiffs claim that cigarette smoking exacerbated the injuries
caused by their exposure to asbestos. Plaintiffs in the smoking and health
actions seek various forms of relief, including compensatory and punitive
damages, treble/multiple damages and other statutory damages and penalties,
creation of medical monitoring and smoking cessation funds, disgorgement of
profits, and injunctive and equitable relief. Defenses raised in these cases
include lack of proximate cause, assumption of the risk, comparative fault
and/or contributory negligence, statutes of limitations and preemption by the
Federal Cigarette Labeling and Advertising Act. In May 1996, the United States
Court of Appeals for the Fifth Circuit held in the Castano case that a class
consisting of all "addicted" smokers nationwide did not meet the standards and
requirements of the federal rules governing class actions. Since this class
decertification, lawyers for plaintiffs have filed numerous putative smoking and
health class action suits in various state and federal courts. In general, these
cases purport to be brought on behalf of residents of a particular state or
states (although a few cases purport to be nationwide in scope) and raise
"addiction" claims and, in many cases, claims of physical injury as well. As of
November 1, 2002, smoking and health putative class actions were pending in
Alabama, Florida, Illinois, Louisiana, Missouri, Nevada, New Jersey, Oregon,
Utah, West Virginia and the District of Columbia, as well as in Brazil, Canada,
Israel and Spain. Class certification has been denied or reversed by courts in
29 smoking and health class actions involving PM Inc. in Arkansas, the District
of Columbia, Illinois (2), Iowa, Kansas, Louisiana, Maryland, Michigan,
Minnesota, Nevada (4), New Jersey (6), New York (2), Ohio, Oklahoma,
Pennsylvania, Puerto Rico, South Carolina, Texas and Wisconsin, while classes
remain certified in the Engle case in Florida (discussed above) and a case in
Louisiana in which plaintiffs seek the creation of funds to pay for medical
monitoring and smoking cessation programs for class members. In May 1999, the
United States Supreme Court declined to review the decision of the United States
Court of Appeals for the Third Circuit affirming a lower court's decertification
of a class. In November 2001, in the first medical monitoring class action case
to go to trial, a West Virginia jury returned a verdict in favor of all
defendants, including PM Inc., and plaintiffs have appealed. Exhibit 99.1 hereto
lists the smoking and health class actions pending as of November 1, 2002, and
discusses certain developments in such cases since August 12, 2002.
Health Care Cost Recovery Litigation
Overview
In certain pending proceedings, domestic and foreign governmental entities and
non-governmental plaintiffs, including union health and welfare funds
("unions"), Native American tribes, insurers and self-insurers such as Blue
Cross and Blue Shield plans, hospitals, taxpayers and others, are seeking
reimbursement of health care cost expenditures allegedly caused by tobacco
products and, in some cases, of future expenditures and damages as well. Relief
sought by some but not all plaintiffs includes punitive damages, multiple
damages and other statutory damages and penalties, injunctions prohibiting
alleged marketing and sales to minors, disclosure of research, disgorgement of
profits, funding of anti-smoking programs, additional disclosure of nicotine
yields, and payment of attorney and expert witness fees. Certain of the health
care cost recovery cases purport to be brought on behalf of a class of
plaintiffs.
The claims asserted in the health care cost recovery actions include the
equitable claim that the tobacco industry was "unjustly enriched" by plaintiffs'
payment of health care costs allegedly attributable to smoking, the equitable
claim of indemnity, common law claims of negligence, strict liability, breach of
express and implied warranty, violation of a voluntary undertaking or special
duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims
under federal and state statutes governing consumer fraud, antitrust, deceptive
trade practices and false advertising, and claims under federal and state RICO
statutes.
-22-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Defenses raised include lack of proximate cause, remoteness of injury, failure
to state a valid claim, lack of benefit, adequate remedy at law, "unclean hands"
(namely, that plaintiffs cannot obtain equitable relief because they
participated in, and benefited from, the sale of cigarettes), lack of antitrust
standing and injury, federal preemption, lack of statutory authority to bring
suit, and statutes of limitations. In addition, defendants argue that they
should be entitled to "set off" any alleged damages to the extent the plaintiff
benefits economically from the sale of cigarettes through the receipt of excise
taxes or otherwise. Defendants also argue that these cases are improper because
plaintiffs must proceed under principles of subrogation and assignment. Under
traditional theories of recovery, a payor of medical costs (such as an insurer)
can seek recovery of health care costs from a third party solely by "standing in
the shoes" of the injured party. Defendants argue that plaintiffs should be
required to bring any actions as subrogees of individual health care recipients
and should be subject to all defenses available against the injured party.
Although there have been some decisions to the contrary, most courts that have
decided motions in these cases have dismissed all or most of the claims against
the industry. In addition, eight federal circuit courts of appeals, the Second,
Third, Fifth, Seventh, Eighth, Ninth, Eleventh and District of Columbia
circuits, as well as California and Tennessee intermediate appellate courts,
relying primarily on grounds that plaintiffs' claims were too remote, have
affirmed dismissals of, or reversed trial courts that had refused to dismiss,
health care cost recovery actions. The United States Supreme Court has refused
to consider plaintiffs' appeals from the cases decided by the courts of appeals
for the Second, Third, Ninth and District of Columbia circuits.
As of November 1, 2002, there were an estimated 43 health care cost recovery
cases pending in the United States against PM Inc., and in some instances, the
Company, including the case filed by the United States government, which is
discussed below under "Federal Government's Lawsuit." Exhibit 99.1 hereto lists
the health care cost recovery cases pending as of November 1, 2002, and
discusses certain developments in such cases since August 12, 2002.
The cases brought in the United States include actions brought by Belize,
Bolivia, Ecuador, Guatemala, Honduras, Nicaragua, the Province of Ontario,
Canada, Panama, the Russian Federation, Tajikistan, Ukraine, Venezuela, 11
Brazilian states and 11 Brazilian cities. The actions brought by Belize,
Bolivia, Ecuador, Guatemala, Honduras, Nicaragua, the Province of Ontario,
Panama, the Russian Federation, Tajikistan, Ukraine, Venezuela, 10 Brazilian
states and 11 Brazilian cities were consolidated for pre-trial purposes and
transferred to the United States District Court for the District of Columbia.
The district court dismissed the cases brought by Guatemala, Nicaragua, Ukraine
and the Province of Ontario, and the dismissals are now final. The district
court has remanded to state courts the remaining cases, except for the cases
brought by Bolivia and Panama. Subsequent to remand, the Ecuador case was
voluntarily dismissed. In November 2001, the cases brought by Venezuela and the
Brazilian state of Espirito Santo were dismissed by the state court, and
Venezuela appealed. In September 2002, the appellate court affirmed the
dismissal of the case brought by Venezuela, and Venezuela has petitioned the
state supreme court for further review. In addition to cases brought in the
United States, health care cost recovery actions have also been brought in
Israel, the Marshall Islands (dismissed), the Province of British Columbia,
Canada, France and Spain, and other entities have stated that they are
considering filing such actions.
In March 1999, in the first health care cost recovery case to go to trial, an
Ohio jury returned a verdict in favor of defendants on all counts. In June 2001,
a New York jury returned a verdict awarding $6.83 million in compensatory
damages against PM Inc. and a total of $11 million against four other defendants
in a health care cost recovery action brought by a Blue Cross and Blue Shield
plan. In February 2002, the court awarded plaintiff approximately $38 million
for attorneys' fees. Defendants, including PM Inc., have appealed.
Settlements of Health Care Cost Recovery Litigation
In November 1998, PM Inc. and certain other United States tobacco product
manufacturers entered into the Master Settlement Agreement (the "MSA") with 46
states, the District of Columbia, Puerto Rico, Guam, the United States Virgin
Islands, American Samoa and the Northern Marianas to settle asserted and
unasserted health care cost recovery and other claims. PM Inc. and certain other
United States tobacco product
-23-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
manufacturers had previously settled similar claims brought by Mississippi,
Florida, Texas and Minnesota (together with the MSA, the "State Settlement
Agreements"). The MSA has received final judicial approval in all 52 settling
jurisdictions. The State Settlement Agreements require that the domestic tobacco
industry make substantial annual payments in the following amounts (excluding
future annual payments contemplated by the agreement with tobacco growers
discussed below), subject to adjustment for several factors, including
inflation, market share and industry volume: 2002, $11.3 billion; 2003, $10.9
billion; 2004 through 2007, $8.4 billion each year; and, thereafter, $9.4
billion each year. In addition, the domestic tobacco industry is required to pay
settling plaintiffs' attorneys' fees, subject to an annual cap of $500 million,
as well as additional annual payments of $250 million through 2003. These
payment obligations are the several and not joint obligations of each settling
defendant. PM Inc.'s portion of ongoing adjusted payments and legal fees is
based on its relative share of the settling manufacturers' domestic cigarette
shipments, including roll-your-own cigarettes, in the year preceding that in
which the payment is due. PM Inc. records its portions of ongoing settlement
payments as part of cost of sales as product is shipped.
The State Settlement Agreements also include provisions relating to advertising
and marketing restrictions, public disclosure of certain industry documents,
limitations on challenges to certain tobacco control and underage use laws,
restrictions on lobbying activities and other provisions.
As part of the MSA, the settling defendants committed to work cooperatively with
the tobacco-growing states to address concerns about the potential adverse
economic impact of the MSA on tobacco growers and quota-holders. To that end,
four of the major domestic tobacco product manufacturers, including PM Inc., and
the grower states, have established a trust fund to provide aid to tobacco
growers and quota-holders. The trust will be funded by these four manufacturers
over 12 years with payments, prior to application of various adjustments,
scheduled to total $5.15 billion. Future industry payments (2002 through 2008,
$500 million each year; 2009 and 2010, $295 million each year) are subject to
adjustment for several factors, including inflation, United States cigarette
volume and certain other contingent events, and, in general, are to be allocated
based on each manufacturer's relative market share. PM Inc. records its portion
of these payments as part of cost of sales as product is shipped.
The State Settlement Agreements have materially adversely affected the volumes
of PM Inc. and the Company; the Company believes that they may materially
adversely affect the business, volumes, results of operations, cash flows or
financial position of PM Inc. and the Company in future periods. The degree of
the adverse impact will depend, among other things, on the rate of decline in
United States cigarette sales in the premium and discount segments, PM Inc.'s
share of the domestic premium and discount cigarette segments, and the effect of
any resulting cost advantage of manufacturers not subject to the MSA and the
other State Settlement Agreements.
Certain litigation, described in Exhibit 99.1, has arisen challenging the
validity of the MSA and alleging violations of antitrust laws.
Federal Government's Lawsuit
In 1999, the United States government filed a lawsuit in the United States
District Court for the District of Columbia against various cigarette
manufacturers and others, including PM Inc. and the Company, asserting claims
under three federal statutes, the Medical Care Recovery Act ("MCRA"), the
Medicare Secondary Payer ("MSP") provisions of the Social Security Act and the
Racketeer Influenced and Corrupt Organizations Act ("RICO"). The lawsuit seeks
to recover an unspecified amount of health care costs for tobacco-related
illnesses allegedly caused by defendants' fraudulent and tortious conduct and
paid for by the government under various federal health care programs, including
Medicare, military and veterans' health benefits programs, and the Federal
Employees Health Benefits Program. The complaint alleges that such costs total
more than $20 billion annually. It also seeks various types of what it alleges
to be equitable and declaratory relief, including
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
disgorgement, an injunction prohibiting certain actions by the defendants, and a
declaration that the defendants are liable for the federal government's future
costs of providing health care resulting from defendants' alleged past tortious
and wrongful conduct. PM Inc. and the Company moved to dismiss this lawsuit on
numerous grounds, including that the statutes invoked by the government do not
provide a basis for the relief sought. In September 2000, the trial court
dismissed the government's MCRA and MSP claims, but permitted discovery to
proceed on the government's claims for relief under RICO. In October 2000, the
government moved for reconsideration of the trial court's order to the extent
that it dismissed the MCRA claims for health care costs paid pursuant to
government health benefit programs other than Medicare and the Federal Employees
Health Benefits Act. In February 2001, the government filed an amended complaint
attempting to replead the MSP claims. In July 2001, the court denied the
government's motion for reconsideration of the dismissal of the MCRA claims and
dismissed the government's amended MSP claims. Trial of the case is currently
scheduled for September 2004.
Certain Other Tobacco-Related Litigation
Lights/Ultra Lights Cases: As of November 1, 2002, there were 11 putative class
actions pending against PM Inc. and, in some instances, the Company in
California, Florida, Illinois, Massachusetts, Minnesota, Missouri, New
Hampshire, Ohio (2), Tennessee and West Virginia on behalf of individuals who
purchased and consumed various brands of cigarettes, including Marlboro Lights,
Marlboro Ultra Lights, Virginia Slims Lights and Superslims, Merit Lights and
Cambridge Lights. Plaintiffs in these cases allege, among other things, that the
use of the terms "Lights" and/or "Ultra Lights" constitutes deceptive and unfair
trade practices, and seek injunctive and equitable relief, including
restitution. Classes have been certified in Illinois, Massachusetts and Florida.
Trial in the Illinois case is scheduled for January 2003. Trial in one of the
Ohio cases is scheduled for August 2003.
Cigarette Contraband Cases: As of November 1, 2002, the European Community and
ten member states, various Departments of Colombia, Ecuador, Belize and Honduras
had filed suits in the United States against the Company and certain of its
subsidiaries, including PM Inc. and PMI, and other cigarette manufacturers and
their affiliates, alleging that defendants sold to distributors cigarettes that
would be illegally imported into various jurisdictions. The claims asserted in
these cases include negligence, negligent misrepresentation, fraud, unjust
enrichment, violations of RICO and its state-law equivalents and conspiracy.
Plaintiffs in these cases seek actual damages, treble damages and undisclosed
injunctive relief. In February 2002, the courts granted defendants' motions to
dismiss all of the actions. In the Colombia and European Community actions,
however, the RICO and fraud claims predicated on allegations of money laundering
claims were dismissed without prejudice. Plaintiffs in each of the cases have
appealed. In October 2001, the United States Court of Appeals for the Second
Circuit affirmed the dismissal of a cigarette contraband case filed against
another cigarette manufacturer. Plaintiff in that case petitioned the United
States Supreme Court for further review, and in October 2002, the Supreme Court
denied plaintiff's petition.
Asbestos Contribution Cases: As of November 1, 2002, an estimated eight suits
were pending on behalf of former asbestos manufacturers and affiliated entities
against domestic tobacco manufacturers, including PM Inc. These cases seek,
among other things, contribution or reimbursement for amounts expended in
connection with the defense and payment of asbestos claims that were allegedly
caused in whole or in part by cigarette smoking. Plaintiffs in most of these
cases also seek punitive damages.
Retail Leaders Case: Three domestic tobacco manufacturers filed suit against PM
Inc. seeking to enjoin the PM Inc. "Retail Leaders" program that became
available to retailers in October 1998. The complaint alleged that this retail
merchandising program is exclusionary, creates an unreasonable restraint of
trade and constitutes unlawful monopolization. In addition to an injunction,
plaintiffs sought unspecified treble damages, attorneys' fees, costs and
interest. In May 2002, the court granted PM Inc.'s motion for summary judgment
and dismissed all of plaintiffs' claims with prejudice. Plaintiffs have
appealed.
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Philip Morris Companies Inc. and Subsidiaries
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(Unaudited)
Vending Machine Case: Plaintiffs, who began their case as a purported nationwide
class of cigarette vending machine operators, allege that PM Inc. has violated
the Robinson-Patman Act in connection with its promotional and merchandising
programs available to retail stores and not available to cigarette vending
machine operators. The initial complaint was amended to bring the total number
of plaintiffs to 211, but by stipulated orders, all claims were stayed, except
those of ten plaintiffs that proceeded to pre-trial discovery. Plaintiffs
request actual damages, treble damages, injunctive relief, attorneys' fees and
costs, and other unspecified relief. In June 1999, the court denied plaintiffs'
motion for a preliminary injunction. Plaintiffs have withdrawn their request for
class action status. In August 2001, the court granted PM Inc.'s motion for
summary judgment and dismissed, with prejudice, the claims of the ten
plaintiffs. In October 2001, the court certified its decision for appeal to the
United States Court of Appeals for the Sixth Circuit following the stipulation
of all plaintiffs that the district court's dismissal would, if affirmed, be
binding on all plaintiffs.
Tobacco Price Cases: As of November 1, 2002, there were 39 putative class
actions pending against PM Inc. and other domestic tobacco manufacturers, as
well as, in certain instances, the Company and PMI, alleging that defendants
conspired to fix cigarette prices in violation of antitrust laws. Seven of the
putative class actions were filed in various federal district courts by direct
purchasers of tobacco products, and the remaining 32 were filed in 14 states and
the District of Columbia by retail purchasers of tobacco products. In November
2001, plaintiffs' motion for class certification was granted in a case pending
in state court in Kansas, and trial in this case is scheduled for September
2003. In November 2001, plaintiffs' motion for class certification was denied in
a case pending in state court in Minnesota. In June 2002, plaintiffs' motion for
class certification was denied in a case pending in the State of Michigan.
Plaintiffs' motion for reconsideration of this ruling was denied. Defendants'
motions for summary judgment are pending. In May 2002, the Arizona Court of
Appeals reversed the trial court's decision to dismiss an action, and defendants
have appealed. The seven federal class actions have been consolidated in the
United States District Court for the Northern District of Georgia. In July 2002,
the court granted defendants' motion for summary judgment dismissing the case in
its entirety, and plaintiffs have appealed. The cases are listed in Exhibit
99.1.
Cases Under the California Business and Professions Code: In June 1997 and July
1998, two suits were filed in California courts alleging that domestic cigarette
manufacturers, including PM Inc. and others, have violated California Business
and Professions Code Sections 17200 and 17500 regarding unfair, unlawful and
fraudulent business practices. Class certification was granted as to plaintiffs'
claims that defendants violated sections 17200 and/or 17500 of California
Business and Professions Code pursuant to which plaintiffs allege that class
members are entitled to reimbursement of the costs of cigarettes purchased
during the class periods and injunctive relief. In September 2002, the court
granted defendants' motions for summary judgment as to all claims in one of the
cases; in November 2002, the court confirmed its earlier rulings granting
defendants' motions for summary judgment. Trial in the other case is scheduled
for April 2003.
Tobacco Growers' Case: In February 2000, a suit was filed on behalf of a
purported class of tobacco growers and quota-holders, and amended complaints
were filed in May 2000 and in August 2000. The second amended complaint alleges
that defendants, including PM Inc., violated antitrust laws by bid-rigging and
allocating purchases at tobacco auctions and by conspiring to undermine the
tobacco quota and price-support program administered by the federal government.
In October 2000, defendants filed motions to dismiss the amended complaint and
to transfer the case, and plaintiffs filed a motion for class certification. In
November 2000, the court granted defendants' motion to transfer the case to the
United States District Court for the Middle District of North Carolina. In
December 2000, plaintiffs served a motion for leave to file a third amended
complaint to add tobacco leaf buyers as defendants. This motion was granted, and
the additional parties were served in February 2001. In March 2001, the leaf
buyer defendants filed a motion to dismiss the case. In July 2001, the court
denied the manufacturer and leaf buyer defendants' motions to dismiss the case,
and in April 2002 granted plaintiffs' motion for class certification.
Defendants' petition for interlocutory review of the class certification order
was denied in June 2002. Trial is scheduled for April 2004.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Consolidated Putative Punitive Damages Cases: In September 2000, a putative
class action was filed in the federal district court in the Eastern District of
New York that purported to consolidate punitive damages claims in ten
tobacco-related actions then pending in federal district courts New York and
Pennsylvania. In July 2002, plaintiffs filed an amended consolidated class
action complaint and a motion for class certification. The complaint sought
certification of