-----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, Je6eCm7ervttYrw9o58srOc7WKosGTl3UNqhqG96Jd2aNSt6u9czKaf1P8835tWQ n/60+Wed12BaK024Eyl9wg== 0001005477-97-000115.txt : 19970131 0001005477-97-000115.hdr.sgml : 19970131 ACCESSION NUMBER: 0001005477-97-000115 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970130 ITEM INFORMATION: Other events ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 19970130 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: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08940 FILM NUMBER: 97514501 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 8-K 1 FORM 8-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported) January 30, 1997 ---------------- PHILIP MORRIS COMPANIES INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Virginia 1-8940 13-3260245 - -------------------------------------------------------------------------------- (State or other (Commission (IRS Employer jurisdiction File Number) Identification No.) of incorporation) 120 Park Avenue, New York, New York 10017-5592 - -------------------------------------------------------------------------------- (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code (212) 880-5000 -------------- - -------------------------------------------------------------------------------- (Former name or former address, if changed since last report) Item 5. Other Events. Filed as part of this Current Report on Form 8-K are the consolidated balance sheets of Philip Morris Companies Inc. and subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996 (the "Financial Statements"), the independent accountants' report thereon and the statement regarding computation of ratios of earnings to fixed charges. The Financial Statements, the independent accountants' report and the statement regarding computation of ratios of earnings to fixed charges will be incorporated by reference in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. Additionally, see Exhibit 1 below. Item 7. Financial Statements and Exhibits. The Financial Statements, together with the independent accountants' report thereon, are included herein. (c) Exhibits 1. Form of Underwriting Agreement, including form of Terms Agreement. 12. Statement regarding computation of ratios of earnings to fixed charges. 23. Consent of independent accountants. 27. Financial Data Schedule. 99. Financial Statements. 2 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. PHILIP MORRIS COMPANIES INC. BY /s/ LOUIS C. CAMILLERI Senior Vice President and Chief Financial Officer DATE January 30, 1997 3 EXHIBIT INDEX Exhibit No. 1. Form of Underwriting Agreement, including form of Terms Agreement. 12. Statement regarding computation of ratios of earnings to fixed charges. 23. Consent of independent accountants. 27. Financial Data Schedule. 99. Financial Statements. EX-1 2 UNDERWRITING AGREEMENT PHILIP MORRIS COMPANIES INC. Debt Securities and Warrants to Purchase Debt Securities UNDERWRITING AGREEMENT Dated as of January 2, 1997 1. Introductory. Philip Morris Companies Inc., a Virginia corporation ("Company"), proposes to issue and sell from time to time certain of its debt securities and warrants to purchase certain of its debt securities in an aggregate principal amount expressed in U.S. dollars or in such foreign currencies or currency units as the Company shall designate at the time of offering. Such debt securities, warrants and debt securities subject to such warrants, registered under the registration statement referred to in Section 2(a), are hereinafter collectively referred to as "Registered Securities". Registered Securities involved in any offering referred to below are hereinafter collectively referred to as "Securities", such debt securities that are Securities are hereinafter referred to as "Purchased Debt Securities", warrants to purchase debt securities that are Securities are hereinafter referred to as "Debt Warrants", debt securities subject to warrants that are Securities are hereinafter referred to as "Warrant Debt Securities", Purchased Debt Securities and Warrant Debt Securities are hereinafter collectively referred to as "Debt Securities" and Purchased Debt Securities and Debt Warrants are hereinafter collectively referred to as "Purchased Securities". The Debt Securities will be issued under an Indenture, dated as of December 2, 1996 (the "Indenture"), between the Company and The Chase Manhattan Bank, as Trustee and the Debt Warrants will be issued under a debt warrant agreement (the "Debt Warrant Agreement"), between the Company and a bank or trust company, as Debt Warrant Agent, specified in the Terms Agreement referred to in Section 3, in one or more series or issues, which may vary as to interest rates, maturities, redemption provisions, exercise prices, expiration dates, selling prices, currency or currency units and other terms, with in each case all such terms for any particular Registered Securities being determined at the time of sale. Particular Purchased Securities will be sold pursuant to a Terms Agreement and for resale in accordance with terms of offering determined at the time of sale. The firm or firms which agree to purchase the Purchased Securities are hereinafter referred to as the "Underwriters" of such Purchased Securities, and the representative or representatives of the Underwriters, if any, specified in a Terms Agreement referred to in Section 3 are hereinafter referred to as the "Representatives"; provided, however, that if the Terms Agreement does not specify any representative of the Underwriters, the term "Representatives", as used in this Agreement (other than in Sections 2(b), 5 and 6 and the second sentence of Section 3), shall mean the Underwriters. 2. Representations and Warranties of the Company. The Company represents and warrants to, and agrees with, each Underwriter that: (a) A registration statement (No. 333-16955), including a prospectus, relating to the Registered Securities has been filed with the Securities and Exchange Commission (the "Commission") and such amendments thereto as may have been required to the date hereof have been filed and such registration statement has become effective. Such registration statement, as amended at the time of any Terms Agreement referred to in Section 3, is hereinafter referred to as the "Registration Statement", and the prospectus included in such Registration Statement, as supplemented as contemplated by Section 3 to reflect the terms of the Securities and the terms of offering thereof, including all material incorporated by reference therein, is hereinafter referred to as the "Prospectus". (b) On the effective date of the registration statement relating to the Registered Securities, such registration statement or, if one or more post-effective amendments shall have been filed with respect to such registration statement, on the most recent effective date of such post-effective amendments, such registration statement, as so amended, conformed in all material respects to the requirements of the Securities Act of 1933 (the "Act"), the Trust Indenture Act of 1939 (the "Trust Indenture Act") and the rules and regulations of the Commission (the "Rules and Regulations") and did not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to 1 make the statements therein not misleading, and, on the date of each Terms Agreement referred to in Section 3 and on each Closing Date as defined in Section 3, the Registration Statement and the Prospectus will conform in all respects to the requirements of the Act, the Trust Indenture Act and the Rules and Regulations, and none of such documents will include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, except that the foregoing does not apply to statements in or omissions from any of such documents based upon written information furnished to the Company by any Underwriter through the Representatives, if any, specifically for use therein. 3. Purchase and Offering of Securities. The obligation of the Underwriters to purchase the Purchased Securities will be evidenced by an exchange of telegraphic or other written communications (the "Terms Agreement") at the time the Company determines to sell the Purchased Securities. The Terms Agreement will incorporate by reference the provisions of this Agreement, except as otherwise provided therein, and will specify the firm or firms which will be Underwriters, the names of any Representatives, the principal amount of Purchased Debt Securities and the number of Debt Warrants to be purchased by each Underwriter, the purchase price to be paid by the Underwriters and the terms of the Purchased Securities not already specified in the Indenture or the Debt Warrant Agreement, as the case may be, including, but not limited to, interest rate, maturity, any redemption provisions and any sinking fund requirements, the exercise price of the Debt Warrants to be purchased, the principal amount of Warrant Debt Securities issuable upon exercise of one such Debt Warrant, the date after which such Debt Warrants are exercisable, the expiration date thereof and the date, if any, such Debt Warrants are detachable and whether any of the Purchased Debt Securities or Debt Warrants may be sold to institutional investors pursuant to Delayed Delivery Contracts (as defined below). The Terms Agreement will also specify the time and date of delivery and payment (such time and date, or such other time not later than seven full business days thereafter as the Representatives and the Company agree as the time for payment and delivery, being herein and in the Terms Agreement referred to as the "Closing Date"), the place of delivery and payment and any details of the terms of offering that should be reflected in the prospectus supplement relating to the offering of the Securities. The obligations of the Underwriters to purchase the Purchased Securities will be several and not joint. It is understood that the Underwriters propose to offer the Purchased Securities for sale as set forth in the Prospectus. The Purchased Securities delivered to the Underwriters on the Closing Date will be in fully registered or bearer form with respect to any Debt Securities, and in fully registered form with respect to Debt Warrants, in each case in such denominations and numbers and registered in such names as the Underwriters may request. If the Terms Agreement provides for sales of Purchased Debt Securities or Debt Warrants pursuant to delayed delivery contracts, the Company authorizes the Underwriters to solicit offers to purchase Purchased Debt Securities or Debt Warrants pursuant to delayed delivery contracts substantially in the form of Annex I attached hereto ("Delayed Delivery Contracts") with such changes therein as the Company may authorize or approve. Delayed Delivery Contracts are to be with institutional investors, including commercial and savings banks, insurance companies, pension funds, investment companies and educational and charitable institutions. On the Closing Date the Company will pay, as compensation, to the Representatives for the accounts of the Underwriters, the fee set forth in such Terms Agreement in respect of the principal amount of Purchased Debt Securities and number of Debt Warrants to be sold pursuant to Delayed Delivery Contracts ("Contract Securities"). The Underwriters will not have any responsibility in respect of the validity or the performance of Delayed Delivery Contracts. If the Company executes and delivers Delayed Delivery Contracts, the Contract Securities will be deducted from the Securities to be purchased by the several Underwriters and the aggregate principal amount of Purchased Debt Securities and number of Debt Warrants, as the case may be, to be purchased by each Underwriter will be reduced pro rata in proportion to the principal amount of Purchased Debt Securities or number of Debt Warrants set forth opposite each Underwriter's name in such Terms Agreement, except to the extent that the Representatives determine that such reduction shall be otherwise than pro rata and so advise the Company. The Company will advise the Representatives not later than the business day prior to the Closing Date of the Purchased Debt Securities and Debt Warrants that are the Contract Securities. 4. Certain Agreements of the Company. The Company agrees with the several Underwriters that it will furnish to Simpson Thacher & Bartlett, counsel for the Underwriters, one signed copy of the registration 2 statement relating to the Registered Securities, including all exhibits, in the form it became effective and of all amendments thereto and that, in connection with each offering of Securities: (a) The Company will advise the Representatives promptly of any proposal to amend or supplement the Registration Statement or the Prospectus and will afford the Representatives a reasonable opportunity to comment on any such proposed amendment or supplement; and the Company will also advise the Representatives promptly of the filing of any such amendment or supplement and of the institution by the Commission of any stop order proceedings in respect of the Registration Statement or of any part thereof and will use its best efforts to prevent the issuance of any such stop order and to obtain as soon as possible its lifting, if issued. (b) If, at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event occurs as a result of which the Prospectus as then amended or supplemented would include an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend the Prospectus to comply with the Act, the Company promptly will prepare and file with the Commission an amendment or supplement which will correct such statement or omission or an amendment which will effect such compliance. (c) As soon as practicable, but not later than 18 months, after the date of each Terms Agreement, the Company will make generally available to its securityholders an earnings statement covering a period of at least 12 months beginning after the later of (i) the most recent effective date of the registration statement relating to the Registered Securities, (ii) the effective date of the most recent post-effective amendment to the Registration Statement to become effective prior to the date of such Terms Agreement and (iii) the date of the Company's most recent Annual Report on Form 10-K filed with the Commission prior to the date of such Terms Agreement, which will satisfy the provisions of Section 11(a) of the Act (including, at the option of the Company, Rule 158 of the Rules and Regulations under the Act). (d) The Company will furnish to the Representatives copies of the Registration Statement, including all exhibits, any related preliminary prospectus, any related preliminary prospectus supplement and all amendments and supplements to such documents, in each case as soon as available, and copies of the Prospectus and all amendments and supplements to the Prospectus not later than 10:00 A.M., New York City time, on the day following the date thereof. The Company will furnish each of such documents in such quantities as are reasonably requested. (e) The Company will arrange for the qualification of the Securities for sale and the determination of their eligibility for investment under the laws of such jurisdictions within the United States as the Representatives designate and will continue such qualifications in effect so long as required for the distribution; provided that the Company will not be required to qualify to do business in any jurisdiction where it is not now qualified or to take any action which would subject it to general or unlimited service of process in any jurisdiction where it is not now subject. (f) During the period of five years after the date of any Terms Agreement, the Company will furnish to the Representatives and, upon request, to each of the other Underwriters, if any, as soon as practicable after the end of each fiscal year, a copy of its annual report to stockholders for such year; and the Company will furnish to the Representatives (i) as soon as available, a copy of each Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Current Report on Form 8-K and definitive proxy statement of the Company filed with the Commission under the Securities Exchange Act of 1934 (the "Exchange Act") or mailed to stockholders, and (ii) from time to time, such other information concerning the Company as the Representatives may reasonably request. (g) The Company will pay all expenses incident to the performance of its obligations under this Agreement and will reimburse the Underwriters for any expenses (including fees and disbursements of counsel) incurred by them in connection with qualification of the Registered Securities for sale and determination of their eligibility for investment under the laws of such jurisdictions as the Representatives 3 may designate and the printing of memoranda relating thereto, for any fees charged by investment rating agencies for the rating of the Securities, for the filing fee of the National Association of Securities Dealers, Inc. relating to the Registered Securities and for expenses incurred in distributing the Prospectus, any preliminary prospectuses and any preliminary prospectus supplements to Underwriters. (h) For a period beginning at the time of execution of the Terms Agreement and ending on the Closing Date, if any Debt Securities are being issued, without the prior consent of the Representatives, the Company will not offer or contract to sell or, except pursuant to a commitment entered into prior to the date of the Terms Agreement, sell or otherwise dispose of any debt securities denominated in the currency or currency unit in which the Securities are denominated and issued or guaranteed by the Company and having a maturity of more than one year from the date of issue. 5. Conditions of the Obligations of the Underwriters. The obligations of the several Underwriters to purchase and pay for the Purchased Securities will be subject to the accuracy of the representations and warranties on the part of the Company herein, to the accuracy of the statements of Company officers made pursuant to the provisions hereof, to the performance by the Company of its obligations hereunder and to the following additional conditions precedent: (a) On or prior to the date of the Terms Agreement, the Representatives, or counsel for the Underwriters, shall have received a letter of Coopers & Lybrand L.L.P., confirming that they are independent certified public accountants within the meaning of the Act and the applicable published Rules and Regulations thereunder and stating in effect that: (i) in their opinion, the financial statements and schedules of the Company audited by them and included in the prospectus contained in the registration statement relating to the Registered Securities, as amended at the date of such letter, comply as to form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations; (ii) on the basis of performing the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in Statement on Auditing Standards No. 71, Interim Financial Information ("SAS No. 71") on any unaudited interim condensed consolidated financial statements of the Company included in such prospectus, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that (A) the unaudited interim condensed consolidated financial statements, if any, of the Company included in such prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Exchange Act as it applies to Quarterly Reports on Form 10-Q and the related published Rules and Regulations or (B) that any material modifications should be made for them to be in conformity with generally accepted accounting principles; (iii) on the basis of a reading of any unaudited pro forma condensed combined financial statements of the Company included in such prospectus, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that the unaudited pro forma condensed combined financial statements included in such prospectus do not comply in form in all material respects with the applicable accounting requirements of Rule 11-02 of Regulation S-X and that the pro forma adjustments, if any, have not been properly applied to the historical amounts in the compilation of those statements; and (iv) they have compared specified dollar amounts (or percentages derived from such dollar amounts) and other financial information contained in such prospectus (in each case to the extent that such dollar amounts, percentages and other financial information are obtained from accounting records that are subject to the internal control structure, policies and procedures of the Company's accounting system or are derived directly from such accounting records by analysis or computation) with the results obtained from procedures specified in such letter and have found such dollar amounts, 4 percentages and other financial information to be in agreement with such results, except as otherwise specified in such letter. All financial statements and schedules included in material incorporated by reference into such prospectus shall be deemed included in such prospectus for purposes of this subsection. (b) No stop order suspending the effectiveness of the Registration Statement or of any part thereof shall have been issued and no proceedings for that purpose shall have been instituted or, to the knowledge of the Company or any Underwriter, shall be contemplated by the Commission. (c) Subsequent to the execution of the Terms Agreement, there shall not have occurred (i) any change in the capital stock or long-term debt of the Company and its subsidiaries or any change, or any development involving a prospective change, in or affecting the general affairs, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus, the effect of which is, in the reasonable judgment of the Representatives, so material and adverse as to make it impracticable or inadvisable to proceed with the public offering or the delivery of the Securities on the terms and in the manner contemplated in the Prospectus; (ii) any downgrading in the rating of the Company's debt securities by any "nationally recognized statistical rating organization" (as defined for purposes of Rule 436(g) under the Act), and no such organization shall have publicly announced that it has under surveillance or review, with possible negative implications, its rating of such debt securities; (iii) any suspension or limitation of trading in securities generally on the New York Stock Exchange or any setting of minimum prices for trading on the New York Stock Exchange or any suspension of trading of any securities of the Company on any United States exchange or in the over-the-counter market; (iv) any banking moratorium declared by Federal or New York authorities, or the authorities of any country in whose currency any Purchased Debt Securities or Debt Warrants are denominated under the applicable Terms Agreement; (v) any outbreak or escalation of major hostilities in which the United States or any country in whose currency any Purchased Debt Securities or Debt Warrants are denominated under the applicable Terms Agreement is involved, any declaration of war by Congress or any other substantial national or international calamity or emergency if, in the reasonable judgment of the Representatives, the effect of any such outbreak, escalation, declaration, calamity or emergency makes it impractical or inadvisable to proceed with completion of the sale of and payment for the Securities; or (vi) any action by any governmental authority or any change, or any development involving a prospective change, involving currency exchange rates or exchange controls, which makes it impracticable or inadvisable in the reasonable judgment of the Representatives to proceed with the public offering or delivery of the Securities on the terms and in the manner contemplated in the Prospectus. (d) The Representatives shall have received an opinion, dated the Closing Date, of Hunton & Williams, counsel for the Company, to the effect that: (i) the Company has been duly incorporated and is an existing corporation in good standing under the laws of the Commonwealth of Virginia, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; and the Company is duly qualified to do business as a foreign corporation in good standing in all other jurisdictions in which it owns or leases substantial properties or in which the conduct of its business requires such qualification and in which the failure to so qualify would have a material adverse effect on the Company; (ii) Philip Morris Incorporated, Philip Morris International Inc. and Kraft Foods, Inc. have been duly incorporated and are existing corporations in good standing under the laws of their respective jurisdictions of incorporation, with corporate power and authority to own their respective properties and conduct their respective businesses as described in the Prospectus; all outstanding shares of capital stock of Philip Morris Incorporated, Philip Morris International Inc. and Kraft Foods, Inc. are owned by the Company, free and clear of any lien, pledge and encumbrance or claim of any third party; (iii) the Indenture and any Debt Warrant Agreement have been duly authorized, executed and delivered by the Company; the Indenture has been duly qualified under the Trust Indenture Act; the Securities have been duly authorized; the Purchased Securities other than any Contract Securities have been duly executed, authenticated, issued and delivered; the Indenture, any Debt Warrant Agreement and the Securities other than any Warrant Debt Securities and any Contract Securities constitute, and 5 any Warrant Debt Securities, when executed, authenticated, issued and delivered in the manner provided in the Indenture and sold pursuant to any Debt Warrant Agreement, and any Contract Securities, when executed, authenticated, issued and delivered in the manner provided in the Indenture and sold pursuant to Delayed Delivery Contracts, will constitute, valid and legally binding obligations of the Company, enforceable in accordance with their terms, subject to the effects of bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally, to general equity principles and any implied covenant of good faith and fair dealing; and the Securities other than any Warrant Debt Securities and any Contract Securities conform, and any Warrant Debt Securities and any Contract Securities, when so issued and delivered and sold, will conform, to the description thereof contained in the Prospectus; (iv) no consent, approval, authorization or order of, or filing with, any governmental agency or body or any court is required for the consummation of the transactions contemplated by the Terms Agreement (including the provisions of this Agreement) in connection with the issuance or sale of the Purchased Securities by the Company, except such as have been obtained and made under the Act and the Trust Indenture Act and such as may be required under state securities laws; (v) the execution, delivery and performance of the Indenture, the Terms Agreement (including the provisions of this Agreement), any Debt Warrant Agreement, and any Delayed Delivery Contracts and the issuance and sale of the Securities and compliance with the terms and provisions thereof will not result in a breach or violation of any of the terms and provisions of, or constitute a default under, the charter or by-laws of the Company, Philip Morris Incorporated, Philip Morris International Inc. or Kraft Foods, Inc., or, to the knowledge of such counsel, the charter or by-laws of any other subsidiary of the Company, any statute, any rule, regulation or order of any governmental agency or body or any court having jurisdiction over the Company or any subsidiary of the Company or any of their properties or any agreement or instrument to which the Company or any such subsidiary is a party or by which the Company or any such subsidiary is bound or to which any of the properties of the Company or any such subsidiary is subject, and the Company has full power and authority to authorize, issue and sell the Securities as contemplated by the Terms Agreement (including the provisions of this Agreement); (vi) the Registration Statement has become effective under the Act, and, to the knowledge of such counsel, no stop order suspending the effectiveness of the Registration Statement or of any part thereof has been issued and no proceedings for that purpose have been instituted or are pending or contemplated under the Act, and the registration statement relating to the Registered Securities, as of its effective date, the Registration Statement and the Prospectus, as of the date of the Terms Agreement, and any amendment or supplement thereto, as of its date, complied as to form in all material respects with the requirements of the Act, the Trust Indenture Act and the Rules and Regulations; such counsel have no reason to believe that such registration statement, as of its effective date, or any amendment or supplement thereto, as of its date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading or that the Prospectus or any amendment or supplement thereto contains any untrue statement of a material fact or omits to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; the descriptions in the Registration Statement and Prospectus of statutes, legal and governmental proceedings and contracts and other documents are accurate and fairly present the information required to be shown; and such counsel do not know of any legal or governmental proceedings required to be described in the Prospectus which are not described as required or of any contracts or documents of a character required to be described in the Registration Statement or Prospectus or to be filed as exhibits to the Registration Statement which are not described and filed as required; it being understood that such counsel need express no opinion as to the financial statements or other financial data contained in the Registration Statement or the Prospectus or any such amendment or supplement; and (vii) the Terms Agreement (including the provisions of this Agreement) and any Delayed Delivery Contracts have been duly authorized, executed and delivered by the Company. 6 In rendering such opinion, Hunton & Williams may state that (1) in clause (iii) with respect to the validity and enforceability of the Indenture, any Debt Warrant Agreement and the Securities, and in clause (iv) and in clause (v) with respect to any statute, rule, regulation or order of any governmental agency, body or court and the power and authority of the Company to authorize, issue and sell the Securities, such counsel has assumed that under the laws of any country in whose currency (or whose currency is a component currency of a currency unit in which) any Securities are denominated or payable, if other than in U.S. dollars, or of any other governmental authority having jurisdiction over any such currency unit, that no consent, approval, authorization, or order of, or filing with any governmental agency, body or court is required for the consummation of the transactions contemplated hereunder in connection with the issuance and sale of the Securities and compliance with the terms and provisions thereof will not result in any breach or violation of any of the terms and provisions in any statute, rule, regulation or order of any governmental agency or body or any court, and (2) in clause (iii) with respect to the enforceability of the Indenture, no opinion is expressed with respect to Section 516 thereof. Such counsel may note that (a) a New York statute provides that with respect to a foreign currency obligation a court of the State of New York shall render a judgment or decree in such foreign currency and such judgment or decree shall be converted into currency of the United States at the rate of exchange prevailing on the date of entry of such judgment or decree and (b) with respect to a foreign currency obligation a United States Federal court in New York may award judgment in United States dollars, provided that such counsel expresses no opinion as to the rate of exchange such court would apply. (e) The Representatives shall have received from Simpson Thacher & Bartlett, counsel for the Underwriters, such opinion or opinions, dated the Closing Date, with respect to the incorporation of the Company, the validity of the Securities, the Registration Statement, the Prospectus and other related matters as they may require, and the Company shall have furnished to such counsel such documents as they request for the purpose of enabling them to pass upon such matters. In rendering such opinion, Simpson Thacher & Bartlett may rely as to the incorporation of the Company and all other matters governed by Virginia law upon the opinion of Hunton & Williams referred to above. (f) The Representatives shall have received a certificate, dated the Closing Date, of the President or any Vice President and a principal financial or accounting officer of the Company in which such officers, to the best of their knowledge after reasonable investigation, shall state that the representations and warranties of the Company in this Agreement are true and correct, that the Company has complied with all agreements and satisfied all conditions on its part to be performed or satisfied hereunder at or prior to the Closing Date, that no stop order suspending the effectiveness of the Registration Statement or of any part thereof has been issued and no proceedings for that purpose have been instituted or are contemplated by the Commission and that, subsequent to the date of the most recent financial statements in the Prospectus, there has been no material adverse change in the financial position or results of operation of the Company and its subsidiaries except as set forth in or contemplated by the Prospectus or as described in such certificate. (g) The Representatives shall have received a letter, dated the Closing Date, of Coopers & Lybrand L.L.P., which reconfirms the matters set forth in their letter delivered pursuant to subsection (a) of this Section and states in effect that: (i) in their opinion, any financial statements or schedules examined by them and included in the Prospectus and not covered by their letter delivered pursuant to subsection (a) of this Section comply in form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations; (ii) on the basis of performing the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in SAS No. 71, on any unaudited interim condensed consolidated financial statements of the Company included in the Prospectus and not covered by their letter delivered pursuant to subsection (a) of this Section, reading the latest available interim financial statements of the Company, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that: (A) the unaudited interim condensed consolidated financial statements of the Company, if any, included in the Prospectus do not comply as to form in all material respects with the 7 applicable accounting requirements of the Act and the related published Rules and Regulations or require any material modifications to be made for them to be in conformity with generally accepted accounting principles; (B) at the date of the latest available consolidated balance sheet of the Company read by such accountants, and at a subsequent specified date not more than three business days prior to the Closing Date, there was any decrease in the outstanding common stock, or consolidated earnings reinvested in the business of the Company other than any decrease resulting from the declaration of regular quarterly cash dividends, or any issuance or assumption of long-term debt by the Company, Philip Morris Incorporated, Philip Morris International Inc., Kraft Foods, Inc. or Philip Morris Capital Corporation (exclusive of any short-term borrowings reclassified as long-term based upon the Company's ability and intention to refinance these short-term borrowings on a long-term basis), and, at the date of the latest available consolidated balance sheet of the Company read by such accountants, there was any decrease in consolidated net current assets or net assets, all as compared with amounts shown on or included in the latest balance sheet of the Company included in the Prospectus; or (C) for the period from the date of the latest consolidated statement of earnings of the Company included in the Prospectus to the date of the latest available consolidated statement of earnings of the Company read by such accountants there were any decreases, as compared with the corresponding period of the previous year, in consolidated operating revenues, operating income, net earnings or the historical ratio of earnings to fixed charges of the Company and consolidated subsidiaries; except in all cases set forth in clauses (B) and (C) above for issuances or assumptions or decreases which the Prospectus discloses have occurred or may occur or which are described in such letter; (iii) with respect to the unaudited capsule information of the Company, if any, included in the Prospectus: (A) on the basis of performing the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in SAS No. 71 on the unaudited interim condensed consolidated financial statements of the Company from which such unaudited capsule information was derived, reading such unaudited capsule information, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that: (1) the amounts contained in the unaudited capsule information included in the Prospectus do not agree with the amounts set forth in the unaudited interim condensed consolidated financial statements of the Company from which such amounts were derived; and (2) the amounts contained in the unaudited capsule information included in the Prospectus were not determined on a basis substantially consistent with that of the corresponding financial information in the latest audited financial statements of the Company included in the Prospectus; or (B) if the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in SAS No. 71 have not been performed on the unaudited interim condensed consolidated financial statements of the Company from which such unaudited capsule information was derived, they have: (1) read the unaudited capsule information and agreed the amounts contained therein with the Company's accounting records from which it was derived; and (2) inquired of certain officials of the Company who have responsibility for financial and accounting matters whether the unaudited capsule information was determined on a basis substantially consistent with that of the corresponding financial information in the latest audited financial statements of the Company included in the Prospectus; and 8 (iv) they have compared specified dollar amounts (or percentages derived from such dollar amounts) and other financial information included in the Prospectus and not covered by their letter delivered pursuant to subsection (a) of this Section (in each case to the extent that such dollar amounts, percentages and other financial information are obtained from accounting records that are subject to the internal control structure, policies and procedures of the Company's accounting system or are derived directly from such accounting records by analysis or computation) with the results obtained from procedures specified in such letter and have found such dollar amounts, percentages and other financial information to be in agreement with such results, except as otherwise specified in such letter. All financial statements and schedules included in material incorporated by reference into the Prospectus shall be deemed included in the Prospectus for the purposes of this subsection. (h) The Representatives shall have received, so long as financial statements audited by any independent accountants for or with respect to any entity acquired by the Company are included in the Prospectus, a letter, dated the Closing Date, of such accountants confirming that as of a specified date immediately prior to such acquisition and during the period covered by the financial statements on which they reported, they were independent accountants with respect to such entity within the meaning of the Act and the applicable published Rules and Regulations thereunder and stating in effect that: (i) in their opinion, the consolidated financial statements audited by them and included in the Prospectus comply in form in all material respects with the applicable accounting requirements of the Act and the Exchange Act and the related published Rules and Regulations, with respect to Registration Statements on Form S-3; and (ii) on the basis of performing the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in SAS No. 71, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that the unaudited financial statements of such entity at any date and for any period ending on or prior to the date of the latest unaudited balance sheet of such entity included in the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations or any material modifications should be made for them to be in conformity with generally accepted accounting principles. All financial statements and schedules included in material incorporated by reference into the Prospectus shall be deemed included in the Prospectus for purposes of this subsection. (i) The Representatives shall have received from counsel, satisfactory to the Representatives, such opinion or opinions, dated the Closing Date, with respect to compliance with the laws of any country, other than the United States, in whose currency Purchased Debt Securities or Debt Warrants are denominated, the validity of the Securities, the Prospectus and other related matters as they may require, and the Company shall have furnished to such counsel such documents as they request for the purpose of enabling them to pass upon such matters. (j) If applicable to the offering of any Securities, the Representatives shall have received an opinion from Sutherland, Asbill & Brennan, L.L.P., special tax counsel for the Company, dated the Closing Date, confirming their opinion as to United States tax matters set forth in the Prospectus. The Company will furnish the Representatives with such conformed copies of such opinions, certificates, letters and documents as they reasonably request. 6. Indemnification and Contribution. (a) The Company will indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, the Prospectus, or any amendment or supplement thereto, or any related preliminary prospectus or preliminary prospectus supplement, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make 9 the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such loss, claim, damage, liability or action as such expenses are incurred; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement in or omission or alleged omission from any of such documents in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representatives, if any, specifically for use therein; and provided further that as to any preliminary prospectus this indemnity agreement shall not inure to the benefit of any Underwriter or any person controlling that Underwriter on account of any loss, claim, damage or liability arising from the sale of Purchased Securities to any person by that Underwriter if that Underwriter failed to send or give a copy of the Prospectus, as the same may be amended or supplemented, to that person within the time required by the Act, and the untrue statement or alleged untrue statement of a material fact or omission or alleged omission to state a material fact in such preliminary prospectus was corrected in the Prospectus, unless such failure resulted from non-compliance by the Company with Section 4(d). For purposes of the second proviso to the immediately preceding sentence, the term Prospectus shall not be deemed to include the documents incorporated therein by reference, and no Underwriter shall be obligated to send or give any supplement or amendment to any document incorporated by reference in a preliminary prospectus or the Prospectus to any person other than a person to whom such Underwriter has delivered such incorporated documents in response to a written request therefor. (b) Each Underwriter will indemnify and hold harmless the Company against any losses, claims, damages or liabilities to which the Company may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, the Prospectus, or any amendment or supplement thereto, or any related preliminary prospectus or preliminary prospectus supplement, or arise out of or are based upon the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives, if any, specifically for use therein, and will reimburse any legal or other expenses reasonably incurred by the Company in connection with investigating or defending any such loss, claim, damage, liability or action as such expenses are incurred. (c) Promptly after receipt by an indemnified party under this Section of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under subsection (a) or (b) above, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under subsection (a) or (b) above. In case any such action is brought against any indemnified party and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party (who shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation. No indemnifying party shall (i) without the prior written consent of the indemnified parties (which consent shall not be unreasonably withheld), settle or compromise or consent to the entry of any judgment with respect to any pending or threatened claim, action, suit or proceeding in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified parties are actual or potential parties to such claim or action) unless such settlement, compromise or consent includes an unconditional release of each indemnified party from all liability arising out of such claim, action, suit or proceeding, or (ii) be liable for any settlement of any such action effected without its written consent (which consent shall not be unreasonably withheld), but if settled with its written consent or if there be a final judgment for the plaintiff in any such action, the indemnifying party agrees to indemnify and hold harmless any indemnified party from and against any loss or liability by reason of such settlement or judgment. 10 (d) If the indemnification provided for in this Section is unavailable or insufficient to hold harmless an indemnified party under subsection (a) or (b) above, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities referred to in subsection (a) or (b) above (i) in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriters on the other from the offering of the Securities or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Company bear to the total underwriting discounts and commissions received by the Underwriters. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this subsection (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any action or claim which is the subject of this subsection (d). Notwithstanding the provisions of this subsection (d), no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Securities underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this subsection (d) to contribute are several in proportion to their respective underwriting obligations and not joint. (e) The obligations of the Company under this Section shall be in addition to any liability which the Company may otherwise have and shall extend, upon the same terms and conditions, to each person, if any, who controls any Underwriter within the meaning of the Act; and the obligations of the Underwriters under this Section shall be in addition to any liability which the respective Underwriters may otherwise have and shall extend, upon the same terms and conditions, to each director of the Company, to each officer of the Company who has signed the Registration Statement and to each person, if any, who controls the Company within the meaning of the Act. 7. Default of Underwriters. If any Underwriter or Underwriters default in their obligations to purchase Purchased Securities under the Terms Agreement and the aggregate amount of the Purchased Securities that such defaulting Underwriter or Underwriters agreed but failed to purchase does not exceed 10% of the aggregate amount of the Purchased Securities, the Representatives may make arrangements satisfactory to the Company for the purchase of such Purchased Securities by other persons, including any of the Underwriters, but if no such arrangements are made by the Closing Date, the non-defaulting Underwriters shall be obligated severally, in proportion to their respective commitments under this Agreement and the Terms Agreement, to purchase the Purchased Securities that such defaulting Underwriters agreed but failed to purchase. If any Underwriter or Underwriters so default and the aggregate amount of the Purchased Securities with respect to which such default or defaults occur exceeds 10% of the aggregate amount of the Purchased Securities and arrangements satisfactory to the Representatives and the Company for the purchase of such Purchased Securities by other persons are not made within 36 hours after such default, such Terms Agreement will terminate without liability on the part of any non-defaulting Underwriter or the Company, except as provided in Section 8. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section. As used in this Section only, the "aggregate amount" of Purchased Securities shall mean the aggregate principal amount of any Purchased Debt Securities plus the public offering price of any Debt Warrants included in the relevant offering of Purchased Securities. Nothing herein will relieve a defaulting Underwriter from liability for its default. The respective commitments of the several Underwriters for the purposes of this Section shall be determined without regard to reduction in the respective Underwriters' obligations to purchase the amount of Purchased Debt 11 Securities set forth opposite their names in the Terms Agreement as a result of Delayed Delivery Contracts entered into by the Company. The foregoing obligations and agreements set forth in this Section will not apply if the Terms Agreement specifies that such obligations and agreements will not apply. 8. Survival of Certain Representations and Obligations. The respective indemnities, agreements, representations, warranties and other statements of the Company or its officers and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation, or statement as to the results thereof, made by or on behalf of any Underwriter, the Company or any of their respective representatives, officers or directors or any controlling person and will survive delivery of and payment for the Purchased Securities. If the obligations of the Underwriters with respect to any offering of Securities are terminated pursuant to Section 7 or if for any reason the purchase of the Purchased Securities by the Underwriters under a Terms Agreement is not consummated, the Company shall remain responsible for the expenses to be paid or reimbursed by it pursuant to Section 4 and the respective obligations of the Company and the Underwriters pursuant to Section 6 shall remain in effect. If for any reason the purchase of the Purchased Securities by the Underwriters is not consummated other than because of the termination of this Agreement pursuant to Section 7 or a failure to satisfy the conditions set forth in Section 5(c), the Company shall reimburse the Underwriters, severally, for all out-of-pocket expenses (including fees and disbursements of counsel) reasonably incurred by them in connection with the offering of the Securities. 9. Notices. All communications hereunder will be in writing and, if sent to the Underwriters, will be mailed, delivered or telegraphed and confirmed to them at their addresses furnished to the Company in writing for the purpose of communications hereunder or, if sent to the Company, will be mailed, delivered or telegraphed and confirmed to it at 120 Park Avenue, New York, New York 10017, Attention: G. Penn Holsenbeck, Vice President, Associate General Counsel and Corporate Secretary. 10. Successors. This Agreement will inure to the benefit of and be binding upon the Company and such Underwriters as are identified in Terms Agreements and their respective successors and the officers and directors and controlling persons referred to in Section 5, and no other person will have any right or obligation hereunder. 11. Applicable Law. This Agreement and the Terms Agreement shall be governed by, and construed in accordance with, the laws of the State of New York. 12 ANNEX I (Three copies of this Delayed Delivery Contract should be signed and returned to the address shown below so as to arrive not later than 9:00 A.M., New York time, on .......... ........, 19....*.) DELAYED DELIVERY CONTRACT [Insert date of initial public offering] Philip Morris Companies Inc. c/o [Insert name and address of lead Underwriter] Attention: Gentlemen: The undersigned hereby agrees to purchase from Philip Morris Companies Inc., a Virginia corporation ("Company"), and the Company agrees to sell to the undersigned, [If one delayed closing, insert-as of the date hereof, for delivery on , 19 ("Delivery Date"),] $........................................ principal amount of the Company's [Insert title of debt securities] ("Debt Securities") and ........................................ of the Company's [Insert title of warrants] ("Debt Warrants") (collectively, the "Securities"), offered by the Company's Prospectus dated , 19 and a Prospectus Supplement dated , 19 relating thereto, receipt of copies of which is hereby acknowledged, at % of the principal amount of the Debt Securities plus accrued interest, if any, and on the further terms and conditions set forth in this Delayed Delivery Contract ("Contract"). [If two or more delayed closings, insert the following: The undersigned will purchase from the Company as of the date hereof, for delivery on the dates set forth below, Debt Securities and Debt Warrants in the principal amounts and number, respectively, set forth below: Principal Amount Number of Debt of Debt Delivery Date Securities Warrants - ------------- ---------------- -------- ............. ................ ........ ............. ................ ........ Each of such delivery dates is hereinafter referred to as a Delivery Date.] Payment for the Securities that the undersigned has agreed to purchase for delivery on [the] [each] Delivery Date shall be made to the Company or its order by certified or official bank check in New York Clearing House (next day) funds at the office of at .M. on [the] [such] Delivery Date upon delivery to the undersigned of the Securities to be purchased by the undersigned [for delivery on such Delivery Date] in definitive fully registered form and in such denominations or numbers and registered in such names as the undersigned may designate by written or telegraphic communication addressed to the Company not less than five full business days prior to [the] [such] Delivery Date. - ------ * Insert date which is third full business day prior to Closing Date under the Terms Agreement. 13 It is expressly agreed that the provisions for delayed delivery and payment are for the sole convenience of the undersigned; that the purchase hereunder of Securities is to be regarded in all respects as a purchase as of the date of this Contract; that the obligation of the Company to make delivery of and accept payment for, and the obligation of the undersigned to take delivery of and make payment for, Securities on [the] [each] Delivery Date shall be subject only to the conditions that (1) investment in the Securities shall not at [the] [such] Delivery Date be prohibited under the laws of any jurisdiction in the United States to which the undersigned is subject and (2) the Company shall have sold to the Underwriters the total principal amount of the Debt Securities less the principal amount thereof covered by this and other similar Contracts. The undersigned represents that its investment in the Securities is not, as of the date hereof, prohibited under the laws of any jurisdiction to which the undersigned is subject and which governs such investment. Promptly after completion of the sale to the Underwriters the Company will mail or deliver to the undersigned at its address set forth below notice to such effect, accompanied by a copy of the opinion of counsel for the Company delivered to the Underwriters in connection therewith. This Contract will inure to the benefit of and be binding upon the parties hereto and their respective successors, but will not be assignable by either party hereto without the written consent of the other. It is understood that the acceptance of any such Contract is in the Company's sole discretion and, without limiting the foregoing, need not be on a first-come, first-served basis. If this Contract is acceptable to the Company, it is requested that the Company sign the form of acceptance below and mail or deliver one of the counterparts hereof to the undersigned at its address set forth below. This will become a binding contract between the Company and the undersigned when such counterpart is so mailed or delivered. Yours very truly, .. (Name of Purchaser) By .. .. (Title of Signatory) .. .. (Address of Purchaser) Accepted, as of the above date. Philip Morris Companies Inc. By .. (Insert Title) 14 PHILIP MORRIS COMPANIES INC. ("Company") Debt Securities and Warrants to Purchase Debt Securities TERMS AGREEMENT , 199 Philip Morris Companies Inc. 120 Park Avenue New York, New York 10017 Attention: Louis C. Camilleri, Senior Vice President and Chief Financial Officer Dear Sirs: On behalf of the several Underwriters named in Schedule A hereto and for their respective accounts, we offer to purchase, on and subject to the terms and conditions of the Underwriting Agreement relating to Debt Securities and Warrants to Purchase Debt Securities dated as of January 2, 1997 ("Underwriting Agreement"), the following securities ("Securities") on the following terms: Debt Securities Title: Principal Amount: $ Interest Rate: % from , 199 , payable: Maturity: Currency of Denomination: Currency of Payment: Form and Denomination: Overseas Paying Agents: Optional Redemption: Sinking Fund: Delayed Delivery Contracts: [authorized] [not authorized] Delivery Date: Minimum Contract: Maximum aggregate principal amount: Fee: % Purchase Price: %, plus accrued interest, or amortized original issue discount, if any, from 19 . Expected Reoffering Price: Debt Warrants Number of Debt Warrants to be issued: Debt Warrant Agreement: Form of Debt Warrants: Registered Issuable jointly with Debt Securities: [Yes] [No] [Number of Debt Warrants issued with each $ principal amount of Debt Securities:] [Detachable Date:] Date from which Debt Warrants are exercisable: Date on which Debt Warrants expire: Exercise price of Debt Warrants: Expected Reoffering price: $ Purchase price: $ Title of Warrant Debt Securities: Principal amount of Warrant Debt Securities purchaseable upon exercise of one Debt Warrant: Interest Rate: % from , 199 , payable: Maturity: Currency of Denomination: Currency of Payment: Form and Denomination: Overseas Paying Agents: Optional Redemption: Sinking Fund: ------------ Names and Addresses of Representatives: The respective principal amounts of the Debt Securities and number of Debt Warrants to be purchased by each of the Underwriters are set forth opposite their names in Schedule A hereto. The provisions of the Underwriting Agreement are incorporated herein by reference. The Closing will take place at A.M., New York City time, on , 199 , at the offices of Philip Morris Companies Inc., 120 Park Avenue, New York, New York. The Securities will be made available for checking and packaging at the office of The Chase Manhattan Bank at least 24 hours prior to the Closing Date. Please signify your acceptance by signing the enclosed response to us in the space provided and returning it to us. Very truly yours, SCHEDULE A DEBT SECURITIES Underwriter Principal Amount - ----------- ---------------- DEBT WARRANTS Number of Debt Underwriter Warrants - ----------- -------------- EX-12 3 STATEMENT RE: COMPUTATION OF RATIOS EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (dollars in millions) Years Ended December 31, -------------------------------------------------- 1996 1995 1994 1993 1992 -------- -------- ------- ------- -------- Earnings before income taxes and cumulative effect of accounting changes $ 10,683 $ 9,347 $ 8,216 $ 6,196 $ 8,608 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (227) (246) (184) (164) (107) Dividends from less than 50% owned affiliates 160 202 165 151 125 Fixed charges 1,421 1,495 1,537 1,716 1,736 Interest capitalized, net of amortization 13 2 (1) (13) (3) -------- -------- ------- ------- -------- Earnings available for fixed charges $ 12,050 $ 10,800 $ 9,733 $ 7,886 $ 10,359 ======== ======== ======= ======= ======== Fixed charges: Interest incurred: Consumer products $ 1,197 $ 1,281 $ 1,317 $ 1,502 $ 1,525 Financial services and real estate 81 84 78 87 95 -------- -------- ------- ------- -------- $ 1,278 $ 1,365 $ 1,395 $ 1,589 $ 1,620 Portion of rent expense deemed to represent interest factor 143 130 142 127 116 -------- -------- ------- ------- -------- Fixed charges $ 1,421 $ 1,495 $ 1,537 $ 1,716 $ 1,736 ======== ======== ======= ======= ======== Ratio of earnings to fixed charges 8.5 7.2 6.3 4.6 6.0 ======== ======== ======= ======= ======== EX-23 4 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in Post-Effective Amendment No. 13 to the registration statement of Philip Morris Companies Inc. (the "Company") on Form S-14 (File No. 2-96149) and in the Company's registration statements on Form S-3 (File No. 333-16955) and Form S-8 (File Nos. 333-16127, 33-1479, 33-1480, 33-10218, 33-13210, 33-14561, 33-17870, 33-37115, 33-38781, 33-39162, 33-40110, 33-48781, 33-59109, 33-63975 and 33-63977), of our report dated January 27, 1997 (included herein), on our audits of the consolidated financial statements of the Company, which is included in this Current Report on Form 8-K dated January 30, 1997, as indicated in item 7 herein. /s/ COOPERS & LYBRAND L.L.P. New York, New York January 30, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Pages 2-3 of the Company's consolidated financial statements for the year ended December 31, 1996 and is qualified in its entirety by reference to such financial statements. 1,000,000 12-MOS DEC-31-1996 DEC-31-1996 240 0 4,636 170 9,002 15,190 19,972 8,221 54,871 14,867 12,961 0 0 935 13,283 54,871 69,204 69,204 26,560 41,211 16,224 0 1,086 10,683 4,380 6,303 0 0 0 6,303 7.68 7.68
EX-99 6 CONSOLIDATED FINANCIAL STATEMENTS EXHIBIT 99 PHILIP MORRIS COMPANIES INC. and SUBSIDIARIES Consolidated Financial Statements for the period ended December 31, 1996 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Philip Morris Companies Inc.: We have audited the accompanying consolidated balance sheets of Philip Morris Companies Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Philip Morris Companies Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. New York, New York January 27, 1997 PHILIP MORRIS COMPANIES INC. and Subsidiaries CONSOLIDATED BALANCE SHEETS, at December 31, (in millions of dollars, except per share data) ---------- 1996 1995 ------- ------- ASSETS Consumer products Cash and cash equivalents $ 240 $ 1,138 Receivables, net 4,466 4,508 Inventories: Leaf tobacco 4,143 3,332 Other raw materials 1,854 1,721 Finished product 3,005 2,809 ------- ------- 9,002 7,862 Other current assets 1,482 1,371 ------- ------- Total current assets 15,190 14,879 Property, plant and equipment, at cost: Land and land improvements 664 726 Buildings and building equipment 5,168 4,976 Machinery and equipment 12,481 11,542 Construction in progress 1,659 1,357 ------- ------- 19,972 18,601 Less accumulated depreciation 8,221 7,485 ------- ------- 11,751 11,116 Goodwill and other intangible assets (less accumulated amortization of $4,391 and $3,873) 18,998 19,319 Other assets 3,015 2,866 ------- ------- Total consumer products assets 48,954 48,180 Financial services and real estate Finance assets, net 5,345 4,991 Real estate held for development and sale 314 339 Other assets 258 301 ------- ------- Total financial services and real estate assets 5,917 5,631 ------- ------- TOTAL ASSETS $54,871 $53,811 ======= ======= 1996 1995 ------- ------- LIABILITIES Consumer products Short-term borrowings $ 260 $ 122 Current portion of long-term debt 1,846 1,926 Accounts payable 3,409 3,364 Accrued liabilities: Marketing 2,106 2,114 Taxes, except income taxes 1,331 1,075 Employment costs 942 995 Other 2,726 2,706 Income taxes 1,269 1,137 Dividends payable 978 834 ------- ------- Total current liabilities 14,867 14,273 Long-term debt 11,827 12,324 Deferred income taxes 731 356 Accrued postretirement health care costs 2,372 2,273 Other liabilities 5,773 5,643 ------- ------- Total consumer products liabilities 35,570 34,869 Financial services and real estate Short-term borrowings 173 671 Long-term debt 1,134 783 Deferred income taxes 3,636 3,382 Other liabilities 140 121 ------- ------- Total financial services and real estate liabilities 5,083 4,957 ------- ------- Total liabilities 40,653 39,826 Contingencies (Note 13) STOCKHOLDERS' EQUITY Common stock, par value $1.00 per share (935,320,439 shares issued) 935 935 Earnings reinvested in the business 22,478 19,779 Currency translation adjustments 192 467 ------- ------- 23,605 21,181 Less cost of repurchased stock (124,871,681 and 104,150,433 shares) 9,387 7,196 ------- ------- Total stockholders' equity 14,218 13,985 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $54,871 $53,811 ======= ======= See notes to consolidated financial statements. 2 CONSOLIDATED STATEMENTS of EARNINGS for the years ended December 31, (in millions of dollars, except per share data) ---------- 1996 1995 1994 ------- ------- ------ Operating revenues $69,204 $66,071 $65,125 Cost of sales 26,560 26,685 28,351 Excise taxes on products 14,651 12,932 11,349 ------- ------- ------- Gross profit 27,993 26,454 25,425 Marketing, administration and research costs 15,630 15,337 15,372 Amortization of goodwill 594 591 604 ------- ------- ------- Operating income 11,769 10,526 9,449 Interest and other debt expense, net 1,086 1,179 1,233 ------- ------- ------- Earnings before income taxes and cumulative effect of accounting changes 10,683 9,347 8,216 Provision for income taxes 4,380 3,869 3,491 ------- ------- ------- Earnings before cumulative effect of accounting changes 6,303 5,478 4,725 Cumulative effect of changes in method of accounting (28) ------- ------- ------- Net earnings $ 6,303 $ 5,450 $ 4,725 ======= ======= ======= Per share data: Earnings before cumulative effect of accounting changes $ 7.68 $ 6.51 $ 5.45 Cumulative effect of changes in method of accounting (.03) ------- ------- ------- Net earnings $ 7.68 $ 6.48 $ 5.45 ======= ======= ======= See notes to consolidated financial statements. 3 CONSOLIDATED STATEMENTS of STOCKHOLDERS' EQUITY (in millions of dollars, except per share data) ----------
Earnings Currency Cost of Total Common Reinvested in Translation Repurchased Stockholders' Stock the Business Adjustments Stock Equity ----- ------------ ----------- ----- ------ Balances, January 1, 1994 $935 $15,718 $(711) $(4,315) $11,627 Net earnings 4,725 4,725 Exercise of stock options and issuance of other stock awards (217) 324 107 Cash dividends declared ($3.03 per share) (2,623) (2,623) Currency translation adjustments 664 664 Stock repurchased (1,600) (1,600) Net unrealized depreciation on securities (114) (114) ---- ------- ----- ------- ------- Balances, December 31, 1994 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 6,303 6,303 Exercise of stock options and issuance of other stock awards (28) 609 581 Cash dividends declared ($4.40 per share) (3,606) (3,606) Currency translation adjustments (275) (275) Stock repurchased (2,800) (2,800) Net unrealized appreciation on securities 30 30 ---- ------- ----- ------- ------- Balances, December 31, 1996 $935 $22,478 $ 192 $(9,387) $14,218 ==== ======= ===== ======= =======
See notes to consolidated financial statements. 4 CONSOLIDATED STATEMENTS of CASH FLOWS for the years ended December 31, (in millions of dollars) ----------
1996 1995 1994 ---- ---- ---- CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net earnings - Consumer products $ 6,180 $ 5,345 $ 4,591 - Financial services and real estate 123 105 134 ------- ------- ------- Net earnings 6,303 5,450 4,725 Adjustments to reconcile net earnings to operating cash flows: Consumer products Depreciation and amortization 1,691 1,671 1,722 Deferred income tax provision 163 15 237 (Gains) losses on sales of businesses (320) (275) 19 Cumulative effect of accounting changes 46 Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net 35 (466) (239) Inventories (952) (5) (387) Accounts payable 60 (260) 582 Income taxes 446 504 202 Other working capital items (448) (482) (288) Other 467 354 180 Financial services and real estate Deferred income tax provision 224 299 376 Decrease (increase) in real estate receivables 11 35 (30) Decrease in real estate held for development and sale 25 61 86 Other 2 (22) (82) ------- ------- ------- Operating cash flow before income taxes on sales of businesses and interest payment on zero coupon bonds 7,707 6,925 7,103 Income taxes on sales of businesses (73) (238) (8) Interest payment on zero coupon bonds - financial services and real estate (156) ------- ------- ------- Net cash provided by operating activities 7,634 6,687 6,939 ------- ------- ------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES Consumer products Capital expenditures (1,782) (1,621) (1,726) Purchase of businesses, net of acquired cash (616) (217) (146) Proceeds from sales of businesses 612 2,202 300 Other (47) 17 28 Financial services and real estate Investments in finance assets (439) (613) (582) Proceeds from finance assets 217 123 889 ------- ------- ------- Net cash used in investing activities (2,055) (109) (1,237) ------- ------- -------
See notes to consolidated financial statements. Continued 5 CONSOLIDATED STATEMENTS of CASH FLOWS (Continued) for the years ended December 31, (in millions of dollars) ----------
1996 1995 1994 ---- ---- ---- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES Consumer products Net (repayment) issuance of short-term borrowings $(1,119) $ (21) $ 172 Long-term debt proceeds 2,699 564 97 Long-term debt repaid (1,979) (1,302) (1,817) Financial services and real estate Net (repayment) issuance of short-term borrowings (498) 67 (325) Long-term debt proceeds 363 185 Long-term debt repaid (139) (44) Repurchase of outstanding stock (2,770) (2,111) (1,532) Dividends paid (3,462) (2,939) (2,487) Stock rights redemption (9) Issuance of shares 448 291 54 Other (88) (28) (20) ------- ------- ------- Net cash used in financing activities (6,406) (5,627) (5,717) ------- ------- ------- Effect of exchange rate changes on cash and cash equivalents (71) 3 17 ------- ------- ------- Cash and cash equivalents: (Decrease) increase (898) 954 2 Balance at beginning of year 1,138 184 182 ------- ------- ------- Balance at end of year $ 240 $ 1,138 $ 184 ======= ======= ======= Cash paid: Interest - Consumer products $ 1,244 $ 1,293 $ 1,340 ======= ======= ======= - Financial services and real estate $ 95 $ 89 $ 229 ======= ======= ======= Income taxes $ 3,424 $ 3,067 $ 2,449 ======= ======= =======
See notes to consolidated financial statements. 6 NOTES to CONSOLIDATED FINANCIAL STATEMENTS ----------- Note 1. Summary of Significant Accounting Policies: Basis of presentation: The consolidated financial statements include all significant subsidiaries. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of operating revenues and expenses during the reporting periods. Actual results could differ from those estimates. Balance sheet accounts are segregated by two broad types of business. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services and real estate assets and liabilities are unclassified, in accordance with respective industry practices. Cash and cash equivalents: Cash equivalents include demand deposits with banks and all highly liquid investments with original maturities of three months or less. Inventories: Inventories are stated at the lower of cost or market. The last-in, first-out ("LIFO") method is used to cost substantially all domestic inventories. The cost of other inventories is determined by the average cost or first-in, first-out methods. It is a generally recognized industry practice to classify the total amount of leaf tobacco inventory as a current asset although part of such inventory, because of the duration of the aging process, ordinarily would not be utilized within one year. Advertising costs: Advertising costs are expensed generally as incurred. Depreciation, amortization and goodwill valuation: Depreciation is recorded by the straight-line method. Substantially all goodwill and other intangible assets are amortized by the straight-line method, principally over 40 years. The Company periodically evaluates the recoverability of goodwill and measures any impairment by comparison to estimated undiscounted cash flows from future operations. Financial instruments: Derivative financial instruments are used by the Company to manage its foreign currency and interest rate exposures. Realized and unrealized gains and losses on foreign currency swaps that are effective as hedges of net assets in foreign subsidiaries are offset against currency translation adjustments as a component of stockholders' equity. The interest differential to be paid or received under the currency and related interest rate swap agreements is recognized over the life of the related debt and is included in interest and other debt expense, net. Unrealized gains and losses on forward contracts that are effective as hedges of assets, liabilities and commitments are deferred and recognized in income as the related transaction is realized. Continued 7 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- Accounting changes: 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 impaired, 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. 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 the 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. The Company's stock compensation plans are discussed in Note 7. Effective January 1, 1995, the Company adopted SFAS No. 116, "Accounting for Contributions Received and Contributions Made." This Statement requires the Company to recognize an unconditional promise to make a contribution as an expense in the period the promise is made. The Company had previously expensed contributions when payment was made. The cumulative effect at January 1, 1995 of adopting SFAS No. 116 reduced 1995 net earnings by $7 million ($.01 per share). The application of SFAS No. 116 did not materially reduce 1995 earnings before cumulative effect of accounting changes. Effective January 1, 1995, the Company adopted SFAS No. 106 for non-U.S. postretirement benefits other than pensions. The cumulative effect at January 1, 1995 of adopting SFAS No. 106, for the non-U.S. plans, reduced 1995 net earnings by $21 million ($.02 per share). However, application of SFAS No. 106 for non-U.S. employees during the year ended December 31, 1995 did not materially reduce earnings before cumulative effect of accounting changes. In October 1996, the AICPA's Accounting Standards Executive Committee issued Statement of Position No. 96-1, "Environmental Remediation Liabilities," which requires adoption by the Company on January 1, 1997. The Company estimates that the effect of adoption will not be material. Note 2. Divestitures and Acquisitions: During 1996, the Company acquired a controlling interest in a Polish tobacco company, at a cost of $285 million and nearly all of the remaining voting shares of a Brazilian confectionery company, at a cost of $314 million. During 1996, the Company sold several domestic and international food businesses for total proceeds of $612 million and net pretax gains of $320 million. In addition, the Company initiated cost saving programs that included downsizing facilities and workforce reductions. The cost of these actions substantially offset the gains from businesses sold. The effect of these and other smaller acquisitions and dispositions, were not material to the Company's 1996 results of operations. Continued 8 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- During 1995, the Company sold its bakery businesses and its North American margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. In addition, several smaller international food businesses were sold. Operating revenues and operating income of these businesses for the period owned in 1995 were $2.0 billion and $107 million, respectively, and for the year ended December 31, 1994 were $5.9 billion and $267 million, respectively. Net assets of the businesses sold were $1.8 billion. Total proceeds and net pretax gains from the sales of these businesses were $2.1 billion and $275 million, respectively. As part of this divestiture program, the Company offered an early retirement program and downsized or closed other food facilities. The cost of these actions offset the gains from businesses sold. During 1994, the Company sold The All American Gourmet Company (frozen dinners business) for $170 million. The effect of this disposition, and other smaller acquisitions and dispositions, was not material to the Company's 1994 results of operations. Note 3. Inventories: The cost of approximately 49% of inventories in 1996 and 50% of inventories in 1995 was determined using the LIFO method. The stated LIFO values of inventories were approximately $965 million and $750 million lower than the current cost of inventories at December 31, 1996 and 1995, respectively. Note 4. Short-Term Borrowings and Borrowing Arrangements: At December 31, the Company's short-term borrowings and related average interest rates consisted of the following: 1996 1995 --------------------- ---------------------- (in millions) Average Average Amount Year-end Amount Year-end Outstanding Rate Outstanding Rate ----------- ---- ----------- ---- Consumer products: Bank loans $ 295 8.1% $ 209 13.1% Commercial paper 1,373 5.7% 2,495 5.8% Amount reclassified as long-term debt (1,408) (2,582) ------- ------- $ 260 $ 122 ======= ======= Financial services and real estate: Commercial paper $ 173 6.0% $ 671 5.9% ======= ======= The fair values of the Company's short-term borrowings at December 31, 1996 and 1995, based upon market rates, approximate the amounts disclosed above. The Company and its subsidiaries maintain credit facilities with a number of lending institutions, amounting to approximately $15.6 billion at December 31, 1996. Approximately $15.3 billion of these facilities were unused at December 31, 1996. Certain of these facilities are used to Continued 9 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- support commercial paper borrowings, are available for acquisitions and other corporate purposes and require the maintenance of a fixed charges coverage ratio. The Company's credit facilities include revolving bank credit agreements totaling $12.0 billion. An agreement for $4.0 billion expires in October 1997. An agreement for $8.0 billion expires in 2000 enabling the Company to refinance short-term debt on a long-term basis. Accordingly, short-term borrowings intended to be refinanced were reclassified as long-term debt. Note 5. Long-Term Debt: At December 31, the Company's long-term debt consisted of the following: 1996 1995 ---- ---- (in millions) Consumer products: Short-term borrowings, reclassified $ 1,408 $ 2,582 Notes, 6.15% to 9.75% (average effective rate 7.82%), due through 2008 9,550 8,598 Debentures, 6.0% to 8.5% (average effective rate 10.77%), $1.2 billion face amount, due through 2017 1,046 1,018 Foreign currency obligations: Swiss franc, 2.13% to 6.88% (average effective rate 5.80%), due through 2000 957 1,303 Deutsche mark, 2.75% to 6.38% (average effective rate 5.96%), due through 2002 411 392 Other foreign 49 102 Other 252 255 ------- ------- 13,673 14,250 Less current portion of long-term debt (1,846) (1,926) ------- ------- $11,827 $12,324 ======= ======= Financial services and real estate: Eurodollar notes, 6.75% and 6.63%, (average effective rate 6.68%) due 1997 and 1999 $ 400 $ 400 Foreign currency obligations: ECU notes, 9.25% and 8.50%, due 1997 and 1998 372 383 Deutsche mark, 6.5%, due 2003 166 French franc, 6.88%, due 2006 196 ------- ------- $ 1,134 $ 783 ======= ======= Continued 10 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- Aggregate maturities of long-term debt, excluding short-term borrowings reclassified as long-term debt, are as follows: Financial services and Consumer products real estate ----------------- ---------------------- (in millions) 1997 $1,846 $386 1998 1,516 186 1999 1,773 200 2000 845 2001 1,730 2002-2006 3,871 362 2007-2011 767 Thereafter 131 The revolving credit facility under which the consumer products short-term debt was reclassified as long-term debt expires in 2000 and any amounts then outstanding mature. Based on market quotes, where available, or interest rates currently available to the Company for issuance of debt with similar terms and remaining maturities, the aggregate fair value of consumer products and financial services and real estate long-term debt, including current portion of long-term debt, at December 31, 1996 and 1995 was $15.3 billion and $15.9 billion, respectively. Note 6. Capital Stock: Shares of authorized common stock are 4 billion; issued, repurchased and outstanding were as follows: Net Shares Shares Shares Issued Repurchased Outstanding ------ ----------- ----------- Balances, January 1, 1994 935,320,439 (58,229,749) 877,090,690 Exercise of stock options and issuance of other stock awards 4,569,731 4,569,731 Repurchased (28,801,356) (28,801,356) ----------- ------------ ----------- Balances, December 31, 1994 935,320,439 (82,461,374) 852,859,065 Exercise of stock options and issuance of other stock awards 6,470,262 6,470,262 Repurchased (28,159,321) (28,159,321) ----------- ------------ ----------- Balances, December 31, 1995 935,320,439 (104,150,433) 831,170,006 Exercise of stock options and issuance of other stock awards 7,890,835 7,890,835 Repurchased (28,612,083) (28,612,083) ----------- ------------ ----------- Balances, December 31, 1996 935,320,439 (124,871,681) 810,448,758 =========== ============ =========== Continued 11 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- At December 31, 1996, 33,794,922 shares of common stock were reserved for stock options and other stock awards under the Company's stock plans and 10,000,000 shares of Serial Preferred Stock, $1.00 par value, were authorized, none of which have been issued. Note 7. Stock Plans: Under the Philip Morris 1992 Incentive Compensation and Stock Option Plan (the "Plan"), the Company may grant to eligible employees stock options, stock appreciation rights, restricted stock and annual incentive and long-term performance cash awards. Up to 37 million shares of common stock are authorized for grant, of which no more than 9 million shares may be awarded as restricted stock. Shares available to be granted at December 31, 1996 and 1995 were 5,882,835 and 12,639,175, respectively. Stock options are granted at an exercise price of not less than fair value on the date of the grant. Stock options granted under the Plan generally become exercisable on the first anniversary of the grant date and have a maximum term of ten years. The Company applies the intrinsic value based method permitted by SFAS No. 123 in accounting for the Plan. Accordingly, no compensation expense has been recognized other than for restricted stock awards. Had compensation cost for stock option awards under the Plan been determined based on the fair value at the grant dates, the effect on the Company's 1996 and 1995 net earnings would not have been material. Option activity was as follows for the years ended December 31, 1994, 1995 and 1996: Weighted Shares Subject Options Average to Option Exercisable Exercise Price --------- ----------- -------------- Balance at January 1, 1994 30,035,681 $51.09 Options granted 511,610 69.73 Options exercised (2,394,089) 34.63 Options cancelled (388,045) 59.87 ---------- Balance at December 31, 1994 27,765,157 27,253,547 52.73 Options granted 7,983,200 74.78 Options exercised (6,750,112) 45.69 Options cancelled (590,121) 68.46 ---------- Balance at December 31, 1995 28,408,124 20,700,934 60.27 Options granted 7,542,405 108.25 Options exercised (8,436,980) 56.81 Options cancelled (442,422) 78.64 ---------- Balance at December 31, 1996 27,071,127 19,649,932 $74.42 ========== The weighted average exercise prices of options exercisable at December 31, 1996, 1995 and 1994 were $61.67, $54.83 and $52.41, respectively. Continued 12 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- The following table summarizes the status of stock options outstanding and exercisable as of December 31, 1996, by range of exercise price: Options Outstanding Options Exercisable ------------------------------------- ---------------------- Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price -------- ----------- ----------- -------- ----------- -------- $20.92-$35.42 1,805,676 2 years $30.56 1,805,676 $30.56 $46.31-$69.25 8,263,823 5 years 53.63 8,263,823 53.63 $73.56-$120.00 17,001,628 8 years 89.18 9,580,433 74.45 ---------- ---------- 27,071,127 19,649,932 ========== ========== The Company may grant shares of restricted stock and rights to receive shares of stock to eligible employees, giving them in most instances all of the rights of stockholders, except that they may not sell, assign, pledge or otherwise encumber such shares and rights. Such shares and rights are subject to forfeiture if certain employment conditions are not met. During 1996, 1995 and 1994 the Company granted 60,000, 212,000 and 2,636,940 shares, respectively, of restricted stock to eligible U.S. based employees and also issued to eligible non-U.S. employees rights to receive 48,000 and 1,034,320 like shares in 1995 and 1994, respectively. At December 31, 1996, restrictions on the stock, net of forfeitures, lapse as follows: 1997-2,433,985 shares; 1998-50,000 shares; 1999-20,000 shares; 2000-262,000 shares; and 2002 and thereafter-223,000 shares. The fair value of the restricted shares and rights at the date of grant is amortized to expense ratably over the restriction period. The unamortized portion is reported as a reduction of earnings reinvested in the business and was $47 million on December 31, 1996. Note 8. Earnings per Share: Earnings per common share have been calculated on the weighted average number of shares of common stock outstanding for each year, which was 821,108,904, 841,558,296 and 867,288,869 for 1996, 1995 and 1994, respectively. Note 9. Pretax Earnings and Provision for Income Taxes: Pretax earnings and provision for income taxes consisted of the following: 1996 1995 1994 ---- ---- ---- (in millions) Pretax earnings: United States $ 7,399 $6,622 $5,781 Outside United States 3,284 2,725 2,435 ------- ------ ------ Total pretax earnings $10,683 $9,347 $8,216 ======= ====== ====== Continued 13 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- 1996 1995 1994 ---- ---- ---- (in millions) Provision for income taxes: United States federal: Current $1,836 $1,946 $1,540 Deferred 438 97 458 ------ ------ ------ 2,274 2,043 1,998 State and local 430 434 419 ------ ------ ------ Total United States 2,704 2,477 2,417 ------ ------ ------ Outside United States: Current 1,727 1,175 919 Deferred (51) 217 155 ------ ------ ------ Total outside United States 1,676 1,392 1,074 ------ ------ ------ Total provision for income taxes $4,380 $3,869 $3,491 ====== ====== ====== At December 31, 1996, applicable United States federal income taxes and foreign withholding taxes have not been provided on approximately $4.2 billion of accumulated earnings of foreign subsidiaries that are expected to be permanently reinvested abroad. If these amounts were not considered permanently reinvested, additional deferred income taxes of approximately $240 million would have been provided. The Company and its subsidiaries are subject to tax examinations in various U.S. and foreign jurisdictions. The Company believes that adequate tax payments have been made and accruals recorded for all years. The effective income tax rate on pretax earnings differed from the U.S. federal statutory rate for the following reasons: 1996 1995 1994 ---- ---- ---- Provision computed at U.S. federal statutory rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State and local income taxes, net of federal tax benefit 2.6 3.0 3.3 Rate differences - foreign operations 3.3 1.9 1.0 Goodwill amortization 1.8 2.1 2.4 Other (1.7) (0.6) 0.8 ---- ---- ---- Provision for income taxes 41.0% 41.4% 42.5% ==== ==== ==== Continued 14 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- The tax effects of temporary differences which gave rise to consumer products deferred income tax assets and liabilities consisted of the following: December 31, 1996 1995 ---- ---- (in millions) Deferred income tax assets: Accrued postretirement and postemployment benefits $ 1,070 $ 1,018 Accrued liabilities 588 451 Restructuring, strategic and other reserves 315 331 Other 399 764 ------- ------- Gross deferred income tax assets 2,372 2,564 Valuation allowance (87) (125) ------- ------- Total deferred income tax assets 2,285 2,439 ------- ------- Deferred income tax liabilities: Property, plant and equipment (1,699) (1,687) Prepaid pension costs (286) (197) ------- ------- Total deferred income tax liabilities (1,985) (1,884) ------- ------- Net deferred income tax assets $ 300 $ 555 ======= ======= Financial services and real estate deferred income tax liabilities are primarily attributable to temporary differences from investments in finance leases. Note 10. Segment Reporting: Tobacco, food, beer, and financial services and real estate are the major segments of the Company's operations. The Company's major products are cigarettes, coffee, cheese, chocolate confections, processed meat products, various packaged grocery products and beer. The Company's consolidated operations outside the United States, which are principally in the tobacco and food businesses, are organized into geographic regions by segment, with Europe the most significant. Intersegment transactions are not reported separately since they are not material. For purposes of segment reporting, operating profit is operating income exclusive of certain unallocated corporate expenses. Substantially all goodwill amortization is attributable to the food segment. Identifiable assets are those assets applicable to the respective industry segments. See Note 2 regarding divestitures and acquisitions. Continued 15 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- Reportable segment data were as follows: Data by Segment for the years ended December 31, 1996 1995 1994 ---- ---- ---- (in millions) Operating revenues: Tobacco $36,549 $32,316 $28,671 Food 27,950 29,074 31,669 Beer 4,327 4,304 4,297 Financial services and real estate 378 377 488 ------- ------- ------- Total operating revenues $69,204 $66,071 $65,125 ======= ======= ======= Operating profit: Tobacco $ 8,263 $ 7,177 $ 6,162 Food 3,362 3,188 3,108 Beer 437 444 413 Financial services and real estate 192 164 208 ------- ------- ------- Total operating profit 12,254 10,973 9,891 Unallocated corporate expenses 485 447 442 ------- ------- ------- Operating income $11,769 $10,526 $ 9,449 ======= ======= ======= Identifiable assets: Tobacco $13,314 $11,196 $ 9,926 Food 32,934 33,447 34,822 Beer 1,707 1,751 1,706 Financial services and real estate 5,917 5,632 5,193 ------- ------- ------- 53,872 52,026 51,647 Other assets 999 1,785 1,002 ------- ------- ------- Total assets $54,871 $53,811 $52,649 ======= ======= ======= Depreciation expense: Tobacco $ 378 $ 350 $ 360 Food 538 556 539 Beer 104 101 108 Capital expenditures: Tobacco $ 829 $ 525 $ 529 Food 812 948 1,072 Beer 122 115 121 Continued 16 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- Data by Geographic Region for the years ended December 31, ---------------------------------------------------------- 1996 1995 1994 ---- ---- ---- (in millions) Operating revenues: United States - domestic $31,993 $32,479 $35,936 - export 6,476 5,920 4,942 Europe 24,232 23,076 19,888 Other 6,503 4,596 4,359 ------- ------- ------- Total operating revenues $69,204 $66,071 $65,125 ======= ======= ======= Operating profit: United States $ 8,762 $ 8,031 $ 7,306 Europe 2,635 2,366 1,914 Other 857 576 671 ------- ------- ------- Total operating profit 12,254 10,973 9,891 Unallocated corporate expenses 485 447 442 ------- ------- ------- Operating income $11,769 $10,526 $ 9,449 ======= ======= ======= Identifiable assets: United States $33,314 $32,521 $33,622 Europe 15,836 15,981 14,845 Other 4,722 3,524 3,180 ------- ------- ------- 53,872 52,026 51,647 Other assets 999 1,785 1,002 ------- ------- ------- Total assets $54,871 $53,811 $52,649 ======= ======= ======= Note 11. Pension Plans: The Company and its subsidiaries sponsor noncontributory defined benefit pension plans covering substantially all U.S. employees. The plans provide retirement benefits for salaried employees based generally on years of service and compensation during the last years of employment. Retirement benefits for hourly employees generally are a flat dollar amount for each year of service. The Company funds these plans in amounts consistent with the funding requirements of federal laws and regulations. Pension coverage for employees of the Company's non-U.S. subsidiaries is provided, to the extent deemed appropriate, through separate plans, many of which are governed by local statutory requirements. The plans provide pension benefits that are based primarily on years of service and employees' salaries near retirement. The Company provides for obligations under such plans by depositing funds with trustees or purchasing insurance policies. The Company records liabilities for unfunded foreign plans. Continued 17 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- U.S. Plans Net pension (income) cost consisted of the following: 1996 1995 1994 ---- ---- ---- (in millions) Service cost - benefits earned during the year $ 143 $ 110 $ 130 Interest cost on projected benefit obligation 373 367 342 (Return) loss on assets - actual (980) (1,344) 94 - deferred gain (loss) 447 848 (605) Amortization of net gain upon adoption of SFAS No. 87 (25) (26) (28) Amortization of unrecognized net loss (gain) from experience differences 9 (13) (12) Amortization of prior service cost 14 13 12 Other (income) cost (35) 75 49 ------ ------ ------ Net pension (income) cost $ (54) $ 30 $ (18) ====== ====== ====== During 1996, 1995 and 1994, the Company sold businesses and instituted early retirement and workforce reduction programs resulting in curtailment and settlement gains of $69 million and additional pension cost of $34 million in 1996, additional pension cost of $103 million and curtailment gains of $28 million in 1995 and additional pension cost of $49 million in 1994. The funded status of U.S. plans at December 31 was as follows: 1996 1995 ---- ---- (in millions) Actuarial present value of accumulated benefit obligation - vested $3,871 $4,116 - nonvested 359 354 ------ ------ 4,230 4,470 Benefits attributable to projected salaries 650 786 ------ ------ Projected benefit obligation 4,880 5,256 Plan assets at fair value 7,101 6,649 ------ ------ Excess of assets over projected benefit obligation 2,221 1,393 Unamortized net gain upon adoption of SFAS No. 87 (108) (140) Unrecognized prior service cost 124 131 Unrecognized net gain from experience differences (1,404) (807) ------ ------ Prepaid pension cost $ 833 $ 577 ====== ====== The projected benefit obligation at December 31, 1996, 1995 and 1994 was determined using an assumed discount rate of 7.75%, 7.25% and 8.5%, respectively, and assumed compensation increases of 4.5% at December 31, 1996 and 1995 and 5.0% at December 31, 1994. The assumed long-term rate of return on plan assets was 9% at December 31, 1996, 1995 and 1994. Plan assets consist principally of common stock and fixed income securities. Continued 18 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued ------------- The Company and certain of its subsidiaries sponsor deferred profit-sharing plans covering certain salaried, nonunion and union employees. Contributions and costs are determined generally as a percentage of pretax earnings, as defined by the plans. Certain other subsidiaries of the Company also maintain defined contribution plans. Amounts charged to expense for defined contribution plans totaled $210 million, $201 million and $191 million in 1996, 1995 and 1994, respectively. In addition, certain of the Company's subsidiaries participate in multiemployer defined benefit plans. Contributions to these plans were immaterial in 1996, 1995 and 1994. Non-U.S. Plans Net pension cost consisted of the following: 1996 1995 1994 ---- ---- ---- (in millions) Service cost - benefits earned during the year $ 80 $ 80 $ 72 Interest cost on projected benefit obligation 166 160 136 (Return) loss on assets - actual (201) (195) 4 - deferred gain (loss) 70 74 (113) Amortization of net loss (gain) upon adoption of SFAS No. 87 3 1 (1) ----- ----- ----- Net pension cost $ 118 $ 120 $ 98 ===== ===== ===== The funded status of the non-U.S. plans at December 31 was as follows: Assets Exceed Accumulated Benefits Accumulated Benefits Exceed Assets -------------------- -------------------- 1996 1995 1996 1995 ---- ---- ---- ---- (in millions) Actuarial present value of accumulated benefit obligation - vested $1,336 $1,257 $ 721 $ 703 - nonvested 39 46 77 69 ------ ------ ------ ------ 1,375 1,303 798 772 Benefits attributable to projected salaries 342 324 127 125 ------ ------ ------ ------ Projected benefit obligation 1,717 1,627 925 897 Plan assets at fair value 1,891 1,780 36 59 ------ ------ ------ ------ Plan assets in excess of (less than) projected benefit obligation 174 153 (889) (838) Unamortized net (gain) loss upon adoption of SFAS No. 87 (14) 11 13 14 Unrecognized net gain from experience differences (22) (42) (5) (34) ------ ------ ------ ------ Prepaid (accrued) pension cost $ 138 $ 122 $ (881) $ (858) ====== ====== ======= ====== Continued 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- The assumptions used in 1996, 1995 and 1994 were as follows: 1996 1995 1994 ---- ---- ---- Discount rates 4.0% to 12.0% 4.5% to 10.0% 5.0% to 13.0% Compensation increases 3.0% to 8.0% 3.5% to 9.0% 3.5% to 11.0% Long-term rates of return on plan assets 4.5% to 11.0% 4.5% to 11.0% 5.5% to 12.0% Plan assets consist primarily of common stock and fixed income securities. Note 12. Postretirement Benefits Other Than Pensions: The Company and its subsidiaries have accrued the estimated cost of retiree health care benefits during the active service periods of employees in the United States and Canada. Health care benefits for retirees outside the United States and Canada are generally covered through local government plans. The Company and its U.S. and Canadian subsidiaries provide health care and other benefits to substantially all retired employees, their covered dependents and beneficiaries. Generally, employees who have attained age 55 and who have rendered at least 5 to 10 years of service are eligible for these benefits. Certain health care plans are contributory; others are noncontributory. Net postretirement health care costs consisted of the following: 1996 1995 1994 ---- ---- ---- (in millions) Service cost - benefits earned during the period $ 59 $ 46 $ 57 Interest cost on accumulated postretirement benefit obligation 180 179 165 Amortization of unrecognized net loss (gain) from experience differences 4 (2) 6 Amortization of unrecognized prior service cost (12) (13) (15) Other (income) cost (8) (13) 32 ---- ---- ---- Net postretirement health care costs $223 $197 $245 ==== ==== ==== During 1996, 1995 and 1994, the Company sold businesses and instituted early retirement and workforce reduction programs resulting in additional income or cost. Continued 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- The Company's postretirement health care plans currently are not funded. The status of the plans at December 31 was as follows: 1996 1995 ------ ------ (in millions) Actuarial present value of accumulated postretirement benefit obligation: Retirees $1,289 $1,353 Fully eligible active plan participants 278 253 Other active plan participants 859 927 ------ ------ 2,426 2,533 Unrecognized net loss from experience differences (75) (303) Unrecognized prior service cost 127 140 ------ ------ Accrued postretirement health care costs $2,478 $2,370 ====== ====== The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for U.S. plans was 9.0% in 1995, 8.5% in 1996 and 8.0% in 1997, gradually declining to 5.0% by the year 2003 and remaining at that level thereafter. For Canadian plans, the assumed health care cost trend rate was 15.0% in 1995, 14.0% in 1996 and 13.0% in 1997, gradually declining to 5.0% by the year 2005 and remaining at that level thereafter. A one-percentage-point increase in the assumed health care cost trend rates for each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 and net postretirement health care cost for the year then ended by approximately 12% and 16%, respectively. The accumulated postretirement benefit obligations for U.S. plans at December 31, 1996, 1995 and 1994 were determined using assumed discount rates of 7.75%, 7.25% and 8.5%, respectively. The accumulated postretirement benefit obligation at December 31, 1996 and 1995 for Canadian plans was determined using an assumed discount rate of 8.25% and 9.75%, respectively. Note 13. 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."), the Company's wholly-owned domestic tobacco subsidiary. Various types of claims are raised in these proceedings, including but not limited to products liability, antitrust, securities law, tax and patent infringement matters. Pending claims related to tobacco products generally fall within three categories: (i) smoking and health cases alleging personal injury brought on behalf of individual smokers, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of plaintiffs, and (iii) health care cost recovery actions brought primarily by states and local governments seeking reimbursement for Medicaid and other health care expenditures allegedly caused by cigarette smoking. In the individual and class action smoking and health cases pending against PM Inc. and, in some cases, the Company and/or certain of its other subsidiaries, plaintiffs allege personal injury resulting from cigarette smoking, "addiction" to cigarette smoking or exposure to environmental tobacco smoke ("ETS") and seek compensatory and, in some cases, punitive Continued 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- damages in amounts ranging into the billions of dollars. During the past two years, there has been a substantial increase in the number of such smoking and health cases in the United States, with a majority of the new cases having been filed in Florida on behalf of individual plaintiffs. As of December 31, 1996, there were 185 smoking and health cases filed and served on behalf of individual plaintiffs in the United States against PM Inc. and, in some cases, the Company, compared to 115 such cases as of December 31, 1995, and 84 such cases as of December 31, 1994. One hundred twenty-two of the cases filed and served as of December 31, 1996, were filed on behalf of individual plaintiffs in the state of Florida. Ten of the individual cases involve allegations of various personal injuries allegedly related to exposure to ETS. In addition to the foregoing individual smoking and health cases, there are 17 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company, including one that involves allegations of various personal injuries related to exposure to ETS. Twelve of these actions purport to constitute state-wide class actions and were filed after the Fifth Circuit Court of Appeals, in the Castano case discussed below, reversed a federal district court's certification of a purported nation-wide class action on behalf of persons who were allegedly addicted to tobacco products. One purported smoking and health class action is pending in Canada and another in Brazil against affiliates of the Company. In California, individuals and local governments and other organizations purportedly acting as "private attorneys general" have filed suits seeking, among other things, injunctive relief, restitution and disgorgement of profits for alleged violations of California's consumer protection statutes. As discussed below, 26 health care cost recovery actions are currently pending. In August 1996, a jury awarded a former smoker and his spouse $750,000 in a smoking and health case against another United States cigarette manufacturer (Carter v. American Tobacco Co., et al.). Neither PM Inc. nor the Company was a party to that litigation. Defendant in that action has appealed the verdict. Later that month, a jury returned a verdict for defendants in a smoking and health case in Indiana against United States cigarette manufacturers, including PM Inc. (Rogers v. R.J. Reynolds Tobacco Company, et al.). Plaintiff has appealed the verdict. Several smoking and health cases and health care cost recovery actions are scheduled for trial in 1997, although trial dates are subject to change. One individual smoking and health case in which PM Inc. is a defendant is scheduled for trial during the first quarter of 1997 and a number of other individual cases against the industry are scheduled for trial later in the year. A purported class action on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft is set for trial in June 1997 in Florida state court. A purported class action on behalf of Florida residents who allege injury from alleged nicotine addiction is set for trial in September 1997. A similar action on behalf of Pennsylvania residents is set for trial in October 1997. Health care cost recovery actions are currently scheduled for trial in Mississippi in June 1997, in Florida in August 1997 and in Texas in September 1997. A description of smoking and health class actions, health care cost recovery litigation and certain other actions pending against the Company and/or its subsidiaries and affiliates follows. Continued 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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, conspiracy, concert of action, and violations of deceptive trade practice laws and consumer protection statutes. 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 July 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 enacted. It is not possible to predict whether any such legislation will be enacted. A smoking and health class action against United States cigarette manufacturers has been pending in Florida state court since October 1991 in which a class has been certified consisting of "all non-smoking flight attendants who are or have been employed by airlines based in the United States" and who are allegedly suffering from 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. Various challenges to the class certification have been denied on appeal, and the case is currently set for trial in June 1997. Another smoking and health class action against United States cigarette manufacturers has been pending in Florida state court since May 1994 in which a class has been certified consisting of all Florida citizens and residents and their survivors who have suffered injury "caused by their addiction to cigarettes that contain nicotine." 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. Various challenges to the class certification have been denied on appeal, and the case is currently set for trial in September 1997. In March 1994, a smoking and health class action was filed in Alabama state court against three United States cigarette manufacturers, and was subsequently removed 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. 94-4-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 Continued 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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 defendants' motion for summary judgment on the grounds that the suit is preempted by the Labeling Act. In March 1994, a smoking and health class action was filed in federal district court in Louisiana against United States cigarette manufacturers and others, including the Company, seeking certification of a purported class consisting 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 February 1995, the trial court certified the class and in May 1996, the Fifth Circuit Court of Appeals reversed the trial court's class certification and remanded the case with instructions that the class allegations be dismissed. Summary judgment motions against the two remaining named plaintiffs in this case are pending. Following the announcement of the Fifth Circuit's class decertification decision in Castano, lawyers for the plaintiffs announced that they would file "state-wide" smoking and health class actions in state courts. Subsequently, smoking and health class actions 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") were filed in a number of states, as described below. Immediately prior to the Fifth Circuit's decision in the Castano case, a purported nicotine-dependence class action was filed in Indiana state court against 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 was filed in Maryland state court against United States cigarette manufacturers and others, including the Company. The case was removed by defendants to federal court and was subsequently remanded to state court. Richardson, et al. v. Philip Morris Incorporated, et al., Circuit Court for Baltimore City, No. 96145050. In May 1996, a purported nicotine-dependence class action was filed in Louisiana state court against four United States cigarette manufacturers and others, including the Company. Scott, et al. v. The American Tobacco Company, Inc., et al., Civil District Court for the Parish of Orleans, State of Louisiana, Docket No. 96-8461. A hearing on plaintiffs' motion for class certification has been scheduled for February 1997. In June 1996, a purported nicotine-dependence class action 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 December 1996, defendants filed motions to dismiss the complaint and to deny class certification. Continued 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- In June 1996, a purported physical injury class action was filed in the Superior Court of the District of Columbia against 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 plaintiffs can pursue a class action has been scheduled for June 1997. In August 1996, a purported nicotine-dependence class action was filed in Pennsylvania state court against United States cigarette manufacturers and others, including the Company, and was subsequently removed 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. A hearing on class certification is set for March 1997, and the trial is scheduled for October 1997. In August 1996, a purported nicotine-dependence class action was filed in Alabama state court, on behalf of Alabama and North Carolina residents, against four 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 was filed in Ohio state court against United States cigarette manufacturers and others, including the Company, and was subsequently removed 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 action was filed in Florida state court against 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 was filed in Minnesota state court against four United States cigarette manufacturers and others, including the Company. The case was removed by defendants to federal court 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. Plaintiffs' motion to remand the case to state court is pending. In October 1996, a purported nicotine-dependence class action was filed in New Mexico state court against four 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. In October 1996, a purported nicotine-dependence class action was filed in federal court in Puerto Rico against four United States cigarette manufacturers and others. Ruiz, et al. v. The American Tobacco Co., 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 United States cigarette manufacturers and others, including the Company. McGinty, et al. v. The American Continued 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Tobacco Co., et al., United States District Court for the Eastern District of Arkansas, Western Division, 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, Inc. 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 consisting of all current and former cigarette smokers in Ontario, their families and the estates of deceased smokers. 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., a wholly-owned subsidiary of the Company, 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. Defendants are seeking further appellate review of this order. Pro se prisoners have filed two purported class actions against 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-dependent 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. In November 1996, the court in Harris entered an order denying class certification. HEALTH CARE COST RECOVERY LITIGATION In certain of the pending proceedings, state and local government entities and others seek reimbursement for Medicaid and/or other health care expenditures allegedly caused by tobacco products. The claims asserted in these health care cost 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, Continued 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- deceptive trade practices and false advertising, and claims under the Federal Racketeer Influenced and Corrupt Organization Act ("RICO") or state RICO statutes. 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 attorney 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 health care 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 health care cost 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 health care cost recovery suits pending against PM Inc. and, in some cases, the Company and the related declaratory judgment actions filed by cigarette manufacturers. 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 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, but stated that this provision might be unconstitutional as applied in the state's case. The court also held that the state's independent cause of action created by the statute 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 Continued 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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 December 1996, PM Inc. and another party filed a petition for a writ of certiorari to the United States Supreme Court on the grounds that the statute violates due process because it creates a unique cause of action on behalf of the state which abrogates certain common law and equitable principles, including affirmative defenses. In February 1995, the State of Florida filed a health care cost 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 count for injunctive relief. The court also ordered the state to disclose the identity of the Medicaid recipients. In October 1996, the state filed a coded listing (without names) for all Medicaid recipients with alleged smoking-related illnesses. The trial court accepted the coded listing and, in January 1997, the Florida Supreme Court determined not to hear and denied defendants' challenge to the sufficiency of the state's purported identification of Medicaid recipients. In November 1996, plaintiffs amended their complaint to add claims for violations of Florida's RICO and consumer protection statutes. In December 1996, the court granted defendants' motion to dismiss various claims brought under state statutes and denied the motion to dismiss claims based on Florida's RICO statute and on a state false advertising statute. In January 1997, defendants waived their rights to a pretrial determination of whether plaintiffs can amend their complaint to include a punitive damages claim. Defendants have reserved their rights to challenge the punitive damages claim on factual or legal bases. Plaintiffs' motion to strike defendants' affirmative defenses was heard on January 24, 1997. The trial in this case is scheduled to begin in August 1997. Mississippi -- In May 1994, the Attorney General of Mississippi filed a health care cost 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. In July 1995, plaintiff filed a motion seeking to preclude defendants from asserting their "set off" defenses. That motion is pending. The Governor of Mississippi and defendants have filed petitions with the Mississippi Supreme Court challenging the authority of the Attorney General to pursue this action. The Mississippi Supreme Court heard arguments on both petitions in September 1996, but has not issued a decision on either petition. The trial is scheduled to begin in June 1997. Minnesota -- In August 1994, the Attorney General of Minnesota and Blue Cross and Blue Shield of Minnesota filed a health care cost 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 Continued 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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 January 1998. West Virginia -- In September 1994, the Attorney General of West Virginia filed a health care cost 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 dismissed eight of ten counts of the complaint and granted defendants' motion to prohibit prosecution of this case pursuant to a contingent fee agreement with private counsel. In June 1996, the Attorney General added the Public Employees' Insurance Agency as a plaintiff. In November 1996, plaintiffs added the West Virginia Department of Health and Human Resources as a plaintiff, and three law firms as defendants, and asserted additional counts under theories of indemnity, negligent misrepresentation, negligence, and strict product liability. In December 1996, the court heard oral argument on defendants' motion to dismiss plaintiff's common law and equitable claims. A hearing on defendants' motion to dismiss plaintiff's statutory claims is scheduled for February 1997. Texas -- In March 1996, the Texas Attorney General filed a health care cost recovery action in federal court in Texas. The State of Texas v. The American Tobacco Company, et al., United States District Court, Eastern District of Texas, Civil No. 5-96CV91. Trial in this action is set for September 1997 and defendants have filed a number of motions to dismiss it. Defendants and others had previously filed an action in Texas state court in November 1995, seeking a declaration that the Texas Attorney General cannot pursue a health care cost recovery action. 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 state court has stayed the action for declaratory relief pending the outcome of the Attorney General's suit. Massachusetts -- In December 1995, the Massachusetts Attorney General filed a health care cost recovery action in Massachusetts state court. Commonwealth of Massachusetts v. Philip Morris Inc., et al., Superior Court, Middlesex County, Civil Action No. 95-7378. Defendants have moved to dismiss the complaint. Defendants had previously filed an action in Massachusetts federal court in November 1995, seeking to enjoin the Attorney General from prosecuting a health care cost recovery action. Philip Morris Incorporated, et al. v. Scott Harshbarger, United States District Court, District of Massachusetts, Case No. 95-12574-GAO. In November 1996, the federal district court denied the Attorney General's motion to dismiss the complaint and stayed the injunction action. Maryland -- In May 1996, the State of Maryland filed a health care cost 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. Defendants' motion to dismiss the state's complaint is scheduled to be heard on January 28, 1997. The trial is scheduled for January 1999. Defendants and others had previously filed a separate action in Maryland state court seeking to enjoin the Maryland Attorney General from prosecuting a health care cost recovery action pursuant to a contingent fee arrangement with special counsel. 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. In August 1996, the court granted Continued 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- defendants' motion for summary judgment and dismissed the injunction action. Plaintiffs have appealed. Louisiana -- In March 1996, the Attorney General of Louisiana filed a health care cost 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. 96-1209. In January 1997, the court denied defendants' motion to dismiss which argued that the Attorney General lacked the authority to bring this action. San Francisco -- In June 1996, the City and County of San Francisco filed a health care cost recovery action in California federal court and has since been 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. In January 1997, the court denied defendants' motion to disqualify plaintiffs' contingency-fee counsel and took under advisement defendants' motion to dismiss. In September 1996, plaintiffs in the federal court action, joined by several medical associations, 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. In January 1997, the court granted in part defendants' motion to dismiss by requiring plaintiffs to replead certain causes of action and denied the motion on other grounds. Washington -- In June 1996, the Attorney General of the State of Washington filed a health care cost recovery action 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. In November 1996, the court dismissed claims based on special duty, unjust enrichment and restitution to the state, but did not dismiss claims brought under Washington's antitrust laws. The State of Washington recently moved to amend its complaint with the stated intention of correcting deficiencies found by the court to exist in the special duty and unjust enrichment claims and to add a claim for restitution under Washington's consumer protection statute. Trial is scheduled for September 1998. Connecticut -- In July 1996, the State of Connecticut filed a health care cost recovery action in Connecticut state court. State of Connecticut v. Philip Morris Inc., et al., Superior Court, Judicial District of Litchfield, Case No. CV-96-01534405. Defendants had previously filed an action in federal district court in June 1996, seeking to enjoin the Connecticut Attorney General from bringing the health care cost recovery action. Philip Morris Inc., et al. v. Richard Blumenthal, United States District Court, District of Connecticut, Case No. 396CV01221 (PCD). This injunction action was dismissed in December 1996 and, in January 1997, plaintiffs appealed the dismissal. Utah -- In September 1996, the Utah Attorney General filed a health care cost 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. Defendants had previously filed an action in Utah state court in July 1996, challenging the right of the Attorney General to bring such an action and to prosecute the case pursuant to a contingent fee arrangement with special counsel. Philip Morris Incorporated, et al. v. Janet C. Graham, Attorney General of the Continued 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- State of Utah, et al., Third Judicial District Court of Salt Lake County, Utah, No. 960904948CV. The parties have agreed that the state court action will be stayed while the federal action is proceeding, except for the challenge to the Attorney General's contingent fee arrangement with special counsel. In December 1996, a motion for partial summary judgment challenging the contingent fee arrangement was argued before the state court. Los Angeles County -- In August 1996, the County of Los Angeles filed a health care cost recovery action in California state court. County of Los Angeles v. R.J. Reynolds Tobacco Company, et al., Superior Court of California, San Diego County. Alabama -- In August 1996, a health care cost recovery action was filed in Alabama state court as a putative class action on behalf of taxpayers of the State of Alabama. 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 health care cost 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. Defendants' motion to dismiss this case is scheduled to be heard in April 1997. Michigan -- In August 1996, the Attorney General of Michigan filed a health care cost recovery action 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 health care cost 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 health care cost 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 claims for Medicaid payments, but seeks recovery of other health care costs as well as other damages and forms of relief. Motions to dismiss the complaint are pending. The trial is scheduled for October 1998. 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 health care cost recovery action by Hawaii. A hearing on defendant's motion to dismiss is scheduled for March 1997. The action is scheduled to go to trial in December 1997. Philip Morris Inc., et al. v. Margery Bronster, U.S. District Court, Hawaii, Civ. No. 96-00722 HG. Continued 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Ohio -- In September 1996, two Ohio local officials filed a health care cost 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 and have filed a motion to dismiss challenging the standing of plaintiffs to bring this action. 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. Plaintiffs motion to remand this action to state court is pending. New Jersey -- In September 1996, the New Jersey Attorney General filed a health care cost 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. In August 1996, defendants filed a separate suit challenging the right of the Attorney General to bring such an action and to prosecute the case pursuant to a contingent fee arrangement with special counsel. 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. Defendants' motion to dismiss the complaint and plaintiffs' motion for summary judgment are pending. New York City -- In October 1996, the City of New York and the New York City Health and Hospitals Corporation filed a health care cost recovery action in New York state court. City of New York, et al. v. 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 health care cost 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. Iowa -- In November 1996, the State of Iowa filed a health care cost recovery action in Iowa state court. State of Iowa, ex rel. Thomas J. Miller, in his capacity as Attorney General of the State of Iowa v. R.J. Reynolds Tobacco Co., et al., District Court for Polk County, Iowa, Case No. CL71048. Alaska -- In January 1997, PM Inc. and three other cigarette manufacturers filed suit against the Alaska Attorney General in federal district court seeking declaratory and injunctive relief to prohibit a threatened health care cost recovery action by Alaska on grounds that it would violate federal law. Philip Morris Inc., et al. v. Bruce Botelho, U.S. District Court, Alaska, No. A 97-003 Civil (JWS). Erie County -- In January 1997, the County of Erie filed a health care cost recovery action in New York state court. County of Erie v. The Tobacco Institute, Inc., et al., Supreme Court of the State of New York, County of Erie, Case No. I1997/359. New York -- On January 27, 1997, it was reported in the press that the State of New York filed a health care cost recovery action. Other state and local government entities have announced that they are considering filing similar health care cost recovery actions. In September 1996, a purported class action was filed in Tennessee state court against four United States cigarette manufacturers and others on behalf of all individuals and entities in the United States who have Continued 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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. This case was removed by defendants to federal court. Perry, et al. v. Philip Morris Incorporated, et al., United States District Court for the Eastern District of Tennessee, Winchester Division, Civil Action No. 4:96-CV-106. Plaintiffs' motion to remand the case to state court is pending. OTHER TOBACCO RELATED CLASS ACTIONS 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 October 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. CERTAIN OTHER ACTIONS 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, Continued 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- the court granted plaintiffs' 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 September 1996, the United States Court of Appeals for the Second Circuit denied the Company's Petition for Writ of Mandamus which had requested that the Court of Appeals direct the trial court to withdraw its order granting class certification. In January 1997, the court granted a motion by an alleged class member to intervene in the action and to be named an additional class representative. 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 an appeal from the judgment in the United States Court of Appeals for the Second Circuit; plaintiffs withdrew the appeal without prejudice in December 1996. In September 1996, the Kurzweil plaintiffs filed a motion in the district court to vacate the judgment and for leave to amend their complaint; this motion remains pending. In March 1995, an antitrust action was filed in California state court against four 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. 206663. 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 and, in January 1997, the Court of Appeals affirmed the trial court's dismissal of this action. 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, Continued 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- 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. Plaintiff seeks injunctive and equitable relief and treble damages. In December 1996, plaintiffs' motion for class certification was denied and defendants' motion to dismiss plaintiffs' action was denied without prejudice. 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. In December 1996, the court denied plaintiffs' motion to consolidate this action with the Stuart case. During 1996, tax assessments alleging the underpayment of Italian value added taxes for the years 1988 to 1994 and income taxes for the year 1987 were asserted against certain affiliates of the Company. The aggregate amount of taxes claimed to be assessed to date, together with interest and penalties, is $798.4 million. The Company anticipates that further substantial value added and income tax assessments may be claimed. The Company and its affiliates believe they have complied with applicable Italian tax laws and intend to vigorously contest the assessments. A hearing concerning value added taxes is scheduled in the Italian tax court for February 4, 1997. The Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. All such cases are, and will continue to be, vigorously defended. 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. Continued 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Note 14. Additional Information: 1996 1995 1994 ------ ------ ------ (in millions) Years ended December 31: Depreciation expense $1,038 $1,024 $1,027 ====== ====== ====== Rent expense $ 430 $ 390 $ 426 ====== ====== ====== Research and development expense $ 515 $ 481 $ 435 ====== ====== ====== Advertising expense $3,633 $3,724 $3,358 ====== ====== ====== Interest and other debt expense, net: Interest expense $1,183 $1,259 $1,288 Interest income (97) (80) (55) ------ ------ ------ $1,086 $1,179 $1,233 ====== ====== ====== Interest expense of financial services and real estate operations included in cost of sales $ 80 $ 84 $ 78 ====== ====== ====== Note 15. Financial Services and Real Estate Operations: Philip Morris Capital Corporation ("PMCC") is a wholly-owned subsidiary of the Company. PMCC invests in leveraged and direct finance leases, other tax-oriented financing transactions, third party financial instruments and engages in various financing activities for customers and suppliers of the Company's subsidiaries. Additionally, PMCC is engaged, through its wholly-owned subsidiary, Mission Viejo Company, in land planning, development and sales activities in California and Colorado. Pursuant to a support agreement, the Company has agreed to retain ownership of 100% of the voting stock of PMCC and make periodic payments to PMCC to the extent necessary to ensure that earnings available for fixed charges equal at least 1.25 times its fixed charges. No payments were required in 1996, 1995 or 1994. Continued 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Condensed balance sheet data at December 31, follow: 1996 1995 ------ ------ (in millions) Assets Finance leases $7,554 $6,858 Other investments 474 471 ------ ------ 8,028 7,329 Less unearned income and allowances 2,682 2,336 ------ ------ Finance assets, net 5,346 4,993 Real estate held for development and sale 314 339 Other assets 258 302 ------ ------ Total assets $5,918 $5,634 ====== ====== Liabilities and stockholder's equity Short-term borrowings $ 173 $ 671 Long-term debt 1,134 783 Deferred income taxes 3,636 3,382 Other liabilities 145 121 Stockholder's equity 830 677 ------ ------ Total liabilities and stockholder's equity $5,918 $5,634 ====== ====== The amounts shown above include receivables and payables with the Company and its other subsidiaries. These amounts were eliminated in the Company's consolidated balance sheets. Finance leases consist of a portfolio of investments in transportation, manufacturing facilities, power generation and real estate. Rentals receivable for finance leases represent unpaid rentals, less principal and interest on third-party nonrecourse debt, if any. PMCC's investment securities, included in other investments, are classified as available for sale and are recorded at fair value, with unrealized gains and losses included as a component of stockholder's equity, net of related deferred income taxes. Other investments also include real estate and commercial receivables, the total estimated fair values of which, at December 31, 1996 and 1995, approximated their carrying values. Fair values were estimated by discounting projected cash flows using the current rates for similar loans to borrowers with similar credit ratings and maturities. Continued 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Condensed income statement data follow for the years ended December 31, 1996 1995 1994 ---- ---- ---- (in millions) Revenues: Financial services $222 $197 $257 Real estate 157 184 236 ---- ---- ---- Total revenues 379 381 493 Expenses: Financial services 107 107 114 Real estate 98 129 190 ---- ---- ---- Total expenses 205 236 304 Equity in earnings of limited partnership investments 15 15 17 ---- ---- ---- Earnings before income taxes 189 160 206 Provision for income taxes 66 55 72 ---- ---- ---- Net earnings $123 $105 $134 ==== ==== ==== Note 16. Financial Instruments: Derivative financial instruments The Company operates internationally, with manufacturing and sales facilities in various locations around the world. Derivative financial instruments are used by the Company for purposes other than trading, principally to reduce exposures to market risks resulting from fluctuations in interest rates and foreign exchange rates by creating offsetting exposures. The Company is not a party to leveraged derivatives. The Company has foreign currency and related interest rate swap agreements which were executed to reduce the Company's borrowing costs and serve as hedges of the Company's net assets in foreign subsidiaries, principally those denominated in Swiss francs. At December 31, 1996 and 1995, the notional principal amounts of these agreements were $2.2 billion and $2.0 billion, respectively. Aggregate maturities at December 31, 1996 were as follows (in millions): 1997-$853; 1998-$186; 1999-$391; 2000-$215 and 2002 and thereafter-$540. The notional amount is the amount used for the calculation of interest payments which are exchanged over the life of the swap transaction and is equal to the amount of foreign currency or dollar principal exchanged at maturity. Forward exchange contracts are used by the Company to reduce the effect of fluctuating foreign currencies on short-term foreign currency denominated intercompany and third party transactions. At December 31, 1996 and 1995, the Company had forward exchange contracts, with maturities of less than one year, of $1.7 billion and $1.2 billion, respectively. Continued 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued ---------- Credit exposure and credit risk The Company is exposed to credit loss in the event of nonperformance by counterparties to the swap agreements. However, such exposure was not material at December 31, 1996, and the Company does not anticipate nonperformance. Further, the Company does not have a significant credit exposure to an individual counterparty. Fair value The aggregate fair value, based on market quotes, of the Company's total debt at December 31, 1996 was $15.7 billion as compared to its carrying value of $15.2 billion. The aggregate fair value of the Company's total debt at December 31, 1995 was $16.7 billion as compared to its carrying value of $15.8 billion. The estimated fair value of financial services and real estate other investments, including commercial and real estate receivables, approximated their carrying values at December 31, 1996 and 1995. The carrying values of the foreign currency and related interest rate swap agreements and of the forward contracts, which did not differ materially from their fair values, were not material. See Notes 4, 5 and 15 for additional disclosures of fair value for short-term borrowings, long-term debt and financial instruments within the financial services and real estate operations, respectively. Note 17. Quarterly Financial Data (Unaudited): 1996 Quarters ------------------------------------------------- 1st 2nd 3rd 4th ------- ------- ------- ------- (in millions, except per share data) Operating revenues $17,491 $17,509 $17,414 $16,790 ======= ======= ======= ======= Gross profit $ 6,989 $ 7,100 $ 7,092 $ 6,812 ======= ======= ======= ======= Net earnings $ 1,565 $ 1,621 $ 1,646 $ 1,471 ======= ======= ======= ======= Per share data: Net earnings $ 1.89 $ 1.97 $ 2.01 $ 1.81 ======= ======= ======= ======= Dividends declared $ 1.00 $ 1.00 $ 1.20 $ 1.20 ======= ======= ======= ======= Market price - high $104-5/8 $107-1/4 $107-1/2 $119 - low $ 85-5/8 $ 85-5/8 $ 85-5/8 $ 89-3/4 During the year, the Company sold several domestic and international food businesses at net pretax gains of $320 million, most of which were reflected in fourth quarter earnings. In addition, the Company initiated cost saving programs that included downsizing facilities and workforce reductions. The cost of these actions substantially offset the gains from businesses sold. The net impact of these divestitures and provisions was not material to fourth quarter operating income, pretax earnings or earnings per share. Continued 39 NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Concluded ---------- 1995 Quarters ------------------------------------------------- 1st 2nd 3rd 4th ------- ------- ------- ------- (in millions, except per share data) Operating revenues $16,517 $17,129 $16,689 $15,736 ======= ======= ======= ======= Gross profit $ 6,467 $ 6,816 $ 6,764 $ 6,407 ======= ======= ======= ======= Earnings before cumulative effect of accounting changes $ 1,363 $ 1,410 $ 1,433 $ 1,272 Cumulative effect of changes in method of accounting (See Note 1) (28) ------- ------- ------- ------- Net earnings $ 1,335 $ 1,410 $ 1,433 $ 1,272 ======= ======= ======= ======= Per share data: Earnings before cumulative effect of accounting changes $ 1.60 $ 1.67 $ 1.71 $ 1.53 Cumulative effect of changes in method of accounting (.03) ------- ------- ------- ------- Net earnings $ 1.57 $ 1.67 $ 1.71 $ 1.53 ======= ======= ======= ======= Dividends declared $ .825 $ .825 $ 1.00 $ 1.00 ======= ======= ======= ======= Market price - high $68 $76-5/8 $84-1/8 $94-3/8 - low $55-3/4 $65-1/4 $71-3/8 $82-5/8 During the year, the Company sold its bakery businesses and its North American margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. In addition, several smaller international food businesses were sold. Net pretax gains from the sales of these businesses were $275 million, most of which were reflected in fourth quarter earnings. In the fourth quarter of 1995, the Company also recorded provisions in connection with these divestitures, primarily for an early retirement program and the write-down of assets of food facilities to be downsized or closed. The net impact of these divestitures and provisions was not material to fourth quarter operating income, pretax earnings or earnings per share. Concluded 40 -----END PRIVACY-ENHANCED MESSAGE-----