-----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, EOlid4wdV304GDGM4RUNgOi6oihrOZmYIMUTqL2X81/oJMwd0h1HY6Um1WWRwuFB fZ1MFZKj+L2YlJApQMY9mA== 0001005477-97-002538.txt : 19971117 0001005477-97-002538.hdr.sgml : 19971117 ACCESSION NUMBER: 0001005477-97-002538 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHILIP MORRIS COMPANIES INC CENTRAL INDEX KEY: 0000764180 STANDARD INDUSTRIAL CLASSIFICATION: FOOD & KINDRED PRODUCTS [2000] IRS NUMBER: 133260245 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-08940 FILM NUMBER: 97718044 BUSINESS ADDRESS: STREET 1: 120 PARK AVE CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 2128805000 MAIL ADDRESS: STREET 1: 120 PARK AVE CITY: NEW YORK STATE: NY ZIP: 10017 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-8940 Philip Morris Companies Inc. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Virginia 13-3260245 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 120 Park Avenue, New York, New York 10017 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 880-5000 ----------------------------- - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ______ At October 31, 1997, there were 2,424,393,006 shares outstanding of the registrant's common stock, par value $0.33 1/3 per share. PHILIP MORRIS COMPANIES INC. TABLE OF CONTENTS Page No. PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited). Condensed Consolidated Balance Sheets at September 30, 1997 and December 31, 1996 3 - 4 Condensed Consolidated Statements of Earnings For the Nine Months Ended September 30, 1997 and 1996 5 For the Three Months Ended September 30, 1997 and 1996 6 Condensed Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 1996 and the Nine Months Ended September 30, 1997 7 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1997 and 1996 8 - 9 Notes to Condensed Consolidated Financial Statements 10 - 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 28 - 52 PART II - OTHER INFORMATION Item 1. Legal Proceedings. 53 Item 6. Exhibits and Reports on Form 8-K. 53 Signature 54 -2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (in millions of dollars) (Unaudited) September 30, December 31, 1997 1996 ------------- ------------ ASSETS Consumer products Cash and cash equivalents $ 779 $ 240 Receivables, net 5,050 4,466 Inventories: Leaf tobacco 3,903 4,143 Other raw materials 1,993 1,854 Finished product 3,029 3,005 ------- ------- 8,925 9,002 Other current assets 1,397 1,482 ------- ------- Total current assets 16,151 15,190 Property, plant and equipment, at cost 19,999 19,972 Less accumulated depreciation 8,390 8,221 ------- ------- 11,609 11,751 Goodwill and other intangible assets (less accumulated amortization of $4,670 and $4,391) 17,823 18,998 Other assets 3,688 3,015 ------- ------- Total consumer products assets 49,271 48,954 Financial services and real estate Finance assets, net 5,593 5,345 Real estate held for development and sale 314 Other assets 179 258 ------- ------- Total financial services and real estate assets 5,772 5,917 ------- ------- TOTAL ASSETS $55,043 $54,871 ======= ======= See notes to condensed consolidated financial statements. Continued -3- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Continued) (in millions of dollars) (Unaudited) September 30, December 31, 1997 1996 ------------- ------------ LIABILITIES Consumer products Short-term borrowings $ 189 $ 260 Current portion of long-term debt 1,687 1,846 Accounts payable 2,305 3,409 Accrued marketing 2,170 2,106 Accrued taxes, except income taxes 1,467 1,331 Other accrued liabilities 3,896 3,668 Income taxes 1,342 1,269 Dividends payable 972 978 -------- ------- Total current liabilities 14,028 14,867 Long-term debt 12,440 11,827 Deferred income taxes 832 731 Accrued postretirement health care costs 2,438 2,372 Other liabilities 5,515 5,773 -------- ------- Total consumer products liabilities 35,253 35,570 Financial services and real estate Short-term borrowings 319 173 Long-term debt 843 1,134 Deferred income taxes 3,723 3,636 Other liabilities 264 140 -------- ------- Total financial services and real estate liabilities 5,149 5,083 -------- ------- Total liabilities 40,402 40,653 Contingencies (Note 3) STOCKHOLDERS' EQUITY Common stock, par value $0.33 1/3 per share (2,805,961,317 shares issued) 935 935 Earnings reinvested in the business 24,519 22,478 Currency translation adjustments (947) 192 -------- ------- 24,507 23,605 Less cost of repurchased stock (381,968,524 and 374,615,043 shares) 9,866 9,387 -------- ------- Total stockholders' equity 14,641 14,218 -------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 55,043 $54,871 ======== ======= See notes to condensed consolidated financial statements. -4- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions, except per share data) (Unaudited) For the Nine Months Ended September 30, ------------------------- 1997 1996 -------- -------- Operating revenues $54,722 $52,414 Cost of sales 19,978 20,001 Excise taxes on products 12,348 11,232 ------- ------- Gross profit 22,396 21,181 Marketing, administration and research costs 11,904 11,724 Settlement charges (Note 3) 812 Amortization of goodwill 438 443 ------- ------- Operating income 9,242 9,014 Interest and other debt expense, net 815 824 ------- ------- Earnings before income taxes 8,427 8,190 Provision for income taxes 3,412 3,358 ------- ------- Net earnings $ 5,015 $ 4,832 ======= ======= Weighted average number of shares 2,425 2,471 ======= ======= Per share data: Net earnings $ 2.07 $ 1.96 ======= ======= Dividends declared $ 1.20 $ 1.07 ======= ======= See notes to condensed consolidated financial statements. -5- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions, except per share data) (Unaudited) For the Three Months Ended September 30, -------------------------- 1997 1996 -------- -------- Operating revenues $18,092 $17,414 Cost of sales 6,571 6,596 Excise taxes on products 4,101 3,726 ------- ------- Gross profit 7,420 7,092 Marketing, administration and research costs 3,854 3,871 Settlement charges (Note 3) 812 Amortization of goodwill 142 150 ------- ------- Operating income 2,612 3,071 Interest and other debt expense, net 249 281 ------- ------- Earnings before income taxes 2,363 2,790 Provision for income taxes 957 1,144 ------- ------- Net earnings $ 1,406 $ 1,646 ======= ======= Weighted average number of shares 2,423 2,454 ======= ======= Per share data: Net earnings $ 0.58 $ 0.67 ======= ======= Dividends declared $ 0.40 $ 0.40 ======= ======= See notes to condensed consolidated financial statements. -6- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 1996 and the Nine Months Ended September 30, 1997 (in millions of dollars, except per share data) (Unaudited)
Earnings Total Reinvested Currency Cost of Stock- Common in the Translation Repurchased holders' Stock Business Adjustments Stock Equity ------ ---------- ----------- ----------- -------- Balances, January 1, 1996 $ 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 ($1.47 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 Net earnings 5,015 5,015 Exercise of stock options and issuance of other stock awards (66) 264 198 Cash dividends declared ($1.20 per share) (2,910) (2,910) Currency translation adjustments (1,139) (1,139) Stock repurchased (743) (743) Net unrealized appreciation on securities 2 2 ------ ------- ------ ------- ------- Balances, September 30, 1997 $ 935 $24,519 $ (947) $(9,866) $14,641 ====== ======= ====== ======= =======
See notes to condensed consolidated financial statements. -7- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (in millions of dollars) (Unaudited) For the Nine Months Ended September 30, ------------------------- 1997 1996 -------- -------- CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net earnings - Consumer products $ 4,881 $ 4,744 - Financial services and real estate 134 88 ------- ------- Net earnings 5,015 4,832 Adjustments to reconcile net earnings to operating cash flows: Consumer products Depreciation and amortization 1,246 1,259 Deferred income tax provision 130 220 Gains on sales of businesses (182) (68) Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net (942) (630) Inventories (331) (617) Accounts payable (972) (915) Income taxes (40) 260 Other working capital items 663 (240) Other 335 207 Financial services and real estate Deferred income tax provision 113 110 Gain on sale of business (103) Other 156 104 ------- ------- Net cash provided by operating activities 5,088 4,522 ------- ------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES Consumer products Capital expenditures (1,176) (1,108) Purchases of businesses, net of acquired cash (628) (515) Proceeds from sales of businesses 402 154 Other 12 Financial services and real estate Investments in finance assets (501) (306) Proceeds from finance assets 256 154 Proceeds from sale of business 427 ------- ------- Net cash used in investing activities (1,220) (1,609) ------- ------- See notes to condensed consolidated financial statements. Continued -8- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Continued) (in millions of dollars) (Unaudited) For the Nine Months Ended September 30, ------------------------- 1997 1996 -------- -------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES Consumer products Net (repayment) issuance of short-term borrowings $(1,006) $ 329 Long-term debt proceeds 2,852 1,966 Long-term debt repaid (1,330) (1,487) Financial services and real estate Net issuance (repayment) of short-term borrowings 146 (450) Long-term debt proceeds 175 363 Long-term debt repaid (387) Repurchase of outstanding stock (805) (2,097) Dividends paid (2,916) (2,483) Issuance of shares 97 341 Other (72) (31) ------- ------- Net cash used in financing activities (3,246) (3,549) Effect of exchange rate changes on cash and cash equivalents (83) (43) ------- ------- Cash and cash equivalents: Increase (decrease) 539 (679) Balance at beginning of period 240 1,138 ------- ------- Balance at end of period $ 779 $ 459 ======= ======= See notes to condensed consolidated financial statements. -9- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1. Accounting Policies: The interim condensed consolidated financial statements of Philip Morris Companies Inc. (the "Company") are unaudited. It is the opinion of the Company's management that all adjustments necessary for a fair statement of the interim results presented have been reflected therein. All such adjustments were of a normal recurring nature. Operating revenues and net earnings for any interim period are not necessarily indicative of results that may be expected for the entire year. These statements should be read in conjunction with the consolidated financial statements and related notes which appear in the Company's annual report to stockholders and which are incorporated by reference into the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 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. Note 2. Capital Stock: On February 26, 1997, the Company's Board of Directors declared a three-for-one split of the Company's common stock, effected by a distribution on April 10, 1997, of two shares for each share held of record at the close of business on March 17, 1997. In addition, the par value of the Company's common stock was changed from $1.00 to $0.33 1/3 per share and authorized shares of common stock were increased from 4 billion to 12 billion shares. All share and per share data have been restated to reflect this stock split for all periods presented. Note 3. Contingencies: Legal proceedings covering a wide range of matters are pending in various U.S. and foreign jurisdictions against the Company, its subsidiaries, including Philip Morris Incorporated ("PM Inc."), the Company's domestic tobacco subsidiary, and indemnitees. Various types of claims are raised in these proceedings, including products liability, consumer protection, antitrust, securities law, tax, patent infringement, employment matters and claims for contribution. OVERVIEW OF TOBACCO-RELATED LITIGATION Types and Number of Cases Pending claims related to tobacco products generally fall within three categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, and (iii) health care cost recovery actions, including class actions, brought by state and local governments, unions and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking. The theories of recovery asserted and defenses raised in these cases are described below under "Smoking and Health Litigation" and "Health Care Cost Recovery Litigation." Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. There continues to be a substantial increase in the number of tobacco-related cases pending in the United States, with many of the new cases having been filed in Florida and New York on behalf of individual plaintiffs. As of November 1, 1997, there were approximately 365 smoking and health cases filed and served on behalf of individual plaintiffs in the United States against PM Inc. and, in some cases, -10- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) the Company (excluding approximately 50 cases in Texas that were voluntarily dismissed but which may be refiled under certain conditions), compared to approximately 300 such cases as of June 30, 1997, and approximately 200 such cases as of September 30, 1996. Seventeen of the individual cases involve allegations of various personal injuries allegedly related to exposure to environmental tobacco smoke ("ETS"). In addition, as of November 1, 1997, there were approximately 45 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including four that involve allegations of various personal injuries related to exposure to ETS) compared to approximately 40 such cases on June 30, 1997, and 20 such cases on September 30, 1996. Most of these actions purport to constitute statewide class actions and were filed after the Fifth Circuit Court of Appeals, in the Castano case, reversed a federal district court's certification of a purported nationwide class action on behalf of persons who were allegedly "addicted" to tobacco products. One purported smoking and health class action is pending in Canada (against an entity in which the Company, through subsidiaries, owns a 40% interest) and another in Brazil against affiliates of the Company. Recently, a purported smoking and health class action was filed in Nigeria against a subsidiary of Philip Morris International Inc., the Company's international tobacco subsidiary. As of November 1, 1997, approximately 95 health care cost recovery actions were pending, compared to approximately 70 on June 30, 1997, and 20 on September 30, 1996. 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 (Ellis, et al. v. R.J. Reynolds Tobacco Company, et al.; Cordova, et al. v. Liggett Group, Inc., et al.). Verdicts in Recent Cases In August 1996, a Florida 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.), and that manufacturer was subsequently ordered to pay approximately $1.8 million in attorneys fees and costs. Neither PM Inc. nor the Company was a party to that litigation. The 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 filed a motion seeking a new trial based on the alleged discovery of new evidence. In May and October 1997, Florida juries also returned verdicts for defendants in smoking and health cases involving another United States cigarette manufacturer (Connor v. R.J. Reynolds Tobacco Company; Karbiwnyk v. R.J. Reynolds Tobacco Company). In September 1997, a court in Brazil awarded plaintiffs in a smoking and health case the Brazilian real equivalent of $81,000, attorneys' fees (in an amount to be determined by the court) and a monthly annuity for 35 years equal to two-thirds of the deceased smoker's last monthly salary (Alves v. Souza Cruz). Defendant is appealing the judgment. Neither the Company nor its affiliates were parties to that action. Settlements In recent months, PM Inc. and other companies in the domestic tobacco industry agreed to settle a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft and two health care cost recovery actions brought by the states of Florida and Mississippi. These settlements are discussed below under the headings "Smoking and Health -11- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Litigation -- Broin," "Health Care Cost Recovery Litigation -- Florida" and "Health Care Cost Recovery Litigation -- Mississippi." Trial Dates A number of smoking and health cases and health care cost recovery actions pending against PM Inc. and, in some cases, the Company, are scheduled for trial through the end of 1998, although trial dates are subject to change. A Florida class action is set for trial in February 1998 (Engle, et al. v. R.J. Reynolds Tobacco Company, et al.). A New York class action may commence during the first quarter of 1998, although a firm trial date has not yet been set (Frosina, et al. v. Philip Morris, Inc., et al.). A Maryland class action is scheduled to go to trial in September 1998 (Richardson, et al. v. Philip Morris Incorporated, et al.). The Texas health care cost recovery trial, previously scheduled to begin in September, has been delayed and no new trial date has been set at this time. The Minnesota health care cost recovery action is scheduled for trial in January 1998. Several other health care cost recovery actions are scheduled for trial later in 1998: Washington (September), Arizona (October) and Oklahoma (November). Approximately 30 other individual cases are currently scheduled for trial in 1998 against PM Inc. and, in some cases, the Company, of which approximately 20 are set for trial in Florida commencing in June 1998. A description of certain recent developments in 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. 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, violations of deceptive trade practice laws and consumer protection statutes, and claims under the federal Racketeer Influenced and Corrupt Organization Act ("RICO") and state RICO statutes. Plaintiffs in these actions seek various forms of relief, including compensatory and punitive damages, creation of a medical monitoring fund, disgorgement of profits, various injunctive and equitable relief. 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. -12- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Recently Filed Smoking and Health Class Actions Since July 1, 1997 through November 1, 1997, the following smoking and health class actions have been filed against PM Inc. and, in some cases, the Company and/or its other subsidiaries: Daley, et al. v. American Brands, Inc., et al., Circuit Court, Cook County, Illinois, filed July 7, 1997. Piscitello, et al. v. Philip Morris, Incorporated, Superior Court, Middlesex County, New Jersey, filed July 28, 1997. Azorsky, et al. v. R.J. Reynolds Tobacco Company, et al., United States District Court, Western District, Pennsylvania, filed August 15, 1997. McCauley, et al. v. Brown & Williamson Tobacco Corporation, et al., United States District Court, Northern District, Georgia, filed August 20, 1997. DaSilva, et al. v. Nigerian Tobacco Company, et al., High Court of Lagos State, Nigeria, filed September 8, 1997. Bush, et al. v. Philip Morris Incorporated, et al., United States District Court, Eastern District, Texas, filed September 10, 1997. Nwanze, et al. v. Philip Morris Companies, Inc., et al., United States District Court, Southern District, New York, filed September 29, 1997. Badillo, et al. v. The American Tobacco Company, Inc., et al., United States District Court, Nevada, filed October 8, 1997. Newborn, et al. v. Brown & Williamson Tobacco Corporation, et al., United States District Court, Western District, Tennessee, filed October 9, 1997. Certain Developments in Smoking and Health Class Actions In addition to the recently filed smoking and health class actions listed above, since July 1, 1997, there have been certain developments in the smoking and health class actions. Broin -- This class action was settled in October 1997 by PM Inc. and other companies in the domestic tobacco industry, subject to final approval by the court. The class, as certified by the court, consisted of "all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from various diseases and disorders caused by their exposure to second-hand smoke in airline cabins." The defendants expressly did not admit liability for injury of any member of the settlement class or that ETS can cause any disease. Under the settlement, the settling defendants will pay $300 million to establish a foundation to sponsor scientific research with respect to diseases associated with cigarette smoking. These funds will be paid in three equal annual installments, with interest, commencing in April 1998. Settling defendants also agreed to pay attorneys' fees of up to $46 million and costs of $3 million, subject to court approval. PM Inc.'s share of all the foregoing payments (exclusive of interest) is approximately $175 million and was charged to expense in the third quarter of 1997. The settling defendants also agreed to support the enactment of federal legislation prohibiting smoking on segments of international flights originating or terminating in the United States. Under the settlement, all defendants (and certain other entities and persons) are released from liability for the claims asserted in the present action. Each individual member of the class, however, may later bring an individual action for diseases and conditions existing on or before January 15, 1997 ("retained claims") based upon certain legal theories against the settling defendants with the following limitations: 1. The individual claims can only seek compensatory damages; they may not seek punitive damages; 2. The defendants retain all defenses against the individual claims, except as noted below. In any individual lawsuits brought by members of the settlement class for retained claims seeking damages on account of specified diseases the settling -13- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) defendants have assumed the burden of proof as to whether ETS can cause certain conditions, but the plaintiff retains the burden of proving that his or her condition was caused by exposure to ETS. Such individual lawsuits may be brought in Dade County, Florida, or wherever the venue is proper. The settling defendants have also agreed not to raise a statute of limitations defense with respect to any retained claims brought by a member of the settlement class within one year after final court approval of the settlement. The settlement does not apply to, nor does it have any effect on, "future" claims brought by members of the settlement class for any new and unrelated diseases or conditions that arose or might arise after January 15, 1997. Broin, et al. v. Philip Morris Incorporated, et al., Circuit Court, Dade County, Florida, filed October 31, 1991. Engle -- The trial of this class action is scheduled to begin in February 1998. Recently, the court reversed an earlier order that had granted defendants partial summary judgment on the grounds that plaintiffs' claims were preempted by the Labeling Act. Engle, et al. v. R.J. Reynolds Tobacco Company, et al., Circuit Court, Dade County, Florida, filed May 5, 1994. Barnes (formerly Arch) -- In October 1997, the court decertified the class and granted defendants' motions for summary judgment against the individual named plaintiffs. Barnes, et al. v. The American Tobacco Company Inc., et al., United States District Court, Eastern District, Pennsylvania, filed August 8, 1996. Frosina -- In October 1997, the court certified the class. Defendants are appealing the class certification. The trial of this case, originally scheduled to begin in November 1997, may commence during the first quarter of 1998. Frosina, et al. v. Philip Morris, Inc., et al., Supreme Court of the State of New York, County of New York, filed June 19, 1996. Reed -- In August 1997, the court denied plaintiffs' motion for class certification and denied a motion by five individuals to intervene as class representatives. Reed, et al. v. Philip Morris Incorporated, et al., Superior Court of the District of Columbia, filed June 21, 1996. Langdeau -- In October 1997, this case was dismissed without prejudice by the Tribal Court on the grounds that plaintiffs failed to effect proper service of process and otherwise failed to follow Tribal Court rules. Langdeau, et al. v. The American Tobacco Company, et al., Tribal Court, Lower Brule Sioux Tribe, Lower Brule, South Dakota, filed June 4, 1997. Thomas -- In October 1997, plaintiffs voluntarily dismissed this purported class action without prejudice. Thomas, et al. v. American Tobacco Company, Inc., et al., Circuit Court for the County of Wayne, State of Michigan, filed June 6, 1997. HEALTH CARE COST RECOVERY LITIGATION In certain of the pending proceedings, foreign, state and local government entities, unions, federal and state taxpayers, Native American tribes and others seek reimbursement for Medicaid and/or other health care expenditures allegedly caused by tobacco products and, in some cases, for future expenditures and damages as well. In one of these cases private citizens seek recovery of alleged tobacco-related health care expenditures by the federal Medicaid and Medicare programs and, in another case, seek recovery of such expenditures by the Department of Defense and the Department of Veterans Administration. In one purported class action, Blue Cross/Blue Shield subscribers in the United States are seeking reimbursement of allegedly increased medical insurance premiums caused by tobacco products. In the Native American cases, claims are also asserted for alleged lost productivity of tribal government employees. Other relief sought by some but not all plaintiffs includes punitive damages, treble damages for alleged antitrust -14- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 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. The claims asserted in these health care cost recovery actions vary. In most of these cases 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 federal and state statutes governing consumer fraud, antitrust, deceptive trade practices and false advertising, and claims under federal and state RICO statutes. 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 the plaintiff benefits economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that these cases are improper because plaintiffs must proceed under principles of subrogation and assignment. Under traditional theories of recovery, a payor of medical costs (such as an insurer 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 declaratory judgment actions in Massachusetts, Texas, Maryland, Connecticut, Utah, New Jersey, Alaska and Hawaii seeking to block the health care cost recovery actions in those states and/or to prevent the state from hiring contingency fee counsel. The Maryland and New Jersey actions have been dismissed. The plaintiff tobacco companies have sought appeals to overturn these dismissals. The New Jersey appellate court has refused to hear the appeal. Recently Filed Health Care Cost Recovery Actions Since July 1, 1997 through November 1, 1997, the following health care cost recovery actions have been filed against PM Inc. and, in some cases, the Company and/or its other subsidiaries. Connecticut Pipe Trades Health Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Connecticut, filed July 1, 1997. Seafarers Welfare Plan and United Industrial Workers Welfare Plan v. Philip Morris, Inc., et al., United States District Court, Maryland, Southern Division, filed July 2, 1997. Laborers and Operating Engineers Utility Agreement Health and Welfare Trust Fund for Arizona v. Philip Morris Incorporated, et al., United States District Court, Arizona, filed July 7, 1997. Woods v. The American Tobacco Company, et al., Superior Court, Wake County, North Carolina, filed July 10, 1997. West Virginia Laborers Pension Fund v. Philip Morris, Inc., et al., United States District Court, Southern District, West Virginia, Huntington Division, filed July 11, 1997. -15- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Rhode Island Laborers Health and Welfare Fund, et al. v. Philip Morris Incorporated, et al., United States District Court, Providence, Rhode Island, filed on or about July 20, 1997. Eastern States Health and Welfare Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Southern District, New York, filed July 28, 1997. Asbestos Workers Local 53 Health and Welfare Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Eastern District, Louisiana, filed August 15, 1997. Steamfitters Local Union No. 420 Welfare Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Eastern District, Pennsylvania, filed August 20, 1997. State of Georgia v. Philip Morris, Inc., et al., Superior Court, Fulton County, Georgia, filed August 29, 1997. Construction Laborers of Greater St. Louis Welfare Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Eastern District, Missouri, filed September 2, 1997. Southeast Florida Laborers District Council Health and Welfare Trust Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Southern District, Florida, filed September 11, 1997. West Virginia--Ohio Valley Area International Brotherhood of Electrical Workers Welfare Fund v. The American Tobacco Company, et al., United States District Court, West Virginia, filed September 11, 1997. The Crow Creek Sioux Tribe v. The American Tobacco Company, et al., Tribal Court, Crow Creek Sioux Tribe, filed September 14, 1997. Teamsters Union No. 142, Health and Welfare Trust Fund, et al. v. Philip Morris Incorporated, et al., United States District Court, Northern District, Indiana, filed September 15, 1997. Operating Engineers Local 12 Health and Welfare Trust, et al. v. American Tobacco Co., Inc., et al., United States District Court, Central District, California, filed September 16, 1997. Puerto Rican ILGWU Health & Welfare Fund, et al. v. Philip Morris Inc., et al., Supreme Court, New York County, New York, filed September 17, 1997. New Jersey Carpenters Health Fund, et al. v. Philip Morris, Inc., et al., United States District Court, New Jersey, filed September 25, 1997. New Mexico and West Texas Multi-Craft Health and Welfare Trust Fund, et al. v. Philip Morris, Inc., et al., Second Judicial District Court, Bernalillo County, New Mexico, filed October 10, 1997. Goodpasture v. American Tobacco Company, Inc., et al., United States District Court, Kansas, filed October 15, 1997. Moore v. American Tobacco Company, et al., United States District Court, Kansas, filed October 15, 1997. The Republic of the Marshall Islands v. The American Tobacco Company, et al., High Court, Republic of the Marshall Islands, filed October 20, 1997. Central States Joint Board Health & Welfare Trust Fund v. Philip Morris, Inc., et al., Circuit Court, Cook County, Illinois, filed October 20, 1997. International Brotherhood of Teamsters, Local 734 Health & Welfare Trust Fund v. Philip Morris, Inc., et al., Circuit Court, Cook County, Illinois, filed October 20, 1997. Texas Carpenters Health Benefit Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Eastern District, Texas, Beaumont Division, filed October 31, 1997. In addition to these actions, other foreign, state and local government entities and others, including unions, have announced that they are considering filing health care cost recovery actions. -16- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Certain Developments in Health Care Cost Recovery Actions In addition to the recently filed health care cost recovery actions listed above, since July 1, 1997, there have been certain developments in the health care cost recovery actions. Florida -- In August 1997, PM Inc. and other companies in the domestic tobacco industry entered into a settlement agreement with the State of Florida to settle all present and future economic claims relating to the subject matter of Florida's health care cost recovery action. 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, filed February 21, 1996. Under the settlement agreement, the settling defendants have deposited into an escrow account $550 million, representing the State's estimate of its share of the $10 billion initial payment under the proposed Resolution discussed below under the caption "Proposed Resolution of Certain Regulatory and Litigation Issues." This amount was allocated among the settling defendants in accordance with their relative market capitalization, resulting in a charge to expense by PM Inc. of $374 million in the third quarter of 1997. On September 15, 1998 and annually thereafter on December 31, the settling defendants will make ongoing payments into a special account for the benefit of the State in the following amounts: 1998: $220 million; 1999: $247.5 million; 2000: $275 million; 2001: $357.5 million; 2002: $357.5 million; and each year thereafter: $440 million. These amounts equal that portion of the annual industry payments under the proposed Resolution which is contemplated to be paid to Florida. These payments would be adjusted for inflation and changes in volume as provided in the proposed Resolution. The settling defendants have reimbursed Florida's expenses and those of its attorneys. PM Inc.'s share of this payment resulted in a charge to expense in the third quarter of 1997 of approximately $11 million. The settling defendants have also agreed to pay reasonable attorneys' fees of Florida's private contingency fee counsel. The amount of such fees will be set by a panel of independent arbitrators. Each of these payments would be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. Certain of Florida's private contingency fee counsel filed charging liens against the funds paid by defendants into the Florida escrow account. In filing the charging liens, contingency counsel argued that the settlement agreement had no effect on their rights under their contingency fee agreement with Florida. On November 12, 1997, the court ordered all parties to comply with the provisions for obtaining attorneys' fees, as set forth in the settlement agreement, and quashed the charging liens. Contingency fee counsel are appealing this ruling. Under the settlement agreement, the settling defendants will also support a two-year pilot program by Florida aimed at reducing the use of tobacco products by persons under the age of eighteen, and have paid into escrow $200 million for the pilot program. PM Inc.'s share of this payment resulted in a charge to expense in the third quarter of 1997 of approximately $99 million. The settling defendants also agreed to discontinue all tobacco product billboards, signs in arenas and stadia and transit advertisements in Florida within several months and to support new legislative and administrative initiatives to prohibit the sale of cigarettes in vending machines, except in adult-only facilities, and to strengthen civil penalties for sales of tobacco products to minors and for possession of tobacco products by minors. -17- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) If legislation implementing the proposed Resolution or its substantial equivalent is enacted, the settlement will remain in place, but the terms of the federal legislation will supersede the settlement agreement (except for the terms of the pilot program and payments thereunder) and the ongoing payments described above will be adjusted so that Florida would receive the same payments as it would receive under the proposed Resolution, provided that in all events Florida will be entitled to the amount of the initial payment described above without any adjustment. The agreement also provides that if federal legislation implementing the proposed Resolution or its substantial equivalent is enacted, the parties contemplate that Florida and any other similar state which has made an exceptional contribution to secure resolution of these matters may apply to a panel of independent arbitrators for reasonable compensation for its efforts in securing the proposed Resolution. The settling defendants have agreed not to oppose an application of $250 million by Florida, payable over five years. The parties have agreed to a nationwide annual cap for all such payments of $100 million. The agreement also provides that if the settling defendants enter into any future pre-verdict settlement agreement with a non-federal governmental plaintiff on more favorable terms (after due consideration of relevant differences in population or other appropriate factors), Florida will obtain treatment at least as relatively favorable as such governmental plaintiff. The agreement provides that it is not an admission or concession or evidence of any liability or wrongdoing on the part of any party, and is entered into by the settling defendants solely to avoid the further expense, inconvenience, burden and uncertainty of litigation. Finally, the agreement provides that the court retains jurisdiction over plaintiffs' claim for non-economic injunctive relief. The court has scheduled a trial date for September 8, 1998 on this claim in the event that the proposed Resolution, or its substantial equivalent, is not enacted. Mississippi -- In July 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding (the "MOU") with the State of Mississippi setting forth the principal terms and conditions of an agreement in principle to settle all present and future claims relating to the subject matter of Mississippi's health care cost recovery action. Moore v. The American Tobacco Company, et al., Chancery Court of Jackson County, Mississippi, filed May 23, 1994. A final settlement agreement, based on the MOU, was signed on October 17, 1997. Under the settlement agreement, the settling defendants have deposited into an escrow account $170 million, representing Mississippi's estimate of its share of the $10 billion initial payment under the proposed Resolution and have paid an additional $15 million (subject to later adjustment) to reimburse Mississippi and its attorneys for legal expenses. The settling defendants have also deposited into an escrow account approximately $62 million to support a pilot program aimed at reducing the use of tobacco products by persons under the age of eighteen. PM Inc.'s share of all of the foregoing payments was approximately $153 million. This amount was charged to expense in the third quarter of 1997. The settlement also provides that beginning December 31, 1998, the settling defendants will pay into escrow 1.7% of that portion of the annual industry payments under the proposed Resolution which is contemplated to be paid to the states. These payments, which are not offset by potential credits for civil tort liability and which would be adjusted as provided in the proposed Resolution, -18- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) could result in payments to the State of Mississippi of $68 million with respect to 1998 and $76.5 million with respect to 1999. These amounts would increase annually to $136 million with respect to 2003 and would continue at that level thereafter. The settling defendants will also be responsible for the attorneys' fees of counsel for Mississippi (which will be set by a panel of arbitrators). Each of these payments would be allocated among the settling defendants in accordance with their relative volume of domestic cigarette sales. If legislation implementing the proposed Resolution or its substantial equivalent is enacted, the settlement will remain in place, but the terms of the federal legislation will supersede the settlement agreement (except for the terms of the pilot program and payments thereunder) and the foregoing payment amounts will be adjusted so that Mississippi would receive the same payment as it would receive under the proposed Resolution, provided that in all events Mississippi will be entitled to the $170 million initial payment described above without any adjustment. The settlement agreement also provides that if the settling defendants enter into any future pre-verdict settlement agreement with a non-federal governmental plaintiff on more favorable terms (after due consideration of relevant differences in population or other appropriate factors), Mississippi will obtain treatment at least as relatively favorable as such governmental plaintiff. In addition, in the event of any future settlement or final judgment with respect to the claims for non-economic injunctive relief pending in Florida's health care cost recovery action, the terms of the Mississippi settlement agreement will be revised so that Mississippi will receive comparable benefits (after due consideration of relevant differences in population or other appropriate factors). The settlement agreement also provides that if federal legislation implementing the proposed Resolution or its substantial equivalent is enacted, the parties contemplate that Mississippi and any other similar state which has made an exceptional contribution to secure resolution of these matters may apply to a panel of independent arbitrators for reasonable compensation for its efforts in securing the proposed Resolution. The settling defendants have agreed not to oppose an application of $75 million by Mississippi, payable over five years. The parties have agreed to a nationwide annual cap for all such payments of $100 million. The settlement agreement also provides that the settling defendants will discontinue all tobacco billboards, signs in arenas and stadia, and transit advertisements in Mississippi within several months and will support legislative and administrative initiatives to prohibit the sale of cigarettes in vending machines, except in adult-only facilities, and to strengthen civil penalties for sales of tobacco products to minors and for possession of tobacco products by minors. Finally, the settlement agreement provides that it is not an admission or concession or evidence of any liability or wrongdoing on the part of any party, and is entered into by the settling defendants solely to avoid the further expense, inconvenience, burden and uncertainty of litigation. Texas -- In September 1997, the court denied defendants' motions for summary judgment and denied defendants' motions to dismiss as to the RICO, simple and gross negligence, strict liability, breach of express and implied warranties, common law fraud (actual and constructive), simple and gross negligent misrepresentation, conspiracy and concert of action, aiding and abetting and vicarious responsibility/respondeat superior causes of action. The court granted defendants' motions to dismiss as to the antitrust, restitution/unjust enrichment, common law public nuisance, negligent performance of a voluntary undertaking, and Texas Deceptive Trade Practices and Consumer Protection Act claims. The court also entered an order dividing the trial into three separate phases. The court directed that Phase I of the trial will consider whether defendants have engaged in conduct prohibited by the RICO statute and any defenses that may be applicable to the initial liability phase of civil RICO. Phase II of the trial will consider issues that relate to any duties imposed upon the parties, any breach of those duties, whether any misrepresentations have been made, whether elements of conspiracy have been satisfied and any defenses that may be applicable to the initial liability elements of these various claims. Phase III, which will occur only if plaintiff prevails in Phase I or Phase II, will consider issues that relate to causation, the materiality of misrepresentations, reliance and the amount of damages. In October 1997, the United States Court of -19- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Appeals for the Fifth Circuit denied defendants' petition for review of various of the trial court's rulings, including the decision to permit the State to establish causation through the use of statistical proof without making a showing of individual injury and the decision to trifurcate the trial. Trial in this matter, originally scheduled to begin in September of this year, has been delayed. No new trial date has been set. The State of Texas v. The American Tobacco Company, et al., United States District Court, Eastern District of Texas, filed March 28, 1996. Massachusetts -- In October 1997, the court denied in part defendants' motions to dismiss the complaint, but reserved ruling on plaintiff's claims of special duty and a portion of plaintiff's deceptive trade practices claim. Commonwealth of Massachusetts v. Philip Morris Inc., et al., Superior Court, Middlesex County, filed December 19, 1995. Washington -- In August 1997, the court reinstated plaintiff's previously dismissed consumer protection statute claims for damages solely to the extent such claims are confined to relief sought for individual consumers, but not for the State itself. Trial of this case is scheduled for September 1998. State of Washington v. American Tobacco Co., Inc., et al., Superior Court of Washington, King County, filed June 5, 1996. Alabama -- This health care cost recovery action was brought as a purported class action on behalf of Alabama taxpayers. In September 1997, the court dismissed plaintiffs' claims that were asserted on behalf of the State of Alabama, but denied defense motions to dismiss claims insofar as they related to plaintiffs' individual claims or those asserted on behalf of children. Crozier, et al. v. The American Tobacco Company, et al., Circuit Court, Montgomery County, Alabama, filed August 18, 1996. Los Angeles County -- The court consolidated for trial the claims under California's consumer protection statutes with similar claims in the Ellis and Cordova cases referenced above under the heading "Overview of Tobacco-Related Litigation--Types and Number of Cases." Trial is scheduled to begin in February 1999. County of Los Angeles v. R.J. Reynolds Tobacco Company, et al., Superior Court of California, San Diego, filed August 5, 1996. Arizona -- After having been instructed by the former governor of Arizona to dismiss the case, the attorney general had filed an amended complaint that abandoned claims for Medicaid payments, but sought recovery of other health care costs as well as other damages and forms of relief. In October 1997, the new governor authorized the attorney general to amend the complaint to include a claim for Medicaid reimbursement. State of Arizona, et al. v. American Tobacco Co., Inc., et al., Superior Court, Maricopa County, Arizona, filed August 20, 1996. Illinois -- In November, 1997, the court denied defendants' motions to dismiss the antitrust, negligence and conspiracy claims and granted defendants' motions to dismiss the special duty, restitution, nuisance and unjust enrichment claims. People of the State of Illinois v. Philip Morris, Inc., et al., Circuit Court of Cook County, Illinois, filed November 12, 1996. Iowa -- In August 1997, the court dismissed plaintiff's claims for deception, breach of assumed duty, disgorgement of profits, and indemnity. The court also denied defendants' motion to dismiss plaintiff's claims for violation of the Iowa Consumer Fraud Act, civil conspiracy, aiding and abetting, nuisance, and injunctive relief. State of Iowa v. R.J. Reynolds Tobacco Co., et al., District Court for Polk County, Iowa, filed November 26, 1996. California -- In October 1997, the court struck several of defendants' affirmative defenses including comparative fault, assumption of risk, failure to mitigate, improper class action, federal preemption (in part), lack of standing, separation of powers doctrine, lack of authority to retain contingency counsel, improper accumulation of actions and "antitrust-related defenses." People of the -20- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) State of California, et al. v. Philip Morris, Inc., et al., San Francisco Superior Court, County of San Francisco, filed September 5, 1996. University of South Alabama -- In August 1997, the court granted the attorney general's motion to dismiss the action on the ground that the university, as an instrumentality of the State, did not have authority to bring this action on its own behalf. University of South Alabama v. The American Tobacco Company, et al., United States District Court, Southern District of Alabama, filed May 19, 1997. The Lower Brule Sioux Tribe -- In October 1997, this case was dismissed without prejudice by the Tribal Court on the grounds that plaintiffs failed to effect proper service of process and otherwise failed to follow Tribal Court rules. The Lower Brule Sioux Tribe, et al. v. The American Tobacco Company, et al., Tribal Court, Lower Brule Sioux Tribe, Lower Brule, South Dakota, filed May 28, 1997. Iowa Laborers District Council Health and Welfare Fund -- This case was voluntarily dismissed without prejudice by plaintiffs in September 1997. The Iowa Laborers District Council Health and Welfare Fund, et al. v. Philip Morris, Inc., et al., United States District Court, Southern District of Iowa, filed June 20, 1997. The Chehalis Tribe -- In October 1997, plaintiffs voluntarily dismissed this case without prejudice. The Chehalis Tribe, et al. v. The American Tobacco Company, et al., Chehalis Tribal Court, Oakville, Washington, filed June 23, 1997. Marshall Islands -- This case, originally filed in June 1997, was voluntarily dismissed by plaintiffs without prejudice in July 1997. The Citizens of the Republic of the Marshall Islands v. The American Tobacco Company, et al., United States District Court, Hawaii, filed June 18, 1997. A new health care cost recovery action was recently filed by the Republic of the Marshall Islands. The Republic of the Marshall Islands v. The American Tobacco Company, et al., High Court, Republic of the Marshall Islands, filed October 20, 1997. CERTAIN OTHER TOBACCO-RELATED LITIGATION In September 1997, Raymark Industries, Inc., an asbestos company, filed suits in Georgia and Florida against domestic tobacco manufacturers, including PM Inc. and others, for contribution for damages Raymark incurred in asbestos litigation. Raymark Industries, Inc. v. Brown & Williamson Tobacco Corporation, et al., United States District Court, Northern District, Georgia, filed September 15, 1997; Raymark Industries, Inc. v. R.J. Reynolds Tobacco Company, et al., United States District Court, Northern District, Florida, filed September 15, 1997. Causes of action alleged in the complaint include negligence, strict liability, fraud and misrepresentation, and conspiracy. Plaintiff seeks contribution and/or indemnity for the defense and payment of asbestos claims in an amount specified to be in excess of $400 million. In November 1997, Fibreboard Corporation and Owens Corning, former asbestos manufacturers, filed suit against domestic tobacco manufacturers, including PM Inc., and others, to recover, among other things, past sums paid by these companies to individuals with smoking-related diseases. Fibreboard Corporation and Owens Corning v. The American Tobacco Company, et al., Superior Court, Alameda County, California, filed November 6, 1997. Plaintiffs also seek punitive damages. Causes of action alleged in the complaint include unfair competition, unjust enrichment and restitution, indemnity, spoliation (i.e., alleged concealment of evidence) and declaratory relief. CERTAIN OTHER ACTIONS 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, filed April 4, 1994 and State Board of Administration of Florida, et al. v. Philip Morris Companies Inc., et al., United -21- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) States District Court for the Southern District of New York, filed September 7, 1994. 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 April 1997, the district court granted a motion filed by the Kurzweil plaintiffs to vacate the judgment and for leave to amend their complaint. Defendants' appeal of this ruling was dismissed by the Court of Appeals on August 5, 1997, for lack of appellate jurisdiction. Since April 1996, five purported class action suits have been filed in Wisconsin alleging that Kraft Foods, Inc. ("Kraft") and others engaged in a conspiracy to fix and depress the prices of bulk cheese and milk through their trading activity on the National Cheese Exchange. Plaintiffs seek injunctive and equitable relief and treble damages. Stuart, et al. v. Kraft Foods, Inc., et al., United States District Court, Eastern District of Wisconsin, filed April 4, 1996; Sheeks, et al. v. Kraft Foods, Inc., et al., United States District Court, Eastern District of Wisconsin, filed September 24, 1996; Servais, et al. v. Kraft Foods, Inc. and the National Cheese Exchange, Inc., Circuit Court of Dane County, Wisconsin, filed May 5, 1997; Dodson, et al. v. Kraft Foods, Inc., et al., United States District Court, Western District of Wisconsin, filed July 1, 1997; Noll, et al. v. Kraft Foods, Inc., et al., United States District Court, Western District of Wisconsin, filed July 11, 1997. The court has granted the Sheeks and Stuart plaintiffs' respective motions for voluntary dismissal without prejudice. Plaintiffs in the three remaining cases have filed a single consolidated class action complaint in Wisconsin seeking certification of a class consisting of all milk producers in the U.S. In October 1997, a purported class action suit was filed against Kraft only. Vincent, et al. v. Kraft Foods, Inc., Circuit Court of Cook County, Illinois, filed October 27, 1997. This suit contains allegations similar to those in the consolidated Wisconsin class action discussed above, but only seeks a class comprised of Kraft's milk suppliers. In September 1997, a purported class action was commenced by private plaintiffs in Alabama state court alleging that the U.S. tobacco companies and others conspired to fix cigarette prices in Alabama, that agreements leading to the price increases were reached during the negotiations leading to the proposed Resolution discussed below, and that prices were increased pursuant to the alleged conspiracy in 1997. The purported class consists of Alabama residents who purchased cigarettes in 1997. Plaintiffs seek actual damages of no more than $500 per class member and statutory damages of $500 for each instance of injury or damages, and costs and interest. In September 1997, the state court conditionally certified the class. Defendants subsequently removed the case to federal court, and the federal court then vacated the state court's conditional class certification. Mosley, et al. v. Philip Morris Companies Inc., et al., United States District Court, Southern District of Alabama, filed September 24, 1997. Tax assessments alleging the nonpayment of taxes in Italy (value added taxes for the years 1988 to 1995 and income taxes for the years 1987 to 1995) have been served upon certain affiliates of the Company. The aggregate amount of unpaid taxes assessed to date is alleged to be the Italian lire equivalent of $2.7 billion. In addition, the Italian lire equivalent of $6.3 billion in interest and penalties have been assessed. The Company anticipates that value added and income tax assessments may also be received in respect of 1996. In September -22- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 1997, in the first of several appeals filed by an affiliate of the Company, the Italian administrative tax court in Milan overturned one of the assessments for value added taxes. A hearing on a second appeal was held in October 1997, and hearings on additional appeals are currently scheduled for December 1997 and January 1998. In a separate proceeding in Naples, a court has dismissed charges of criminal association against certain present and former officers and directors of affiliates of the Company, but permitted charges of tax evasion to proceed to trial. The Company, its affiliates and the officers and directors who are subject to the proceedings believe they have complied with applicable Italian tax laws and are vigorously contesting the pending tax assessments and the pending proceedings in Naples. It is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries. 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 could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention, including the announcement in March 1997 that another cigarette manufacturer had settled certain health care cost recovery actions and a purported nationwide smoking and health class action, and a decision by a federal district court on a motion for summary judgment not to preclude the United States Food and Drug Administration (the "FDA") from asserting jurisdiction over cigarettes as "drugs" or "medical devices," which decision is now under appeal. These developments, as well as the widespread media attention given to the proposed Resolution discussed below and the settlements of the Florida and Mississippi health care cost recovery actions and the Broin class action, may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. 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 unfavorable outcome of certain pending litigation or by the proposed Resolution discussed below or by settlement, if any, of certain pending cases. However, implementation of the proposed Resolution would resolve the most significant tobacco litigation against the Company and its subsidiaries. Furthermore, 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. Except as described below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues--Effects on Litigation," all such cases are, and will continue to be, vigorously defended. PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES On June 20, 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding to support the adoption of federal legislation and any necessary ancillary undertakings, incorporating the features described in the proposed Resolution attached to the Memorandum of Understanding (together, the "Resolution"). The proposed Resolution, which is subject to approval of the boards of directors of the participating companies, can be implemented only by federal legislation. The Company's Board of Directors approved the proposed Resolution in June 1997. If enacted into law, the legislation would resolve many of the regulatory and litigation issues affecting the United States tobacco industry and, thereby, reduce uncertainties facing the industry and increase stability in business and capital markets. -23- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) There can be no assurance that federal legislation in the form of the proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to the Company or that any modification would be acceptable to the Company or that, if enacted, the legislation would not face legal challenges. Moreover, the negotiation and signing of the proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry and regulation of the international tobacco industry. The proposed Resolution includes provisions relating to advertising and marketing restrictions, product warnings and labeling, access restrictions, licensing of tobacco retailers, the adoption and enforcement of "no sales to minors" laws by states, surcharges against the industry for failure to achieve underage smoking reduction goals (discussed below), regulation of tobacco products by the FDA, public disclosure of industry documents and research, smoking cessation programs, compliance programs by the industry, public smoking and smoking in the workplace, enforcement of the proposed Resolution, industry payments (discussed below) and litigation (discussed below). Surcharge for Failure to Achieve Underage Smoking Reduction Goals The proposed Resolution would impose surcharges on the industry if required reductions in underage smoking are not achieved. A "look back" provision would require the following reductions in the incidence of underage smoking from estimated levels over the past decade: 30% in the fifth and sixth years after enactment of implementing federal legislation, 50% in the seventh, eighth and ninth years, and 60% in the tenth year, with incidence remaining at such reduced levels thereafter. For any year in which these required reductions are not met, the FDA must impose a mandatory surcharge on the participating members of the cigarette industry based upon an approximation of the present value of the profit the companies would earn over the lives of the number of underage consumers in excess of the required reduction. The annual surcharge would be $80 million (as adjusted for changes in population and cigarette profitability) for each percentage point by which the reduction in underage smoking falls short of the required reductions (as adjusted to prevent double counting of persons whose smoking has already resulted in the imposition of a surcharge in previous years). The annual surcharge would be subject to a $2 billion annual cap (as adjusted for inflation). The surcharge would be the joint and several obligation of participating manufacturers allocated among participating manufacturers based on their market share of the United States cigarette industry and would be payable on or before July 1 of the year in which it is assessed. Manufacturers could receive a partial refund of this surcharge (up to 75%) only after paying the assessed amount and only if they could thereafter prove to the FDA that they had fully complied with the proposed Resolution, had taken all reasonably available measures to reduce youth tobacco usage and had not acted to undermine the achievement of the reduction goals. Industry Payments The proposed Resolution would require participating manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10 billion initial Industry Payment on the date federal legislation implementing the terms of the proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations and the Company currently estimates that its share of the initial Industry Payment would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi and Florida pursuant to settlements of health care cost recovery actions). Thereafter, the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic -24- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels): year 1: $8.5 billion; year 2: $9.5 billion; year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15 billion. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate determined with reference to the Consumer Price Index. The Industry Payments would increase or decrease in proportion to changes from 1996 domestic sales volume levels. Volume declines would be measured based on adult sales volume figures; volume increases would be measured by total sales volume. If sales volume declines but the industry's domestic net operating profit exceeds base year inflation-adjusted levels, the reduction in the annual Industry Payment due to volume decline, if any, would be offset to the extent of 25% of the increased profit. At current levels of sales and prior to any adjustment for inflation, the proposed Resolution would require total Industry Payments of $368.5 billion over the first 25 years (subject to credits described below in connection with potential civil tort liability). The Industry Payments would be separate from any surcharges required under the "look back" provision discussed above under the heading "Surcharge for Failure to Achieve Underage Smoking Reduction Goals." The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities selling tobacco products in the United States (and not their affiliated companies). The proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use. Effects on Litigation If enacted, the federal legislation provided for in the proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity other than the federal government), parens patriae and smoking and health class actions and all "addiction"/dependence claims and would bar similar actions from being maintained in the future. However, the proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. In recent months PM Inc. and other companies in the domestic tobacco industry agreed to settle two health care cost recovery actions in Mississippi and Florida and a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft. The Company may enter into discussions to postpone or settle other actions pending the enactment of the legislation contemplated by the proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved, or, if achieved, as to the terms thereof. The proposed Resolution would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective. Under the proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis and could be maintained only against tobacco manufacturing companies (and not their retailers, -25- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) distributors or affiliated companies). In addition, all punitive damage claims based on past conduct would be resolved as part of the proposed Resolution and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party. The proposed Resolution contemplates that participating tobacco manufacturers would enter into a joint sharing agreement for civil liabilities relating to past conduct. Judgments and settlements arising from tort actions would be paid as follows. The proposed Resolution would set an annual aggregate cap of up to 33% of the annual base Industry Payment (including any reductions for volume declines). Any judgments or settlements exceeding the cap in a year would roll over into the next year. While judgments and settlements would run against the defendant, they would give rise to an 80-cents-on-the-dollar credit against the annual Industry Payment. Finally, any individual judgments in excess of $1 million would be paid at the rate of $1 million per year unless every other judgment and settlement could first be satisfied within the annual aggregate cap. In all circumstances, however, the companies would remain fully responsible for costs of defense and certain costs associated with the fees of attorneys representing certain plaintiffs in the litigation that would be settled by the proposed Resolution. Financial Effects The Company anticipates that its share of the industry's $10 billion initial payment, which it currently estimates would be approximately $6.6 billion (adjusted downward for initial payments made to Mississippi and Florida pursuant to settlements of health care cost recovery actions) would be charged to expense in the period in which federal legislation implementing the terms of the proposed Resolution is enacted. In addition, the Company currently anticipates that implementation of the proposed Resolution would require a significant charge to expense in the period of enactment to comply with the proposed Resolution's regulations on advertising, marketing and production. The initial payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The initial payment would have a material adverse effect on the Company's operating income and cash flows in the quarter and year in which the proposed Resolution is enacted and on its financial position. The initial payment would result in higher debt and higher interest expense, the amounts of which would depend upon the final form of the proposed Resolution, borrowing requirements and interest rates. The Company anticipates that PM Inc.'s share of future annual Industry Payments related to cigarette sales would be charged to expense as the related sales occur and would be funded through price increases. The Company anticipates that annual surcharges, if any, imposed by the FDA for failure to meet required reduction levels in underage smoking beginning in the fifth year after the proposed Resolution is implemented would be charged to expense in the year of assessment or in the year prior thereto if it is then probable that such assessment will be made. The Company believes that implementation of the proposed Resolution would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. The degree of the adverse impact would depend, among other things, on the rates of decline in United States -26- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) cigarette sales in the premium and discount segments, PM Inc.'s share of the domestic premium and discount cigarette segments, interest rates and the timing of principal payments on debt incurred to finance the initial payment due under the proposed Resolution, and the effect of the proposed Resolution on cigarette consumption and the regulatory and litigation environment outside the United States. Note 4. New Accounting Standards: In 1996, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities," which, as required, was adopted by the Company as of January 1, 1997. The adoption and application of SOP No. 96-1 had no material effect on the Company's 1997 results of operations or financial position for the three or nine month periods ended September 30, 1997. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which is effective for the year ending December 31, 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share ("EPS") and requires the presentation of both basic and diluted EPS. Based upon the Company's current capitalization structure, the basic and diluted EPS amounts calculated in accordance with SFAS No. 128 are expected to approximate the Company's EPS amounts computed in accordance with Accounting Principles Board Opinion No. 15, "Earnings Per Share." -27- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. - ------------------------------------------------------------------------ Consolidated Operating Results For the Nine Months Ended September 30, Operating Revenues --------------------------------------- (in millions) 1997 1996 ---- ---- Tobacco $ 30,506 $ 27,837 Food 20,619 20,888 Beer 3,318 3,418 Financial services and real estate 279 271 -------- -------- Operating revenues $ 54,722 $ 52,414 ======== ======== Operating Income --------------------------------------- (in millions) 1997 1996 ---- ---- Tobacco $ 6,339 $ 6,356 Food 3,065 2,909 Beer 410 392 Financial services and real estate 256 139 -------- -------- Operating companies income 10,070 9,796 Amortization of goodwill (438) (443) General corporate expenses (334) (313) Minority interest in earnings of consolidated subsidiaries (56) (26) -------- -------- Operating income $ 9,242 $ 9,014 ======== ======== For the Three Months Ended September 30, Operating Revenues --------------------------------------- (in millions) 1997 1996 ---- ---- Tobacco $ 10,433 $ 9,497 Food 6,455 6,710 Beer 1,125 1,118 Financial services and real estate 79 89 -------- -------- Operating revenues $ 18,092 $ 17,414 ======== ======== Operating Income --------------------------------------- (in millions) 1997 1996 ---- ---- Tobacco $ 1,667 $ 2,226 Food 947 941 Beer 125 117 Financial services and real estate 150 49 -------- -------- Operating companies income 2,889 3,333 Amortization of goodwill (142) (150) General corporate expenses (112) (103) Minority interest in earnings of consolidated subsidiaries (23) (9) -------- -------- Operating income $ 2,612 $ 3,071 ======== ======== -28- Operating revenues and operating income for the first nine months of 1997 increased $2.3 billion (4.4%) and $228 million (2.5%), respectively, over the comparable 1996 period. Operating revenues were higher due primarily to increases in domestic and international tobacco and North American food operations. Operating income was reduced as a result of pretax charges of $812 million taken by PM Inc., the Company's domestic tobacco subsidiary, for up-front payments related to settling health care cost recovery litigation in Mississippi and Florida and a one-time charge for settling the Broin case, a Florida class action brought on behalf of non-smoking flight attendants. Excluding the settlement charges, operating income increased 11.5%, reflecting favorable results of operations in domestic tobacco, international tobacco, North American food, beer and financial services operations. Operating revenues for the third quarter of 1997 increased $678 million (3.9%) over the comparable 1996 period, while operating income for the third quarter of 1997 decreased $459 million (14.9%) from the third quarter of 1996, reflecting settlement charges of $812 million discussed previously. Operating revenues were higher due primarily to increases in domestic and international tobacco. Excluding the settlement charges, operating income increased 11.5%, reflecting favorable results of operations in domestic tobacco, international tobacco, North American food, beer and financial services operations. Currency movements, primarily the strengthening of the U.S. dollar versus key European and Asian currencies, decreased operating income by $334 million and $154 million in the first nine months and third quarter of 1997, respectively, versus the comparable 1996 periods. Although the Company cannot predict future movements in currency rates, it anticipates that the strength of the U.S. dollar will continue to have an unfavorable impact on operating income for the remainder of 1997 and will negatively impact 1998 at current exchange rates. Net earnings per share of $2.07 in the first nine months of 1997 increased by 5.6% over the comparable 1996 period, due to higher net earnings and fewer shares outstanding. Net earnings per share of $0.58 in the third quarter of 1997 decreased 13.4% from the comparable 1996 period due to lower net earnings, partially offset by fewer shares outstanding. Net earnings in both periods in 1997 were lowered by the after-tax effect of PM Inc.'s settlement charges ($496 million). Excluding the impact of these charges, net earnings and earnings per share increased over the comparable 1996 period by 14.1% and 15.8%, respectively, for the first nine months and 15.6% and 16.4%, respectively, for the third quarter. As a result of share repurchases, the weighted average number of shares outstanding decreased 1.9% to 2,425 million shares in the first nine months of 1997 and decreased 1.3% to 2,423 million shares in the third quarter of 1997 from the comparable 1996 periods. The Company does not believe that the anticipated costs of Year 2000 systems conversions will have a material impact on the Company's future consolidated results of operations. However, in any given reporting period, such costs may be a factor in describing changes in operating income for the Company's business segments. Operating Results by Business Segment Tobacco Business Environment As discussed below, the tobacco industry, including PM Inc., the Company's domestic tobacco subsidiary, and Philip Morris International Inc. ("PMI"), the Company's international tobacco subsidiary, have faced, and continue to face, a number of issues which may adversely affect volume, operating revenues, cash flows, operating income and financial position. -29- In the United States, these issues include proposed federal regulatory controls (including, as discussed below, the issuance of final regulations by the United States Food and Drug Administration (the "FDA") which regulate cigarettes as "drugs" or "medical devices"); actual and proposed excise tax increases; new and proposed federal, state and local governmental and private restrictions on smoking (including proposals to ban or restrict smoking in workplaces and in buildings permitting public access); new and proposed restrictions on tobacco manufacturing, marketing, advertising (including decisions by certain companies to limit or not accept tobacco advertising) and sales; new and proposed legislation and regulations to require substantial additional health warnings on cigarette packages and in advertising, and to eliminate the tax deductibility of tobacco advertising and promotional costs; actual and proposed requirements regarding disclosure of cigarette ingredients and other proprietary information; increased assertions of adverse health effects associated with both smoking and exposure to environmental tobacco smoke ("ETS"); legislation or other governmental action seeking to ascribe to the industry responsibility and liability for the purported adverse health effects associated with both smoking and exposure to ETS; the diminishing social acceptance of smoking; increased pressure from anti-smoking groups; unfavorable press reports; governmental and grand jury investigations; increased smoking and health litigation, including private plaintiff class action litigation and health care cost recovery actions brought by state and local governments, unions and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking; and the proposed legislative resolution of certain regulatory and litigation issues affecting the United States tobacco industry discussed below. Cigarettes are subject to substantial excise taxes in the United States and to similar taxes in most foreign markets. The United States federal excise tax on cigarettes is currently $12 per 1,000 cigarettes ($0.24 per pack of 20 cigarettes). In August 1997, legislation was enacted that will raise the federal excise tax to $17 per 1,000 cigarettes ($0.34 per pack of 20 cigarettes) starting in the year 2000 and then to $19.50 per 1,000 cigarettes ($0.39 per pack of 20 cigarettes) in 2002. In general, excise taxes, sales taxes and other cigarette-related taxes levied by various states, counties and municipalities have been increasing, and additional increases have been proposed in a number of states. These taxes vary considerably and, when combined with the current federal excise tax, may be as high as $1.50 per pack. In the opinion of PM Inc. and PMI, past increases in excise and similar taxes have had an adverse impact on sales of cigarettes. Any future increases, the extent of which cannot be predicted, could result in volume declines for the cigarette industry, including PM Inc. and PMI, and might cause sales to shift from the premium segment to the discount segment. In August 1996, the FDA issued final regulations pursuant to which it asserts jurisdiction over cigarettes as "drugs" or "medical devices" under the provisions of the Food, Drug and Cosmetic Act. The final regulations include severe restrictions on the distribution, marketing and advertising of cigarettes, and would require the industry to comply with a wide range of labeling, reporting, recordkeeping, manufacturing, and other requirements applicable to medical devices and their manufacturers. For the most part, the regulations were scheduled to become effective on August 28, 1997. The FDA's exercise of jurisdiction, if not reversed by judicial or legislative action, could lead to more expansive FDA-imposed restrictions on cigarette operations than those set forth in the final regulations, and could materially adversely affect the volume, operating revenues and operating income of PM Inc. PM Inc. and other domestic cigarette manufacturers and an advertising firm sued the FDA, seeking a judicial declaration that the FDA has no authority to regulate cigarettes and asking the court to permanently enjoin the FDA from enforcing its regulations. Similar suits have been filed against the FDA by manufacturers of smokeless tobacco products, by a trade association of cigarette retailers and by advertising agency associations. In April 1997, a U.S. district court ruled that Congress has not precluded the FDA from regulating cigarettes as "drugs" or "medical devices" and that the FDA may so regulate cigarettes if the facts asserted in support of the -30- FDA's assertion of jurisdiction are proven to be correct. The court also ruled, however, that the section of the Food, Drug and Cosmetic Act relied upon by the agency does not give the FDA authority to implement its regulations restricting cigarette advertising and promotions. The court stayed implementation of the FDA's regulations scheduled for August 28, 1997. The court left in effect the specific regulations that took effect in February 1997 establishing a federal minimum age of 18 for the sale of tobacco products and requiring proof of age for anyone under age 27. The tobacco company plaintiffs, including PM Inc., are appealing that portion of the district court's order relating to the FDA's assertion of jurisdiction. The FDA is appealing that portion of the order enjoining the advertising and promotion restrictions. The respective appeals were heard by the U.S. Court of Appeals for the Fourth Circuit in August 1997. The outcome of the litigation challenging the FDA regulations cannot be predicted. In August 1996, the Commonwealth of Massachusetts enacted legislation that would require cigarette manufacturers to disclose to the Massachusetts Department of Public Health ("DPH") the flavorings and other ingredients used in each brand of cigarettes sold in the Commonwealth, and to provide "nicotine-yield ratings" for their products based on standards to be established by the DPH. PM Inc. believes that enforcement of the statute, which is scheduled to take effect on December 15, 1997, could permit the disclosure by DPH to the public of valuable proprietary information concerning its brands. PM Inc. and three other domestic cigarette manufacturers have filed suit in federal district court in Boston challenging the legislation as being preempted by the Federal Cigarette Labeling and Advertising Act, as amended (the "Labeling Act") and as violating the commerce, full faith and credit, due process and takings clauses of the U.S. Constitution. In February 1997, the court ruled on summary judgment motions that the Labeling Act does not preempt the requirement that ingredient information be provided to the Commonwealth and that decision was subsequently affirmed by the First Circuit Court of Appeals. The plaintiffs will continue to assert their other constitutional claims. The ultimate outcome of this lawsuit cannot be predicted. The enactment of this legislation has encouraged efforts to enact, and the enactment of, ingredients disclosure legislation in other states, such as Texas and Minnesota. In June 1995, PM Inc. announced that it had voluntarily undertaken a program to limit minors' access to cigarettes. Elements of the program include discontinuing free cigarette sampling to consumers in the United States, discontinuing the distribution of cigarettes by mail to consumers in the United States, placing a notice on cigarette cartons and packs for sale in the United States stating "Underage Sale Prohibited," working with others in support of state legislation to prevent youth access to tobacco products, taking measures to encourage retailer compliance with minimum-age laws, and independent auditing of the program. Some foreign countries have also taken steps to restrict or prohibit cigarette advertising and promotion, to require ingredient disclosure (such as Thailand), to impose maximum constituent levels, to increase taxes on cigarettes, to control prices, to restrict imports, to ban or severely restrict smoking in workplaces and public places, and otherwise to discourage cigarette smoking. It is not possible to predict what, if any, other foreign governmental legislation or regulations will be adopted relating to the manufacturing, advertising, sale or use of cigarettes or to the tobacco industry generally. PM Inc. has received requests for information (including grand jury subpoenas) in connection with governmental investigations of the tobacco industry, and is cooperating with respect to such requests. Certain present and former employees of PM Inc. have testified or have been asked to testify in connection with certain of these matters. The investigations are as follows: PM Inc. has been informed that an investigation by the United States Attorney for the Southern District of New York, which had been initiated following the publication of an article in The New York Times that made allegations about PM Inc. documents and supposedly secret research relating to nicotine, has been -31- consolidated with the United States Department of Justice investigation discussed immediately below. PM Inc. has been informed of an investigation by the United States Attorney for the Eastern District of New York relating to The Council for Tobacco Research-U.S.A., Inc., a research organization of which PM Inc. is a sponsor; and an investigation by the United States Department of Justice relating to issues raised in testimony provided by tobacco industry executives before Congress and other related matters. PM Inc. has been advised that the Federal Trade Commission has commenced an investigation to determine whether PM Inc. unfairly restricts the distribution of competing manufacturers' cigarette brands through its merchandising practices at the wholesale and retail levels. While the outcomes of these investigations cannot be predicted, PM Inc. believes it has acted lawfully. In March 1997, Liggett Group Inc. ("Liggett"), a United States cigarette manufacturer with approximately 2% of the domestic cigarette market, announced agreements with the attorneys general of twenty-two states to settle the health care cost recovery actions pending against Liggett in those states. Liggett also entered into an agreement to settle a purported nationwide class action suit which, subject to court approval, provides, during its 25-year term, for (i) the mandatory settlement of all present and future claims by Liggett smokers and their estates and families, as well as claims by individuals who allege injury from exposure to ETS, and (ii) the settlement of all present and future claims against Liggett by individuals or entities alleging economic loss as a result of payments for the treatment of diseases or medical conditions allegedly caused by cigarette smoking or exposure to ETS. As a part of the settlements, Liggett agreed, among other things, (i) to pay 25% of its "Pre-tax Income," if any, for the next 25 years into a settlement fund, subject to certain conditions and offsets, (ii) to comply with certain aspects of the FDA regulations discussed above, (iii) to acknowledge that cigarettes cause health problems and that nicotine is "addictive," (iv) to add a warning to each package of its cigarettes and its advertising stating that "Smoking is Addictive," (v) to acknowledge that cigarette companies have targeted marketing programs toward minors, and (vi) to cooperate with otherwise adverse parties in certain investigations and lawsuits and, in furtherance thereof, to waive the attorney-client privilege and other protections with respect to certain of its documents and information and to assist in obtaining court adjudication with respect to documents ("protected documents") in its possession that are subject to joint defense or other privileges and protections held by other members of the tobacco industry. The issue of Liggett's proposed disclosure of these protected documents is being litigated in state courts. In Florida's health care cost recovery action certain -32- of these protected documents were publicly disclosed pursuant to court order. The settlement agreements contain certain provisions that would apply to any other member of the tobacco industry having a share of the domestic cigarette market of less than 30% that acquires, or is acquired by, Liggett. Each settlement can be terminated by Liggett upon the occurrence of specified events. Liggett has sought to have the purported nationwide class action certified, and the related settlement agreement approved, in actions brought in Alabama state court and in federal court in West Virginia. In March 1997, the Alabama state court conditionally certified the nationwide class and preliminarily approved the related settlement agreement, subject to final approval after a fairness hearing. In August 1997, the federal court in the West Virginia case withdrew its earlier preliminary approval of the settlement and the settlement class and denied plaintiffs' motion to certify the class. As further discussed in Note 3 to the Condensed Consolidated Financial Statements ("Note 3"), there is litigation pending in various jurisdictions related to tobacco products. These cases generally fall within three categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, and (iii) health care cost recovery actions. Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. There continues to be a substantial increase in the number of tobacco-related cases pending in the United States, with many of the new cases having been filed in Florida and New York on behalf of individual plaintiffs. As of November 1, 1997, there were approximately 365 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 (excluding approximately 50 cases in Texas that were voluntarily dismissed but which may be refiled under certain conditions), compared to approximately 300 such cases as of June 30, 1997, and approximately 200 such cases as of September 30, 1996. Seventeen of the individual cases involve allegations of various personal injuries allegedly related to exposure to ETS. In addition, as of November 1, 1997, there were approximately 45 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including four that involve allegations of various personal injuries related to exposure to ETS) compared to approximately 40 such cases on June 30, 1997, and 20 such cases on September 30, 1996. Most of these actions purport to constitute statewide class actions and were filed after the Fifth Circuit Court of Appeals, in the Castano case, reversed a federal district court's certification of a purported nationwide class action on behalf of persons who were allegedly "addicted" to tobacco products. One purported smoking and health class action is pending in Canada and another in Brazil against affiliates of the Company. Recently, a purported smoking and health class action was filed in Nigeria against a subsidiary of PMI. As of November 1, 1997, approximately 95 health care cost recovery actions were pending compared to approximately 70 on June 30, 1997, and 20 on September 30, 1996. 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. Legislation has recently been enacted in California removing a statutory bar to the filing of smoking and health cases by private plaintiffs and health care cost recovery actions by public entities under California law. As a result, additional smoking and health cases similar to those now pending in other states may be filed in California, and existing health care cost recovery actions in California may be expanded to claim the benefit of the amended statute. -33- Other foreign, state, and local government entities and others, including unions, have announced that they are considering filing health care cost recovery actions. It is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries. 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 could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention, including the announcement in March 1997 that another cigarette manufacturer had settled certain health care cost recovery actions and a purported nationwide smoking and health class action, and a decision by a federal district court on a motion for summary judgment not to preclude the FDA from asserting jurisdiction over cigarettes as "drugs" or "medical devices" which decision is now under appeal. These developments, as well as the widespread media attention given to the proposed Resolution, discussed below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues," and the settlements of the Florida and Mississippi health care cost recovery actions and the Broin class action discussed in Note 3, may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. 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 unfavorable outcome of certain pending litigation or by the proposed Resolution discussed below or by settlement, if any, of certain pending cases. However, implementation of the proposed Resolution would resolve the most significant tobacco litigation against the Company and its subsidiaries. Furthermore, 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. Except as described below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues -- Effects on Litigation," all such cases are, and will continue to be, vigorously defended. PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES On June 20, 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding to support the adoption of federal legislation and any necessary ancillary undertakings, incorporating the features described in the proposed Resolution attached to the Memorandum of Understanding. The Memorandum of Understanding and the proposed Resolution (together, the "Resolution") resulted from negotiations with state attorneys general, representatives of the public health community and attorneys representing plaintiffs in certain smoking and health litigation. The proposed Resolution contains certain regulatory and legislative provisions with which the industry does not necessarily agree, but which the industry has agreed to accept in the interest of achieving the proposed Resolution. The proposed Resolution, which is subject to approval of the boards of directors of the participating companies, can be implemented only by federal legislation. The Company's Board of Directors approved the proposed Resolution in June 1997. If enacted into law, the legislation would resolve many of the regulatory and litigation issues affecting the United States tobacco industry and, thereby, reduce uncertainties facing the industry and increase stability in business and capital markets. Certain members of the public health community have expressed concern with certain aspects of the proposed Resolution, the White House has announced policy guidelines supporting modifications to the proposed Resolution and various -34- members of Congress have introduced or indicated that they may introduce alternative legislation. Accordingly, there can be no assurance that federal legislation in the form of the proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to the Company or that any modification would be acceptable to the Company or that, if enacted, the legislation would not face legal challenges. In any event, implementation of the proposed Resolution would materially adversely affect the financial position of the Company in the year of implementation and would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. Moreover, the negotiation and signing of the proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry and regulation of the international tobacco industry. The following summary of the proposed Resolution is qualified by reference to the complete text, which has been filed with the Securities and Exchange Commission as Exhibit 10 to the Company's Current Report on Form 8-K dated June 20, 1997, and which is incorporated herein by reference. Certain terms of the proposed Resolution would apply to all tobacco products sold in the United States; certain terms would apply only to tobacco manufacturers that consent to participate in the proposed Resolution; other terms would apply only to non-consenting manufacturers. Advertising and Marketing Restrictions The proposed Resolution would incorporate certain restrictions previously promulgated by the FDA and add additional restrictions to curtail tobacco product advertising and marketing. Among other things, it would: Prohibit the use of human images and cartoon characters, such as Joe Camel and the Marlboro man, in all tobacco-product advertising. Ban all outdoor tobacco-product advertising, including advertising in enclosed stadia and advertising inside a retail establishment that is directed outside. Except for advertising in adult-only facilities or adult publications, limit tobacco-product advertising to black text on a white background. Ban sponsorships (including concerts and sporting events) in the name, logo or selling message of a tobacco brand. Ban all non-tobacco merchandise (such as caps, jackets and bags) bearing the name, logo or selling message of a tobacco brand. Ban offers of non-tobacco items or gifts based on proof of purchase of tobacco products. Ban direct or indirect payments for tobacco product placement in movies, television programs and video games. Prohibit direct and indirect payments to "glamorize" tobacco use in media appealing to minors, including live and recorded music performances. Prohibit tobacco-product advertising on the Internet unless designed to be inaccessible in or from the United States. In addition, the proposed Resolution would require that use of currently employed product descriptors such as "low tar" and "light" be accompanied by a mandatory health disclaimer in advertisements, and would prohibit the use of any new descriptors embodying express or implied health claims unless approved by the FDA. The FDA would also have the corresponding power, but not the obligation, to modify advertising restrictions with respect to tobacco products that it concludes present sufficiently reduced health risks. Exemplars of all new -35- advertising and tobacco product labeling would be submitted to the FDA for its ongoing review. Warnings and Labeling The proposed Resolution would mandate a new set of rotating warnings to be placed on packages of tobacco products with greater prominence than previous warnings (25% of the front of cigarette packs at the top of the pack). The new rotating warnings would also appear in all advertisements in an area that would occupy 20% of press advertisements. Cigarette packs and advertisements would also carry the FDA mandated statement of intended use ("Nicotine Delivery Device"), and the FDA would be authorized to require that they also carry disclaimers about "tar and nicotine yields." Access Restrictions The proposed Resolution would restrict access to tobacco products by minors. Without preventing state and local governments from imposing stricter measures, the proposed Resolution would incorporate regulations previously promulgated by the FDA that restrict access to tobacco products and would also add additional restrictions. Taken together, these access restrictions would include the following: Setting a minimum age of 18 to purchase tobacco products. Requiring retailers to check photo identification of anyone under 27 years of age. Establishing a requirement of face-to-face transactions for all sales of tobacco products. Banning the sale of tobacco products from opened packages, requiring a minimum package size of 20 cigarettes, and banning the sampling of tobacco products. Banning the distribution of tobacco products through the mail except for sales subject to proof of age (with subsequent FDA review to determine if minors are obtaining tobacco products through the mail). Imposing retailer compliance obligations to ensure that all displays, advertising, labeling, and other items conform with all applicable requirements. Banning all sales of tobacco products through vending machines. Banning self-service displays of tobacco products except in adult-only facilities. Licensing of Tobacco Retailers The proposed Resolution would require that any entity that sells tobacco products directly to consumers obtain a license. Sellers would be subject to monetary penalties and suspension or loss of their licenses if they do not comply with the access restrictions. The federal government and state and local authorities would enforce these access and licensing provisions through funding provided by Industry Payments, as defined below under the heading "Industry Payments." State Enforcement The proposed Resolution would require states to adopt "no sales to minors" laws and would contain economic incentives for the states to enforce such laws. If a state does not meet "no sales to minors" performance targets, the FDA may refuse to pay that state certain funds otherwise payable under the proposed Resolution. To comply with the "no sales to minors" law, the state must achieve compliance -36- rate results of 75% by the fifth year after enactment of federal legislation, 85% by the seventh year and 90% by the tenth year and each year thereafter. Compliance would be measured as a percentage of random, unannounced compliance checks in which the retailer refused to sell tobacco products to minors. Funds withheld from states for failure to achieve the performance targets would, in turn, be reallocated to those states that demonstrated superior "no sales to minors" enforcement records. Surcharge for Failure to Achieve Underage Smoking Reduction Goals The proposed Resolution would impose surcharges on the industry if required reductions in underage smoking are not achieved. A "look back" provision would require the following reductions in the incidence of underage smoking from estimated levels over the past decade: 30% in the fifth and sixth years after enactment of implementing federal legislation, 50% in the seventh, eighth and ninth years, and 60% in the tenth year, with incidence remaining at such reduced levels thereafter. For any year in which these required reductions are not met, the FDA must impose a mandatory surcharge on the participating members of the cigarette industry based upon an approximation of the present value of the profit the companies would earn over the lives of the number of underage consumers in excess of the required reduction. The annual surcharge would be $80 million (as adjusted for changes in population and cigarette profitability) for each percentage point by which the reduction in underage smoking falls short of the required reductions (as adjusted to prevent double counting of persons whose smoking has already resulted in the imposition of a surcharge in previous years). The annual surcharge would be subject to a $2 billion annual cap (as adjusted for inflation). The surcharge would be the joint and several obligation of participating manufacturers allocated among participating manufacturers based on their market share of the United States cigarette industry and would be payable on or before July 1 of the year in which it is assessed. Manufacturers could receive a partial refund of this surcharge (up to 75%) only after paying the assessed amount and only if they could thereafter prove to the FDA that they had fully complied with the proposed Resolution, had taken all reasonably available measures to reduce youth tobacco usage and had not acted to undermine the achievement of the reduction goals. The FDA would use the surcharges to fund its administrative costs and to fund grants to states for additional efforts to reduce underage smoking. Regulation Under the proposed Resolution, the FDA would oversee the development, manufacturing, marketing and sale of tobacco products in the United States, including FDA oversight of ingredients and imposition of standards for reducing or eliminating the level of certain constituents, including nicotine. Under the proposed Resolution, tobacco would continue to be categorized as a "drug" and a "device" under the Food, Drug and Cosmetic Act. The FDA's authority to regulate tobacco products as "restricted medical devices" would be explicitly recognized and tobacco products would be classified as a new subcategory of Class II devices. For a period of at least twelve years after implementing legislation is effective, the FDA would be permitted, subject to certain procedures and judicial review, to adopt performance standards that require the modification of existing tobacco products, including the gradual reduction, but not the elimination, of nicotine yields, and the possible elimination of other constituents or components of the tobacco product, based upon a finding that the modification: (i) will result in a significant reduction of the health risks associated with such products to consumers thereof; (ii) is technologically feasible; and (iii) will not result in the creation of a significant demand for contraband or other tobacco products that do not meet the performance standards. -37- The proposed Resolution would also require, effective three years after implementing legislation is effective, that no cigarette sold in the United States can exceed a 12 mg. "tar" yield, using the Federal Trade Commission's presently existing methodology to determine "tar" yields. Beginning twelve years after implementing legislation becomes effective, the FDA would be permitted to set performance standards that exceed those discussed above, including the elimination of nicotine and the elimination of other constituents or other demonstrated harmful components of tobacco products, based upon a finding that: (i) the safety standard will result in a significant overall reduction of the health risks to tobacco consumers as a group; (ii) the modification is technologically feasible; and (iii) the modification will not result in the creation of a significant demand for contraband or other tobacco products that do not meet the performance standards. An FDA determination to eliminate nicotine would have to be based upon a preponderance of the evidence and be subject to judicial review and a two-year phase-in to permit Congressional review. The proposed Resolution would require disclosure of non-tobacco ingredients to the FDA, require manufacturers to submit within five years a safety assessment for non-tobacco ingredients currently used, and require manufacturers to obtain comparable review for any new non-tobacco ingredients. The FDA would have authority to disapprove an ingredient's safety. The proposed Resolution also outlines legislation that would require companies to notify the FDA of technology they develop or acquire that reduces the risk from tobacco products and that would mandate cross-licensing of technology that the FDA determines reduces the risk from tobacco products and that would authorize the FDA to mandate the introduction or licensing of "less hazardous tobacco products" that are technologically feasible. The proposed Resolution would subject the tobacco industry to "good manufacturing practice" standards, including requirements regarding quality control systems, FDA inspections and record-keeping and reporting. Public Disclosure The proposed Resolution would require the tobacco industry to disclose to the public previously confidential internal laboratory research as well as certain other documents relating to smoking and health, "addiction" or nicotine dependency, "safer or less hazardous" cigarettes and underage tobacco use and marketing. The proposed Resolution would also require the industry to disclose all such internal laboratory research generated in the future. The proposed Resolution would provide protection for proprietary information and applicable privileges, and would establish a streamlined process by which interested persons could contest claims of privilege. Cessation Programs The proposed Resolution would authorize the Secretary of Health and Human Services to accredit smoking cessation programs and techniques that the agency determines to be potentially effective. Compliance Programs Participating tobacco manufacturers would be required to create, and to update each year, plans to ensure compliance with all applicable laws and regulations, to identify ways to reduce underage use of tobacco products, and to provide internal incentives for reducing underage use and for developing products with "reduced risk." Participating manufacturers would also be required to implement compliance programs setting compliance standards and procedures for employees and agents that are reasonably capable of reducing violations. These programs must assign to -38- specific high-level personnel the overall responsibility for overseeing compliance, forbid delegation of substantial discretionary authority to individuals who have shown a propensity to disregard corporate policies, establish training or equivalent means of educating employees and agents, and institute appropriate disciplinary measures and steps to respond to violations and prevent similar ones from recurring. Participating manufacturers would be required to promulgate corporate principles that express and explain the company's commitment to compliance, reduction of underage tobacco use, and development of "reduced risk" tobacco products. They would be required to work with retail organizations on compliance, including retailer compliance checks and financial incentives for compliance, and disband certain industry associations and only form new ones subject to regulatory oversight. Participating manufacturers would be subject to fines and penalties for breaching any of these obligations. Companies would be required to direct their employees to report known or alleged violations to the company compliance officer, who in turn would be required to provide reports to the FDA. Finally, companies would be prohibited from taking adverse action against "whistleblowers" who report violations to the government. Public Smoking The proposed Resolution would mandate minimum federal standards governing smoking in public facilities (with states and localities retaining power to impose stricter requirements). These restrictions, which would be enforced by the Occupational Safety and Health Administration, would: Restrict indoor smoking in "public facilities" to ventilated areas with systems that exhaust the air directly to the outside, maintain the smoking area at "negative pressure" compared with adjoining areas and do not recirculate the air inside the public facility. Ensure that no employee may be required to enter a designated smoking area while smoking is occurring. Exempt restaurants (other than fast food restaurants) and bars, private clubs, hotel guest rooms, casinos, bingo parlors, tobacco merchants and prisons. Enforcement Violations of the proposed Resolution's terms would carry civil and criminal penalties based upon the penalty provisions of the Food, Drug and Cosmetic Act and, where applicable, the provisions of the United States criminal code. Special enhanced civil penalties of up to ten times the penalties applicable to similar violations by drug companies would attach to violations of the obligations to disclose research about health effects of tobacco products and information about the toxicity of non-tobacco ingredients. Terms of the proposed Resolution would be embodied in state consent decrees, giving the states concurrent enforcement powers. State enforcement could not impose obligations or requirements beyond those imposed by the proposed Resolution (except where the proposed Resolution specifically does not preempt additional state-law obligations) and would be limited to the penalties specified in the proposed Resolution and by prohibition of duplicative penalties. Industry Payments The proposed Resolution would require participating manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10 billion initial Industry Payment on the date federal legislation implementing -39- the terms of the proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations and the Company currently estimates that its share of the initial Industry Payment would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi and Florida pursuant to settlements of health care cost recovery actions). Thereafter, the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels): year 1: $8.5 billion; year 2: $9.5 billion; year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15 billion. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate determined with reference to the Consumer Price Index. The Industry Payments would increase or decrease in proportion to changes from 1996 domestic sales volume levels. Volume declines would be measured based on adult sales volume figures; volume increases would be measured by total sales volume. If sales volume declines but the industry's domestic net operating profit exceeds base year inflation-adjusted levels, the reduction in the annual Industry Payment due to volume decline, if any, would be offset to the extent of 25% of the increased profit. At current levels of sales and prior to any adjustment for inflation, the proposed Resolution would require total Industry Payments of $368.5 billion over the first 25 years (subject to credits described below in connection with potential civil tort liability). The Industry Payments would be separate from any surcharges required under the "look back" provision discussed above under the heading "Surcharge for Failure to Achieve Underage Smoking Reduction Goals." The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities selling tobacco products in the United States (and not their affiliated companies). The proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use. The Industry Payments would be made to a central trust and then allocated among various programs and entities to provide funds for federal and state enforcement efforts; federal, state and local governments' health benefit programs; public benefits to resolve past punitive damages claims that might be asserted in private litigation; and the expenses related to the administration of federal legislation enacted pursuant to the proposed Resolution. A portion of these expenditures would be to fund a variety of public and private non-profit efforts to discourage minors from beginning to use tobacco products and to assist current tobacco consumers to quit. Those programs include research, public education campaigns, individual cessation programs, and impact grants. Effects on Litigation If enacted, the federal legislation provided for in the proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity other than the federal government), parens patriae and smoking and health class actions and all "addiction"/dependence claims and would bar similar actions from being maintained in the future. However, the proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. In recent months PM Inc. and other companies in the domestic tobacco industry agreed to settle two health care cost recovery actions in Mississippi and Florida and a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft. The Company may enter into discussions to postpone or settle other actions pending the enactment of the legislation contemplated by the proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved, or, if achieved, as to the terms thereof. The proposed Resolution -40- would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective. Under the proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis and could be maintained only against tobacco manufacturing companies (and not their retailers, distributors or affiliated companies). In addition, all punitive damage claims based on past conduct would be resolved as part of the proposed Resolution and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party. The proposed Resolution contemplates that participating tobacco manufacturers would enter into a joint sharing agreement for civil liabilities relating to past conduct. Judgments and settlements arising from tort actions would be paid as follows. The proposed Resolution would set an annual aggregate cap of up to 33% of the annual base Industry Payment (including any reductions for volume declines). Any judgments or settlements exceeding the cap in a year would roll over into the next year. While judgments and settlements would run against the defendant, they would give rise to an 80-cents-on-the-dollar credit against the annual Industry Payment. Finally, any individual judgments in excess of $1 million would be paid at the rate of $1 million per year unless every other judgment and settlement could first be satisfied within the annual aggregate cap. In all circumstances, however, the companies would remain fully responsible for costs of defense and certain costs associated with the fees of attorneys representing certain plaintiffs in the litigation that would be settled by the proposed Resolution. Non-participating Manufacturers The proposed Resolution would contain certain measures to ensure that non-participating manufacturers are not free to undercut the proposed Resolution by selling tobacco products at lower prices because they were not making the Industry Payments. Financial Effects The Company anticipates that its share of the industry's $10 billion initial payment, which it currently estimates would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi and Florida pursuant to settlements of health care cost recovery actions) would be charged to expense in the period in which federal legislation implementing the terms of the proposed Resolution is enacted. In addition, the Company currently anticipates that implementation of the proposed Resolution would require a significant charge to expense in the period of enactment to comply with the proposed Resolution's regulations on advertising, marketing and production. The initial payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The initial payment would have a material adverse effect on the Company's operating income and cash flows in the quarter and year in which the proposed Resolution is enacted and on its financial position. The initial payment would result in higher debt and higher interest expense, the amounts of which would depend upon the final form of the proposed Resolution, borrowing requirements and interest rates. -41- The Company anticipates that PM Inc.'s share of future annual Industry Payments related to cigarette sales would be charged to expense as the related sales occur and would be funded through price increases. The Company anticipates that annual surcharges, if any, imposed by the FDA for failure to meet required reduction levels in underage smoking beginning in the fifth year after the proposed Resolution is implemented would be charged to expense in the year of assessment or in the year prior thereto if it is then probable that such assessment will be made. The Company believes that implementation of the proposed Resolution would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. The degree of the adverse impact would depend, among other things, on the rates of decline in United States cigarette sales in the premium and discount segments, PM Inc.'s share of the domestic premium and discount cigarette segments, interest rates and the timing of principal payments on debt incurred to finance the initial payment due under the proposed Resolution, and the effect of the proposed Resolution on cigarette consumption and the regulatory and litigation environment outside the United States. At the request of a United States Senate task force analyzing the financial impact of the proposed Resolution on the tobacco industry, PM Inc., together with other companies in the United States tobacco industry, submitted a report to the task force. The report concludes, among other things, that (i) "[t]he industry conservatively estimates that retail [cigarette] prices will increase by an absolute minimum of $1.20 per pack by the fifth year and by an absolute minimum of $1.50 per pack by the tenth year of implementation of the proposed [R]esolution", (ii) "[c]igarette consumption would decline by up to 43% in the next decade . . . and [the industry] believes the decline in consumption could be greater," and (iii) "[i]ndustry pretax earnings will suffer even if unit margins rise to offset the higher burden of unit fixed costs in the face of declining sales volumes." The report is filed as Exhibit 99 hereto and is incorporated herein by reference. The foregoing estimates constitute forward-looking information and are based on assumptions with respect to elasticity, smoking trends and retail price structure, among others, as set forth in the report and in the preceding paragraph. Any change in the final terms of the proposed Resolution could materially alter the conclusions contained in the report. The Company does not undertake to update the information contained in this paragraph in the event of such change. In view of the foregoing, the Company may reevaluate its share repurchase and dividend policies. Operating Results For the Nine Months Ended September 30, -------------------------------------------- Operating Revenues Operating Income -------------------- ------------------ (in millions) 1997 1996 1997 1996 ---- ---- ---- ---- Domestic tobacco $ 9,959 $ 9,251 $2,685 $3,131 International tobacco 20,547 18,586 3,654 3,225 ------- ------- ------ ------ Total $30,506 $27,837 $6,339 $6,356 ======= ======= ====== ====== Domestic tobacco. During the first nine months of 1997, PM Inc.'s operating revenues increased 7.7% over the comparable 1996 period, due to pricing ($408 million), higher volume ($254 million) and improved product mix ($46 million). Operating income for the first nine months of 1997 decreased 14.2% from the comparable 1996 period, due primarily to tobacco litigation settlement charges ($812 million) higher marketing, administration and research costs -42- ($209 million, primarily higher marketing expense) and higher fixed manufacturing expense ($55 million), partially offset by pricing ($408 million), higher volume ($162 million) and improved product mix ($43 million). As discussed in Note 3, "Contingencies," of the Notes to the Condensed Consolidated Financial Statements, in the third quarter of 1997, PM Inc. and other companies in the United States tobacco industry entered into agreements to settle health care cost recovery actions in Mississippi and Florida, and, in October 1997, PM Inc. and other companies in the United States tobacco industry entered into an agreement to settle a class action lawsuit in Florida. Based on the agreements, PM Inc. recorded settlement charges of $812 million in the third quarter of 1997. Excluding the impact of settlement charges, PM Inc.'s operating income for the first nine months of 1997 increased 11.7% over the comparable 1996 period. PM Inc.'s shipment volume for the first nine months of 1997 was 177.0 billion units, an increase of 2.8% over the first nine months of 1996 on higher Marlboro volume and wholesaler purchases, which the Company believes was in anticipation of price increases. Marlboro shipment volume increased 7.5 billion units (6.4%) to 123.7 billion units for a 34.3% share of the total industry, an increase of 2.2 share points over the first nine months of 1996. Domestic tobacco industry volume declined 0.4%; however, PM Inc. estimates that, excluding the effects of increased wholesaler buying mentioned above, the industry's volume continued to decline in line with historical trends of 1% to 2% per annum. While PM Inc. cannot predict future growth rates, it believes that, over the long term, industry shipments will continue to decline in line with these historical trends, subject to the effects, if implemented, of the proposed Resolution discussed under "Tobacco--Business Environment" above. PM Inc.'s shipment market share was 49.1%, an increase of 1.5 share points over the comparable 1996 period. Based on shipments, the premium and discount segments accounted for approximately 72.6% and 27.4%, respectively, of domestic cigarette industry volume in the first nine months of 1997, versus approximately 71.5% and 28.5%, respectively, in the comparable 1996 period. This reflects a continued shift to the higher-margin premium segment, which began in the second half of 1993. In the premium segment, PM Inc.'s volume increased 4.6%, compared with a 1.1% increase for the industry, resulting in a premium segment share of 58.0%, an increase of 1.9 share points over the first nine months of 1996, reflecting higher Marlboro volume. In the discount segment, PM Inc.'s shipments decreased 6.7%, to 25.4 billion units in the first nine months of 1997 compared with an industry decline of 4.2%, resulting in a discount segment share of 25.7%, a decrease of 0.7 share points from the first nine months of 1996. Basic shipment volume increased 233 million units to 17.6 billion units, for a 17.8% share of the discount segment, an increase of 0.9 share points over the first nine months of 1996. Retail sales data (compiled by the ACNielsen Company) indicate PM Inc. and Marlboro market shares of 50.9% and 35.1%, respectively, during the first nine months of 1997, compared with 49.3% and 33.2%, respectively, in the comparable 1996 period. PM Inc. cannot predict future change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, shipment market share or retail market share; however, it believes that implementation of the proposed Resolution discussed above would materially adversely affect PM Inc.'s shipments. In September 1997, PM Inc. announced a price increase of $3.50 per thousand cigarettes on its domestic premium and discount brands. PM Inc. previously announced a price increase of $2.50 per thousand cigarettes on its domestic -43- premium and discount brands in March 1997 and increased the price of its domestic premium and discount brands by $2.00 per thousand cigarettes in the second quarter of 1996. In October 1997, PM Inc. announced that it would commence limited consumer acceptability research on a new cigarette smoking system. The new smoking system includes a cigarette specially designed to be smoked while partially inside an electronic Puff Activated Lighter(TM) so that the cigarette burns only when puffed. The limited consumer research is expected to take approximately 12 months to complete. International tobacco. During the first nine months of 1997, tobacco operating revenues of PMI increased 10.6% over the comparable 1996 period, due to higher foreign excise taxes ($1.2 billion, principally for the consolidation of previously unconsolidated and newly acquired subsidiaries), favorable volume/mix ($525 million), price increases ($554 million) and the consolidation of previously unconsolidated and newly acquired subsidiaries ($431 million), partially offset by unfavorable currency movements ($719 million). Operating income for the first nine months of 1997 increased 13.3% over the comparable 1996 period, due to price increases, net of cost increases ($443 million), favorable volume/mix ($330 million) and the consolidation of previously unconsolidated and newly acquired subsidiaries ($60 million), partially offset by unfavorable currency movements ($306 million) and higher marketing, administration and research costs. PMI's volume grew 40.3 billion units (7.8%) in the first nine months of 1997 over the comparable 1996 period to 558.1 billion units, including local brands manufactured by Tabaqueira, Portugal's leading tobacco company, and ZPT-Krakow, Poland's largest cigarette manufacturer. PMI acquired a controlling interest in these companies during the first quarters of 1997 and 1996, respectively. Volume advanced in most markets, including Germany, Italy, the Benelux countries, Spain, Central and Eastern Europe, the Baltics, Turkey, the Middle East, the Asia/Pacific region and Mexico. Volume was down in France, Japan and Australia. However, Marlboro gained both volume and market share in France and Japan. Volume continued to grow for PMI's portfolio of international brands, including Marlboro, PMI's largest brand. PMI recorded market share gains in most major markets. For the Three Months Ended September 30, ------------------------------------------- Operating Revenues Operating Income ------------------- ------------------ (in millions) 1997 1996 1997 1996 ---- ---- ---- ---- Domestic tobacco $ 3,590 $3,284 $ 426 $1,098 International tobacco 6,843 6,213 1,241 1,128 ------- ------ ------ ------ Total $10,433 $9,497 $1,667 $2,226 ======= ====== ====== ====== Domestic tobacco. During the third quarter of 1997, PM Inc.'s operating revenues increased 9.3% over the comparable 1996 period, due to pricing ($159 million), higher volume ($128 million) and improved product mix ($19 million). Operating income for the 1997 third quarter decreased 61.2% from the comparable 1996 period, due primarily to tobacco litigation settlement charges ($812 million), higher marketing, administration and research costs ($111 million, primarily higher marketing expense) and higher fixed manufacturing expense ($28 million), partially offset by pricing ($159 million), higher volume ($82 million) and improved product mix ($17 million). Excluding the impact of previously discussed settlement charges, PM Inc.'s operating income increased 12.8%. PM Inc.'s shipment volume for the third quarter of 1997 was 62.8 billion units, an increase of 4.0% over the third quarter of 1996. The increase in PM Inc.'s shipments was due largely to higher Marlboro volume and wholesaler purchases, which the Company believes was in anticipation of price increases, which also affected industry volume. For the third quarter of 1997, Marlboro shipment volume increased 3.2 billion units (7.7%) to 44.4 billion units for a 34.7% share of the total industry, an increase of 1.9 share points over the third quarter of 1996. Domestic tobacco industry volume increased 1.8%, reflecting increases in wholesaler purchases; however, PM Inc. estimates that, excluding the effects of -44- increased wholesaler buying mentioned above, the industry's volume continued to decline in line with historical trends of 1% to 2% per annum. While PM Inc. cannot predict future growth rates, it believes that, over the long term, industry shipments will continue to decline in line with these historical trends, subject to the effects, if implemented, of the proposed Resolution discussed under "Tobacco--Business Environment" above. PM Inc.'s 1997 third quarter shipment market share was 49.2%, an increase of 1.0 share points over the comparable 1996 period. Based on shipments, the premium and discount segments accounted for approximately 73.3% and 26.7%, respectively, of domestic cigarette industry volume in the third quarter of 1997, versus approximately 71.9% and 28.1%, respectively, in the comparable 1996 period. This reflects a continued shift to the higher-margin premium segment, which began in the second half of 1993. In the premium segment, PM Inc.'s volume increased 6.2%, compared with a 3.8% increase for the industry, resulting in a premium segment share of 58.0%, an increase of 1.3 share points over the third quarter of 1996, due largely to higher Marlboro volume. In the discount segment, PM Inc.'s shipments decreased 8.0%, to 8.5 billion units in the third quarter of 1997 compared with an industry decline of 3.3%, resulting in a discount segment share of 25.0%, down 1.3 share points from the third quarter of 1996. Basic shipment volume increased 114 million units to 6.1 billion units for a 17.9% share of the discount segment, an increase of 0.9 share points over the third quarter of 1996. Retail sales data (compiled by the ACNielsen Company) indicate PM Inc. and Marlboro market shares of 51.3% and 35.7%, respectively, during the third quarter of 1997, compared with 49.7% and 33.7%, respectively, in the comparable 1996 period. PM Inc. cannot predict future change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, shipment market share or retail market share; however, it believes that implementation of the proposed Resolution discussed above would materially adversely affect PM Inc.'s shipments. International tobacco. During the third quarter of 1997, tobacco operating revenues of PMI increased 10.1% over the comparable 1996 period, due to higher foreign excise taxes ($445 million, principally for the consolidation of previously unconsolidated and newly acquired subsidiaries), favorable volume/mix ($183 million), price increases ($170 million) and the consolidation of previously unconsolidated and newly acquired subsidiaries ($139 million), partially offset by unfavorable currency movements ($307 million). Operating income for the 1997 third quarter increased 10.0% over the comparable 1996 period, due primarily to price increases, net of cost increases ($146 million), favorable volume/mix ($102 million), the consolidation of previously unconsolidated and newly acquired subsidiaries ($21 million), partially offset by higher marketing, administrative and research costs and unfavorable currency movements ($141 million). PMI's volume grew 12.9 billion units (7.3%) in the third quarter of 1997 over the comparable 1996 period to 190.1 billion units, including local brands manufactured by Tabaqueira, in which PMI acquired a controlling interest in January 1997. Volume advanced in most markets, including Germany, Italy, the Benelux countries, Spain, Central and Eastern Europe, the Baltics, Turkey, Mexico and the Asia/Pacific region, where gains in most of this region's markets were partially offset by lower volume in Japan due to the impact of the April tax-driven retail price increase. In France, industry and PMI volume were down. However, in Japan and France, Marlboro gained both volume and market share. Volume continued to grow for PMI's portfolio of international brands, including Marlboro, PMI's largest brand. PMI recorded market share gains in most major markets. -45- Food Business Environment Kraft Foods, Inc. ("Kraft"), the largest processor and marketer of retail packaged food in the United States, and its subsidiary Kraft Foods International, Inc. ("KFI"), which markets coffee, confectionery and grocery products in Europe and the Asia/Pacific region, are subject to fluctuating commodity costs and competitive challenges in various product categories and markets. Certain subsidiaries and affiliates of PMI that manufacture and sell food products in Latin America are also subject to competitive challenges in various product categories and markets. In addition, the results of KFI, as well as PMI's food operations in Latin America, are subject to the impact of currency fluctuations. Steps continue to be taken to build the value of premium brands, reduce costs and improve the Company's food business portfolio. The North American food business has been reorganized to streamline operations and improve effectiveness and customer response. The realignment included the creation of a unified sales force in the United States. KFI has been realigned to capitalize on future growth opportunities and reorganized into separate regional units. During 1996, Kraft sold its bagel business and KFI sold its margarine businesses in the U.K. and Italy. In the first nine months of 1997, KFI sold a Scandinavian sugar confectionery business and Kraft sold certain of its maple-flavored syrup businesses, including the Log Cabin and Country Kitchen brands. Kraft and KFI have also sold several smaller non-strategic businesses in 1996 and 1997. In October 1997, PMI sold its Brazilian ice cream business along with its share of a Brazilian ice cream joint venture for $930 million, subject to adjustment. The sale is expected to result in a pretax gain in excess of $700 million in the fourth quarter of 1997. The Company is currently evaluating cost reduction alternatives regarding its international food operations, which may result in material charges to fourth quarter 1997 operating income. Kraft acquired the Taco Bell grocery business during the third quarter of 1996. In Latin America, PMI acquired nearly all of the remaining voting shares of Industrias de Chocolate Lacta S.A. ("Lacta"), a Brazilian chocolate confectionery company, in the second quarter of 1996. The North American and international food businesses are affected by fluctuating commodity costs, particularly coffee bean prices, which can influence consumer and trade buying patterns, affect retail price volatility and lead to price competition in some markets. During the first quarter of 1997, coffee prices rose dramatically due primarily to speculation concerning 1997's South American crop and unusually low world stocks. Coffee bean prices reached a twenty-year high in late May and led to price increases by Kraft, KFI and their competitors. Coffee volume declined in the first nine months of 1997 from the comparable 1996 period as customers reacted to commodity-driven price increases. Kraft and KFI estimate that coffee consumption may remain sluggish, as higher than average coffee bean prices persist. Kraft was also affected by record high cheese commodity costs in 1996, as well as other higher dairy commodity costs, arising from low U.S. milk production. Cheese and dairy commodity costs moderated in the first quarter of 1997 and have remained stable. Kraft's cereal business continues to be affected by intense price competition, particularly from value brands. In response, Kraft implemented a price rollback and simplified couponing of its cereal products in the second quarter of 1996. Several competitors followed with similar pricing strategies. The reduction of cereal prices in 1996 lowered operating revenues and operating income in 1996 and the first quarter of 1997 in relation to prior period results. -46- Operating Results For the Nine Months Ended September 30, -------------------------------------------- Operating Revenues Operating Income ------------------- ------------------ (in millions) 1997 1996 1997 1996 ---- ---- ---- ---- North American food $12,779 $12,509 $2,245 $2,062 International food 7,840 8,379 820 847 ------- ------- ------ ------ Total $20,619 $20,888 $3,065 $2,909 ======= ======= ====== ====== North American food. During the first nine months of 1997, operating revenues increased 2.2% over the comparable 1996 period, due to volume increases in ongoing operations ($382 million), pricing ($211 million) and the impact of acquisitions ($47 million), partially offset by the impact of divestitures ($267 million), unfavorable product mix ($89 million) and unfavorable currency movements ($14 million). Operating income for the first nine months of 1997 increased 8.9% over the comparable 1996 period, due primarily to price increases and net cost decreases (aggregating $268 million) and volume increases in ongoing operations ($233 million), partially offset by the impact of divestitures ($41 million), unfavorable product mix ($21 million) and higher marketing, administration and research costs ($256 million, due primarily to higher marketing expense, which included additional marketing activities for new products). Included in marketing, administration and research costs was a gain of $159 million on the sale of certain maple-flavored syrup businesses, as well as charges of $64 million related to the discontinuation of several small operations, Year 2000 systems conversion costs of $38 million and the above mentioned additional marketing expense for new product initiatives. Excluding operating results of the divested North American food businesses discussed above, operating revenues and operating income increased 4.4% and 11.2%, respectively, in the first nine months of 1997 over the comparable 1996 period. Strong ongoing volume gains were achieved in frozen pizza, driven by new products; meals, due to strength in macaroni and cheese dinners and the acquisition and subsequent growth of Taco Bell grocery products; beverages, on the strength of ready-to-drink products; cereals, aided by new product introductions and the implementation of a price rollback as discussed previously; and desserts and snacks, due to new product introductions and strength in refrigerated ready-to-eat desserts and shelf stable puddings. Volume gains were also realized in processed meats, driven by continued growth of lunch combinations (including new product introductions) and growth in hot dogs and cold cuts. Cheese volume also increased, benefiting from new products and marketing initiatives. Coffee volume declined in the first nine months of 1997 from the comparable 1996 period as customers reacted to commodity-driven price increases. International food. Operating revenues for the first nine months of 1997 decreased 6.4% from the comparable 1996 period, due to unfavorable currency movements ($609 million), lower volume/mix ($249 million) and the impact of divestitures ($156 million), partially offset by the impact of newly acquired and previously unconsolidated subsidiaries ($263 million) and pricing ($212 million). Operating income for the first nine months of 1997 decreased 3.2% over the first nine months of 1996, due to lower volume ($76 million), cost increases, net of price increases (aggregating $33 million), unfavorable currency movements ($28 million) and the impact of divestitures ($25 million), partially offset by the impact of newly acquired and previously unconsolidated subsidiaries ($39 million) and lower marketing, administration and research costs ($88 million). -47- Excluding operating results of the divested international food businesses discussed above, operating revenues decreased 4.7% and operating income decreased 0.2% in the first nine months of 1997 from the comparable 1996 period. Lower ongoing volume for the first nine months of 1997 for KFI was due primarily to lower coffee and confectionery volumes and to one less selling week during the first quarter of 1997 compared to the first quarter of 1996. KFI's coffee volume decreased during the first nine months of 1997, reflecting customers' reactions to commodity-driven price increases. KFI's confectionery volume declined, due primarily to an exceptionally warm summer in Scandinavia and lower volume in Romania and Bulgaria, reflecting poor economic environments. KFI's cheese and grocery volumes decreased due primarily to the impact of one less selling week during the first quarter of 1997, partially offset by gains in KFI's Asian markets. PMI's food volume in Latin America for the first nine months of 1997 increased over the comparable 1996 period, due primarily to the acquisition of Lacta and higher volume in beverages. For the Three Months Ended September 30, ----------------------------------------- Operating Revenues Operating Income ------------------ ---------------- (in millions) 1997 1996 1997 1996 ---- ---- ---- ---- North American food $4,048 $4,062 $687 $642 International food 2,407 2,648 260 299 ------ ------ ---- ---- Total $6,455 $6,710 $947 $941 ====== ====== ==== ==== North American food. During the third quarter of 1997, operating revenues decreased 0.3% from the comparable 1996 period, due primarily to the impact of divestitures ($114 million), unfavorable product mix ($24 million) and unfavorable currency movements ($9 million), partially offset by pricing ($76 million), volume increases in ongoing operations ($49 million) and the impact of acquisitions ($8 million). Operating income for the third quarter of 1997 increased 7.0% over the comparable 1996 period, due primarily to price increases and net cost decreases (aggregating $146 million) and volume increases in ongoing operations ($26 million), partially offset by the impact of divestitures ($24 million), unfavorable product mix ($5 million) and higher marketing, administration and research costs ($98 million, due primarily to higher marketing expense which included additional marketing activities for new products). Included in marketing, administration and research costs was a gain of $159 million on the sale of certain maple-flavored syrup businesses, as well as charges of $64 million related to the discontinuation of several small operations, Year 2000 systems conversion costs of $28 million and the above mentioned additional marketing expense for new product initiatives. Excluding operating results of the divested North American businesses discussed above, operating revenues and operating income increased 2.5% and 11.2%, respectively, in the third quarter of 1997 over the comparable 1996 period. Strong ongoing volume gains were achieved in meals, due to strength in macaroni and cheese dinners and instant stuffing as well as the acquisition and subsequent growth of Taco Bell grocery products; beverages, on the strength of ready-to-drink products; cheese, benefiting from new products and marketing initiatives as well as a favorable comparison with the third quarter of 1996, when shipments declined following a commodity-driven price increase; and frozen pizza, driven by new products. Volume gains were realized in processed meats, driven by continued growth of lunch combinations (including new product introductions) and growth in hot dogs and cold cuts; desserts and snacks, due to new product introductions in refrigerated ready-to-eat and dry packaged desserts; and cereals, aided by new product introductions. Volume was down in barbecue sauce and spoonable -48- dressings. Coffee volume declined in the third quarter of 1997 from the comparable 1996 period as customers reacted to commodity-driven price increases. International food. Operating revenues for the third quarter of 1997 decreased 9.1% from the third quarter of 1996, due to unfavorable currency movements ($266 million), lower volume/mix ($124 million) and the impact of divestitures ($40 million), partially offset by pricing ($124 million) and the impact of newly acquired and previously unconsolidated subsidiaries ($65 million). Operating income for the third quarter of 1997 decreased 13.0% from the third quarter of 1996, due to cost increases, net of price increases ($54 million), lower volume ($20 million), unfavorable currency movements ($11 million) and the impact of divestitures ($7 million), partially offset by the impact of newly acquired and previously unconsolidated subsidiaries ($4 million) and lower marketing, administration and research costs ($49 million). During the quarter, cost increases lowered margins in key European coffee and cocoa businesses reflecting higher U.S. dollar- and sterling-denominated coffee and cocoa costs. Excluding operating results of the divested international food businesses discussed above, operating revenues decreased 7.7% and operating income decreased 11.0% in the third quarter of 1997 from the comparable 1996 period. Lower third quarter ongoing volume for KFI primarily reflects a decline in coffee volume during the third quarter of 1997 as a result of market contraction as consumers respond to commodity-driven price increases. KFI's confectionery volume declined slightly, due primarily to exceptionally warm weather in Scandinavia and volume declines in Romania and Bulgaria, reflecting poor economic environments. KFI's cheese and grocery volumes increased reflecting recoveries in sliced beef volume in Italy, and peanut butter volume in Australia, which had been adversely affected by a product recall in 1996. In addition, cheese and grocery volume grew in KFI's Asian markets. PMI's food volume in Latin America for the third quarter of 1997 increased over the comparable 1996 period, due primarily to the acquisition of Lacta and higher volume in beverages. Beer Nine Months ended September 30 Operating revenues of the Miller Brewing Company ("Miller") for the first nine months of 1997 decreased $100 million (2.9%) from the comparable 1996 period, due to unfavorable price/mix ($80 million) and lower volume ($20 million). Operating income for the first nine months of 1997 increased $18 million (4.6%) over the comparable 1996 period, due primarily to lower marketing, administration and research costs ($53 million) and lower fixed manufacturing expense ($21 million), partially offset by unfavorable price/mix ($51 million) and lower volume ($8 million). Operating revenues, manufacturing costs and marketing, administration and research costs were impacted by actions taken by Miller in the fourth quarter of 1996 to restore growth, streamline its organization and reduce costs. Miller's 1997 shipment volume of 34.3 million barrels for the first nine months of 1997 decreased 0.6% from the comparable 1996 period, reflecting lower shipments of premium-priced brands. Lower shipment volume was due largely to a decision to reduce wholesaler inventories in 1997 and an unfavorable comparison to last year, which was favorably affected by the launch of Miller Beer. However, wholesalers' sales to retailers in the first nine months of 1997 increased slightly from the comparable 1996 period, reflecting higher sales of Miller Lite, as Miller's new advertising and promotional campaigns renewed focus on core brands. Quarter ended September 30 Operating revenues for Miller for the third quarter of 1997 increased $7 million (0.6%) from the comparable 1996 period due to higher volume ($40 million), partially offset by unfavorable price/mix ($33 million). Operating income for the third quarter of 1997 increased $8 million (6.8%) over the comparable 1996 -49- period, due primarily to higher volume ($16 million), lower fixed manufacturing expense ($9 million) and lower marketing, administration and research costs ($4 million), partially offset by unfavorable price/mix ($21 million). Miller's 1997 third quarter shipment volume of 11.8 million barrels increased 3.6% from the comparable 1996 period, reflecting higher shipments of premium-priced and budget-priced brands. Shipments of Miller Lite rose, driven by new advertising and promotional activity. Shipment volume increases were also recorded for Miller High Life, Red Dog, Milwaukee's Best, Icehouse and Foster's. Wholesalers' sales to retailers in the third quarter increased slightly. Financial Services and Real Estate During the third quarter of 1997, Philip Morris Capital Corp. ("PMCC") sold its real estate subsidiary, Mission Viejo Company, for a pretax gain of $103 million. Operating revenues and operating income from PMCC's financial services business increased in the first nine months and third quarter due to the continued growth of its finance lease portfolio. Financial Review Net Cash Provided by Operating Activities During the first nine months of 1997, cash provided by operating activities was $5.1 billion, $566 million higher than in the first nine months of 1996, due primarily to higher net earnings and lower cash requirements for working capital items. The $5.1 billion of cash provided by operating activities during the first nine months of 1997 is after making up-front payments of $606 million for settling litigation. Net Cash Used in Investing Activities During the first nine months of 1997, cash used in investing activities was $1.2 billion, compared with $1.6 billion used during the comparable 1996 period. The change was due primarily to higher cash provided by divestitures. During 1997, cash provided by divestitures reflects the sale of Mission Viejo Company and several food businesses. Cash used in acquisitions during 1997 reflects the purchase of a tobacco operation in Portugal and an increased equity interest in a Mexican cigarette business. In the fourth quarter of 1997, PMI sold its Brazilian ice cream businesses for proceeds of $930 million, subject to adjustment. Net Cash Used in Financing Activities During the first nine months of 1997, the Company's net cash used in financing activities decreased to $3.2 billion, compared to $3.5 billion used in the first nine months of 1996, due primarily to lower stock repurchases, partially offset by higher dividends paid and lower net proceeds from the issuance of debt. Debt The Company's total debt and consumer products debt were $15.5 billion and $14.3 billion, respectively, at September 30, 1997, compared to $15.2 billion and $13.9 billion, respectively, at December 31, 1996. At both September 30, 1997 and December 31, 1996, the Company's ratio of consumer products debt to total equity was 0.98. The ratio of total debt to total equity was 1.06 and 1.07 at September 30, 1997 and December 31, 1996, respectively. The Company has negotiated new revolving bank credit agreements totaling $10.0 billion. These facilities are used to support the Company's commercial paper borrowings and are available for acquisitions and other corporate purposes. An agreement for $2.0 billion expires in October 1998. An agreement for $8.0 billion expires in 2002, enabling the Company to refinance short-term debt on a long-term basis, based upon its intent and ability to refinance such debt. At -50- September 30, 1997, $0.5 billion of consumer products commercial paper was reclassified as long-term debt. The Company expects to continue to refinance long-term and short-term debt from time to time. The nature and amount of the Company's long-term and short-term debt and the proportionate amount of each can be expected to vary as a result of future business requirements, market conditions and other factors. As discussed above in "Tobacco--Business Environment," PM Inc. estimates that the proposed Resolution in its current form, would result in an initial payment by PM Inc. of approximately $6.6 billion upon enactment (to be adjusted downward for initial payments made to Mississippi and Florida pursuant to settlements of health care cost recovery actions). The Company anticipates that the payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The Company further anticipates that the payment will result in significant increases in its consumer products debt to total equity ratio, total debt to total equity ratio and total debt outstanding. The Company operates internationally, with manufacturing and sales facilities in various locations around the world. The Company continually evaluates its foreign currency net asset exposure (primarily the Swiss franc, German mark, Netherlands guilder, Swedish krona and Canadian dollar) based on current market conditions and business strategies, and it acts to manage such exposure, when deemed prudent, through various hedging transactions. The Company has entered into currency and related interest rate swap agreements to manage exposure to currency movements. The U.S. dollar value of aggregate notional principal amounts for these agreements outstanding was equivalent to $1.4 billion and $2.2 billion at September 30, 1997 and December 31, 1996, respectively. Of these amounts, $726 million and $1.5 billion related to consumer products debt at September 30, 1997 and December 31, 1996, respectively. The Company enters into forward exchange and option contracts, for purposes other than trading, to reduce the effects of fluctuating foreign currency on foreign currency denominated current assets, liabilities, commitments and short-term intercompany transactions. At September 30, 1997 and December 31, 1996, the Company had entered into contracts, with maturities of less than one year and U.S. dollar equivalents of $3.0 billion (including $1.8 billion in option contracts) and $1.7 billion, respectively. Use of the above mentioned derivative financial instruments has not had a material impact on the Company's financial position at September 30, 1997 or results of operations for the three and nine months then ended. The Company's credit ratings by Moody's at September 30, 1997 and December 31, 1996 were "P-1" in the commercial paper market and "A2" for long-term debt obligations. The Company's credit ratings by Standard & Poor's ("S&P") at September 30, 1997 and December 31, 1996 were "A-1" in the commercial paper market and "A" for long-term debt obligations. In April 1997, S&P placed the debt ratings of the Company on its CreditWatch list with the intent of monitoring tobacco litigation developments. Equity and Dividends On February 26, 1997, the Company's Board of Directors declared a three-for-one split of the Company's common stock, effected by a distribution on April 10, 1997, of two shares for each share held of record at the close of business on March 17, 1997. All share and per share data have been restated to reflect this stock split for all periods presented. During the first nine months of 1997, the Company repurchased 18.2 million shares of its common stock at an aggregate cost of $743 million. Of these purchases, 16.9 million shares ($692 million) were made pursuant to the Company's repurchase program, announced in 1994, to purchase up to $6.0 billion of its common stock in the open market, and the remainder were made under an $8.0 billion share repurchase program approved by the Board of Directors in the first quarter of -51- 1997. These 1997 repurchases, net of 10.9 million shares issued under the Company's stock award plans during 1997, resulted in lower weighted average shares outstanding for the first nine months and third quarter of 1997 as compared to the first nine months and third quarter of 1996. No shares were repurchased during the third quarter of 1997. Dividends paid in 1997 were 17.4% higher than in 1996, reflecting a higher dividend rate in the first half of 1997, partially offset by fewer shares outstanding. The Board of Directors increased the Company's quarterly dividend rate to $0.40 per share in the third quarter of 1996, resulting in an annualized dividend rate of $1.60 per share. As discussed above in the last paragraph of "Tobacco--Business Environment--Proposed Resolution of Certain Regulatory and Litigation Issues," the Company may reevaluate its share repurchase and dividend policies. During the first nine months of 1997, currency translation adjustments reduced equity by $1.1 billion due to the strengthening of the U.S. dollar versus European currencies, primarily the Swiss franc, German mark, Netherlands guilder and Swedish krona. New Accounting Standards In 1996, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities," which, as required, was adopted by the Company as of January 1, 1997. The adoption and application of SOP No. 96-1 had no material effect on the Company's 1997 results of operations or financial position for the three or nine month periods ended September 30, 1997. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which is effective for the year ending December 31, 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share ("EPS") and requires the presentation of both basic and diluted EPS. Based upon the Company's current capitalization structure, the basic and diluted EPS amounts calculated in accordance with SFAS No. 128 are expected to approximate the Company's EPS amounts computed in accordance with Accounting Principles Board Opinion No. 15, "Earnings Per Share." Contingencies See Note 3 to the Condensed Consolidated Financial Statements for a discussion of contingencies. Forward-Looking and Cautionary Statements Reference is made to Item 1 (c) "Other Matters--Forward-Looking and Cautionary Statements" in the Company's Form 10-K regarding important factors that could cause actual results to differ materially from those contained in any forward-looking statement made by or on behalf of the Company, including forward-looking statements contained in this report. Reference is also made to the section herein under the heading "Tobacco--Business Environment." -52- Part II - OTHER INFORMATION Item 1. Legal Proceedings. Reference is made to Note 3, "Contingencies," of the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report, and to "Tobacco--Business Environment," of the Management's Discussion and Analysis of Financial Condition and Results of Operations included in Part I, Item 2 of this report. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 3.2 By-Laws, as amended, of the Company. 4.3 5-Year Revolving Credit Agreement dated as of October 14, 1997, among the Company and the Initial Lenders named therein and Citibank, N.A. and The Chase Manhattan Bank, as Administrative Agents, and Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent. 12 Statement regarding computation of ratios of earnings to fixed charges. 27 Financial Data Schedule. 99 Report to the Senate Democratic Task Force on Tobacco, Impact of Proposed Resolution on U.S. Cigarette Industry, dated October 8, 1997. (b) Reports on Form 8-K. Since the beginning of the quarter for which this report is filed, the Registrant filed a Current Report on Form 8-K, dated July 2, 1997, concerning the proposed Resolution and other recent developments, including an agreement in principle to settle Mississippi's health care cost recovery action, and a Current Report on Form 8-K, dated August 25, 1997, concerning an agreement to settle Florida's health care cost recovery action. -53- Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHILIP MORRIS COMPANIES INC. /s/ LOUIS C. CAMILLERI Louis C. Camilleri, Senior Vice President and Chief Financial Officer November 13, 1997 -54- EX-3.2 2 BY-LAWS Exhibit 3.2 BY-LAWS of PHILIP MORRIS COMPANIES INC. ARTICLE I Meetings of Stockholders Section 1. Annual Meetings. - The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting, and any postponement or adjournment thereof, shall be held on such date and at such time as the Board of Directors may in its discretion determine. Section 2. Special Meetings. - Unless otherwise provided by law, special meetings of the stockholders may be called by the chairman of the Board of Directors, or in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, an executive vice president or by order of the Board of Directors, whenever deemed necessary. Section 3. Place of Meetings. - All meetings of the stockholders shall be held at such place in the Commonwealth of Virginia as from time to time may be fixed by the Board of Directors. Section 4. Notice of Meetings. - Written notice, stating the place, day and hour and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given by mail not less than ten nor more than sixty days before the date of the meeting (except as a different time is specified herein or by law), to each stockholder of record having voting power in respect of the business to be transacted thereat, at his or her address as it appears on the stock transfer books of the Corporation. Notice of a stockholders' meeting to act on an amendment of the Articles of Incorporation, a plan of merger or share exchange, a proposed sale of all, or substantially all of the Corporation's assets, otherwise than in the usual and regular course of business, or the dissolution of the Corporation shall be given, in the manner provided above, not less than twenty-five nor more than sixty days before the date of the meeting and shall be accompanied, as appropriate, by a copy of the proposed amendment, plan of merger or share exchange or sale agreement. August 27, 1997 -1- Notwithstanding the foregoing, a written waiver of notice signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A stockholder who attends a meeting shall be deemed to have (i) waived objection to lack of notice or defective notice of the meeting, unless at the beginning of the meeting he or she objects to holding the meeting or transacting business at the meeting, and (ii) waived objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless he or she objects to considering the matter when it is presented. Section 5. Quorum. - At all meetings of the stockholders, unless a greater number or voting by classes is required by law, a majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum. If a quorum is present, action on a matter is approved if the votes cast favoring the action exceed the votes cast opposing the action, unless the vote of a greater number or voting by classes is required by law or the Articles of Incorporation, and except that in elections of directors those receiving the greatest number of votes shall be deemed elected even though not receiving a majority. Less than a quorum may adjourn. Section 6. Organization and Order of Business. - At all meetings of the stockholders, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the most senior executive vice president, shall act as chairman. In the absence of all of the foregoing officers or, if present, with their consent, a majority of the shares entitled to vote at such meeting, may appoint any person to act as chairman. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary at all meetings of the stockholders. In the event that neither the secretary nor any assistant secretary is present, the chairman may appoint any person to act as secretary of the meeting. The chairman shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts and things as are necessary or desirable for the proper conduct of the meeting, including, without limitation, the establishment of procedures for the dismissal of business not properly presented, the maintenance of order and safety, limitations on the time allotted to questions or comments on the affairs of the Corporation, restrictions on entry to such meeting after the time prescribed for the commencement thereof and the opening and closing of the voting polls. At each annual meeting of stockholders, only such business shall be conducted as shall have been properly brought before the meeting (a) by or at the direction of the Board of Directors or (b) by any stockholder of the Corporation who shall be entitled to vote at such meeting and who complies with the notice -2- procedures set forth in this Section 6. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation. To be timely, a stockholder's notice must be given, either by personal delivery or by United States certified mail, postage prepaid, and received at the principal executive offices of the Corporation (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of stockholders or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting. A stockholder's notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting, including the complete text of any resolutions to be presented at the annual meeting, and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder proposing such business, (c) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to bring the business before the meeting specified in the notice, (d) the class and number of shares of stock of the Corporation beneficially owned by the stockholder and (e) any material interest of the stockholder in such business. Notwithstanding anything in the By-Laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 6. The chairman of an annual meeting shall, if the facts warrant, determine that the business was not brought before the meeting in accordance with the procedures prescribed by this Section 6. If the chairman should so determine, he or she shall so declare to the meeting and the business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 6, a stockholder seeking to have a proposal included in the Corporation's proxy statement shall comply with the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended (including, but not limited to, Rule 14a-8 or its successor provision). The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. Section 7. Voting. - A stockholder may vote either in person or by proxy executed in writing by the stockholder or by his or her duly authorized attorney-in-fact. No stockholder may authorize more than four persons to act for him or her, and any proxy shall be delivered to the secretary of the meeting at or prior to the time designated by the chairman or in the order of business for so delivering such proxies. No proxy shall be valid after eleven months from its date, unless otherwise provided in the proxy. Each holder of record of stock of any class shall, as to all -3- matters in respect of which stock of such class has voting power, be entitled to such vote as is provided in the Articles of Incorporation for each share of stock of such class standing in the holders's name on the books of the Corporation. Unless required by statute or determined by the chairman to be advisable, the vote on any questions need not be by ballot. On a vote by ballot, each ballot shall be signed by the stockholder voting or by such stockholder's proxy, if there be such proxy. Section 8. Inspectors. - At every meeting of the stockholders for election of directors, the proxies shall be received and taken in charge, all ballots shall be received and counted and all questions touching the qualifications of voters, the validity of proxies, and the acceptance or rejection of votes shall be decided, by two inspectors. Such inspectors shall be appointed by the chairman of the meeting. They shall be sworn faithfully to perform their duties and shall in writing certify to the returns. No candidate for election as director shall be appointed or act as inspector. ARTICLE II Board of Directors Section 1. General Powers. - The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. Section 2. Number. - The number of directors shall be fourteen (14). Section 3. Term of Office and Qualification. - Each director shall serve for the term for which he or she shall have been elected and until a successor shall have been duly elected. Section 4. Nomination and Election of Directors. - At each annual meeting of stockholders, the stockholders entitled to vote shall elect the directors. No person shall be eligible for election as a director unless nominated in accordance with the procedures set forth in this Section 4. Nominations of persons for election to the Board of Directors may be made by the Board of Directors or any committee designated by the Board of Directors or by any stockholder entitled to vote for the election of directors at the applicable meeting of stockholders who complies with the notice procedures set forth in this Section 4. Such nominations, other than those made by the Board of Directors or any committee designated by the Board of Directors, may be made only if written notice of a stockholder's intent to nominate one or more persons for election as directors at the applicable meeting of stockholders has been given, either by personal delivery or by United States certified mail, postage prepaid, to the secretary of the Corporation and received (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of -4- stockholders, or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting, or (iii) with respect to any special meeting of stockholders called for the election of directors, not later than the close of business on the seventh day following the date on which notice of such meeting is first given to stockholders. Each such stockholder's notice shall set forth (a) as to the stockholder giving the notice, (i) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder, (ii) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to nominate the person or persons specified in the notice, (iii) the class and number of shares of stock of the Corporation beneficially owned by such stockholder, and (iv) a description of all arrangements or understandings between such stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by such stockholder; and (b) as to each person whom the stockholder proposes to nominate for election as a director, (i) the name, age, business address and, if known, residence address of such person, (ii) the principal occupation or employment of such person, (iii) the class and number of shares of stock of the Corporation which are beneficially owned by such person, (iv) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors or is otherwise required by the rules and regulations of the Securities and Exchange Commission promulgated under the Securities Exchange Act of 1934, as amended, and (v) the written consent of such person to be named in the proxy statement as a nominee and to serve as a director if elected. The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. Any person nominated for election as director by the Board of Directors or any committee designated by the Board of Directors shall, upon the request of the Board of Directors or such committee, furnish to the secretary of the Corporation all such information pertaining to such person that is required to be set forth in a stockholder's notice of nomination. The chairman of the meeting of stockholders shall, if the facts warrant, determine that a nomination was not made in accordance with the procedures prescribed by this Section 4. If the chairman should so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded. Section 5. Organization. - At all meetings of the Board of Directors, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the senior most executive vice president, shall act as chairman of the meeting. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary of meetings of -5- the Board of Directors. In the event that neither the secretary nor any assistant secretary shall be present at such meeting, the chairman of the meeting shall appoint any person to act as secretary of the meeting. Section 6. Vacancies. - Any vacancy occurring in the Board of Directors, including a vacancy resulting from amending these By-Laws to increase the number of directors by thirty percent or less, may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors. Section 7. Place of Meeting. - Meetings of the Board of Directors, regular or special, may be held either within or without the Commonwealth of Virginia. Section 8. Organizational Meeting. - The annual organizational meeting of the Board of Directors shall be held immediately following adjournment of the annual meeting of stockholders and at the same place, without the requirement of any notice other than this provision of the By-Laws. Section 9. Regular Meetings: Notice. - Regular meetings of the Board of Directors shall be held at such times and places as it may from time to time determine. Notice of such meetings need not be given if the time and place have been fixed at a previous meeting. Section 10. Special Meetings. - Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if any) or two of the directors. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each director, addressed to his or her residence or usual place of business, at least two days before the day on which the meeting is to be held, or shall be sent to such place by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held Section 11. Waiver of Notice. - Whenever any notice is required to be given to a director of any meeting for any purpose under the provisions of law, the Articles of Incorporation or these By-Laws, a waiver thereof in writing signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A director's attendance at or participation in a meeting waives any required notice to him or her of the meeting unless at the beginning of the meeting or promptly upon the director's arrival, he or she objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. -6- Section 12. Quorum and Manner of Acting. - Except where otherwise provided by law, a majority of the directors fixed by these By-Laws at the time of any regular or special meeting shall constitute a quorum for the transaction of business at such meeting, and the act of a majority of the directors present at any such meeting at which a quorum is present shall be the act of the Board of Directors. In the absence of a quorum, a majority of those present may adjourn the meeting from time to time until a quorum be had. Notice of any such adjourned meeting need not be given. Section 13. Order of Business. - At all meetings of the Board of Directors business may be transacted in such order as from time to time the Board of Directors may determine. Section 14. Committees. - In addition to the executive committee authorized by Article III of these By-Laws, other committees, consisting of two or more directors, may be designated by the Board of Directors by a resolution adopted by the greater number of (i) a majority of all directors in office at the time the action is being taken or (ii) the number of directors required to take action under Article II, Section 12 hereof. Any such committee, to the extent provided in the resolution of the Board of Directors designating the committee, shall have and may exercise the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, except as limited by law. ARTICLE III Executive Committee Section 1. How Constituted and Powers. - The Board of Directors, by resolution adopted pursuant to Article II, Section 14 hereof, may designate, in addition to the chairman of the Board of Directors, one or more directors to constitute an executive committee, who shall serve during the pleasure of the Board of Directors. The executive committee, to the extent provided in such resolution and permitted by law, shall have and may exercise all of the authority of the Board of Directors. Section 2. Organization, Etc. - The executive committee may choose a chairman and secretary. The executive committee shall keep a record of its acts and proceedings and report the same from time to time to the Board of Directors. Section 3. Meetings. - Meetings of the executive committee may be called by any member of the committee. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each member of the committee, addressed to his or her residence or usual place of business, at least two -7- days before the day on which the meeting is to be held or shall be sent to such place by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held. Section 4. Quorum and Manner of Acting. - A majority of the executive committee shall constitute a quorum for transaction of business, and the act of a majority of those present at a meeting at which a quorum is present shall be the act of the executive committee. The members of the executive committee shall act only as a committee, and the individual members shall have no powers as such. Section 5. Removal. - Any member of the executive committee may be removed, with or without cause, at any time, by the Board of Directors. Section 6. Vacancies. - Any vacancy in the executive committee shall be filled by the Board of Directors. ARTICLE IV Officers Section 1. Number. - The officers of the Corporation shall be a chairman of the Board of Directors, a deputy chairman of the Board of Directors (if elected by the Board of Directors), a president (if elected by the Board of Directors), one or more vice chairmen of the Board of Directors (if elected by the Board of Directors), a chief operating officer (if elected by the Board of Directors), one or more vice presidents (one or more of whom may be designated executive vice president or senior vice president), a treasurer, a controller, a secretary, one or more assistant treasurers, assistant controllers and assistant secretaries and such other officers as may from time to time be chosen by the Board of Directors. Any two or more offices may be held by the same person. Section 2. Election, Term of Office and Qualifications. - All officers of the Corporation shall be chosen annually by the Board of Directors, and each officer shall hold office until a successor shall have been duly chosen and qualified or until the officer resigns or is removed in the manner hereinafter provided. The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) and the vice chairmen of the Board of Directors (if any) shall be chosen from among the directors. Section 3. Vacancies. - If any vacancy shall occur among the officers of the Corporation, such vacancy shall be filled by the Board of Directors. -8- Section 4. Other Officers, Agents and Employees - Their Powers and Duties. - - The Board of Directors may from time to time appoint such other officers as the Board of Directors may deem necessary, to hold office for such time as may be designated by it or during its pleasure, and the Board of Directors or the chairman of the Board of Directors may appoint, from time to time, such agents and employees of the Corporation as may be deemed proper, and may authorize any officers to appoint and remove agents and employees. The Board of Directors or the chairman of the Board of Directors may from time to time prescribe the powers and duties of such other officers, agents and employees of the Corporation. Section 5. Removal. - Any officer, agent or employee of the Corporation may be removed, either with or without cause, by a vote of a majority of the Board of Directors or, in the case of any agent or employee not appointed by the Board of Directors, by a superior officer upon whom such power of removal may be conferred by the Board of Directors or the chairman of the Board of Directors. Section 6. Chairman of the Board of Directors and Chief Executive Officer. - - The chairman of the Board of Directors shall preside at meetings of the stockholders and of the Board of Directors and shall be a member of the executive committee. The chairman shall be the Chief Executive Officer of the Corporation and shall be responsible to the Board of Directors. He or she shall be responsible for the general management and control of the business and affairs of the Corporation and shall see to it that all orders and resolutions of the Board of Directors are implemented. The chairman shall from, time to time, report to the Board of Directors on matters within his or her knowledge which the interests of the Corporation may require be brought to its notice. The chairman shall do and perform such other duties as from time to time the Board of Directors may prescribe. Section 7. Deputy Chairman of the Board of Directors. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The deputy chairman shall be responsible to the chairman of the Board of Directors and shall perform such duties as shall be assigned to him or her by the chairman of the Board of Directors. The deputy chairman shall from time to time report to the chairman of the Board of Directors on matters within the deputy chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. Section 8. President. - In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The president shall be responsible to the chairman of the Board of Directors. Subject to the authority of the chairman of the Board of Directors, the president shall be devoted to the Corporation's business -9- and affairs under the basic policies set by the Board of Directors and the chairman of the Board of Directors. He or she shall from, time to time, report to the chairman of the Board of Directors on matters within the president's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if any) shall, except as otherwise directed by the Board of Directors, have all of the powers and the duties of the chairman of the Board of Directors. The president (if any) shall do and perform such other duties as from time to time the Board of Directors or the chairman of the Board of Directors may prescribe. Section 9. Vice Chairmen of the Board of Directors. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), the vice chairman of the Board of Directors designated for such purpose by the chairman of the Board of Directors (if any) shall preside at meetings of the stockholders and of the Board of Directors. Each vice chairman of the Board of Directors shall be responsible to the chairman of the Board of Directors. Each vice chairman of the Board of Directors shall from time to time report to the chairman of the Board of Directors on matters within the vice chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence or inability to act of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), such vice chairman of the Board of Directors as the chairman of the Board of Directors may designate for the purpose shall have the powers and discharge the duties of the chairman of the Board of Directors. In the event of the failure or inability of the chairman of the Board of Directors to so designate a vice chairman of the Board of Directors, the Board of Directors may designate a vice chairman of the Board of Directors who shall have the powers and discharge the duties of the chairman of the Board of Directors. Section 10. Chief Operating Officer. - The chief operating officer (if any) shall be responsible to the Chairman of the Board of Directors for the principal operating businesses of the Corporation and shall perform those duties which may from time to time be assigned. Section 11. Vice Presidents. - The vice presidents of the Corporation shall assist the chairman of the Board of Directors, the deputy chairman of the Board of Directors, the president (if any) and the vice chairmen (if any) of the Board of Directors in carrying out their respective duties and shall perform those duties which may from time to time be assigned to them. The chief financial officer shall be a vice president of the Corporation (or more senior) and shall be responsible for the management and supervision of the financial affairs of the Corporation. -10- Section 12. Treasurer. - The treasurer shall have charge of the funds, securities, receipts and disbursements of the Corporation. He or she shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such banks or trust companies or with such bankers or other depositaries as the Board of Directors may from time to time designate. The treasurer shall render to the Board of Directors, the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), the vice chairmen of the Board of Directors (if any), and the chief financial officer, whenever required by any of them, an account of all of his transactions as treasurer. If required, the treasurer shall give a bond in such sum as the Board of Directors may designate, conditioned upon the faithful performance of the duties of the treasurer's office and the restoration to the Corporation at the expiration of his or her term of office or in case of death, resignation or removal from office, of all books, papers, vouchers, money or other property of whatever kind in his or her possession or under his or her control belonging to the Corporation. The treasurer shall perform such other duties as from time to time may be assigned to him or her. Section 13. Assistant Treasurers. - In the absence or disability of the treasurer, one or more assistant treasurers shall perform all the duties of the treasurer and, when so acting, shall have all the powers of, and be subject to all restrictions upon, the treasurer. Assistant treasurers shall also perform such other duties as from time to time may be assigned to them. Section 14. Secretary. - The secretary shall keep the minutes of all meetings of the stockholders and of the Board of Directors in a book or books kept for that purpose. He or she shall keep in safe custody the seal of the Corporation, and shall affix such seal to any instrument requiring it. The secretary shall have charge of such books and papers as the Board of Directors may direct. He or she shall attend to the giving and serving of all notices of the Corporation and shall also have such other powers and perform such other duties as pertain to the secretary's office, or as the Board of Directors, the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) or any vice chairman of the Board of Directors may from time to time prescribe. Section 15. Assistant Secretaries. - In the absence or disability of the secretary, one or more assistant secretaries shall perform all of the duties of the secretary and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the secretary. Assistant secretaries shall also perform such other duties as from time to time may be assigned to them. Section 16. Controller. - The controller shall be administrative head of the controller's department. He or she shall be in charge of all functions relating to accounting and the preparation and analysis of budgets and statistical reports and shall establish, through appropriate channels, recording and reporting procedures -11- and standards pertaining to such matters. The controller shall report to the chief financial officer and shall aid in developing internal corporate policies whereby the business of the Corporation shall be conducted with the maximum safety, efficiency and economy. The controller shall be available to all departments of the Corporation for advice and guidance in the interpretation and application of policies which are within the scope of his or her authority. The controller shall perform such other duties as from time to time may be assigned to him or her. Section 17. Assistant Controllers. - In the absence or disability of the controller, one or more assistant controllers shall perform all of the duties of the controller and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the controller. Assistant controllers shall also perform such other duties as from time to time may be assigned to them. ARTICLE V Contracts, Checks, Drafts, Bank Accounts, Etc. Section 1. Contracts. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the chairman of the Board of Directors may authorize shall have the power to execute any contract or other instrument on behalf of the Corporation; no other officer, agent or employee shall, unless otherwise in these By-Laws provided, have any power or authority to bind the Corporation by any contract or acknowledgement, or pledge its credit or render it liable pecuniarily for any purpose or to any amount. Section 2. Loans. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the Board of Directors may authorize shall have the power to effect loans and advances at any time for the Corporation from any bank, trust company or other institution, or from any corporation, firm or individual, and for such loans and advances may make, execute and deliver promissory notes or other evidences of indebtedness of the Corporation, and, as security for the payment of any and all loans, advances, indebtedness and liability of the Corporation, may pledge, hypothecate or transfer any and all stocks, securities and other personal property at any time held by the Corporation, and to that end endorse, assign and deliver the same. Section 3. Voting of Stock Held. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any -12- vice chairman of the Board of Directors (if any), any vice president or the secretary may from time to time appoint an attorney or attorneys or agent or agents of the Corporation to cast the votes that the Corporation may be entitled to cast as a stockholder or otherwise in any other corporation, any of whose stock or securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other corporation, or to consent in writing to any action by any other such corporation, and may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent, and may execute or cause to be executed on behalf of the Corporation such written proxies, consents, waivers or other instruments as such officer may deem necessary or proper in the premises; or the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president or the secretary may attend in person any meeting of the holders of stock or other securities of such other corporation and thereat vote or exercise any and all powers of the Corporation as the holder of such stock or other securities of such other corporation. ARTICLE VI Certificates Representing Shares Certificates representing shares of the Corporation shall be signed by the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), or the vice chairman of the Board of Directors (if any), or the president of the Corporation (if any) and the secretary or an assistant secretary. Any and all signatures on such certificates, including signatures of officers, transfer agents and registrars, may be facsimile. ARTICLE VII Dividends The Board of Directors may declare dividends from funds of the Corporation legally available therefor. -13- ARTICLE VIII Seal The Board of Directors shall provide a suitable seal or seals, which shall be in the form of a circle, and shall bear around the circumference the words "Philip Morris Companies Inc." and in the center the word and figures "Virginia, 1985." ARTICLE IX Fiscal Year The fiscal year of the Corporation shall be the calendar year. ARTICLE X Amendment The power to alter, amend or repeal the By-Laws of the Corporation or to adopt new By-Laws shall be vested in the Board of Directors, but By-Laws made by the Board of Directors may be repealed or changed by the stockholders, or new ByLaws may be adopted by the stockholders, and the stockholders may prescribe that any By-Laws made by them shall not be altered, amended or repealed by the directors. ARTICLE XI Emergency By-Laws If a quorum of the Board of Directors cannot be readily assembled because of some catastrophic event, and only in such event, these By-Laws shall, without further action by the Board of Directors, be deemed to have been amended for the duration of such emergency, as follows: Section 1. Section 6 of Article II shall read as follows: Any vacancy occurring in the Board of Directors may be filled by the affirmative vote of a majority of the directors present at a meeting of the Board of Directors called in accordance with these By-Laws. -14- Section 2. The first sentence of Section 10 of Article II shall read as follows: Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors or a deputy chairman (if any), or of the president (if any) or any vice chairman of the Board of Directors (if any) or any director or of any person having the powers and duties of the chairman of the Board of Directors, the deputy chairman, the president or any vice chairman of the Board of Directors. Section 3. Section 12 of Article II shall read as follows: The directors present at any regular or special meeting called in accordance with these By-Laws shall constitute a quorum for the transaction of business at such meeting, and the action of a majority of such directors shall be the act of the Board of Directors, provided, however, that in the event that only one director is present at any such meeting no action except the election of directors shall be taken until at least two additional directors have been elected and are in attendance. -15- EX-4.3 3 CREDIT AGREEMENT Exhibit 4.3 U.S.$8,000,000,000 5-YEAR REVOLVING CREDIT AGREEMENT Dated as of October 14, 1997 Among PHILIP MORRIS COMPANIES INC. and THE INITIAL LENDERS NAMED HEREIN and CITIBANK, N.A. and THE CHASE MANHATTAN BANK as Administrative Agents and CREDIT SUISSE FIRST BOSTON as Syndication Agent and DEUTSCHE BANK AG, NEW YORK BRANCH as Documentation Agent TABLE OF CONTENTS Page ARTICLE I DEFINITIONS AND ACCOUNTING TERMS SECTION 1.01. Certain Defined Terms......................................... 1 SECTION 1.02. Computation of Time Periods................................... 11 SECTION 1.03. Accounting Terms.............................................. 11 ARTICLE II AMOUNTS AND TERMS OF THE ADVANCES SECTION 2.01. The Revolving Credit Advances................................. 11 SECTION 2.02. Making the Revolving Credit Advances.......................... 12 SECTION 2.03. The Competitive Bid Advances.................................. 13 SECTION 2.04. Fees.......................................................... 17 SECTION 2.05. Termination or Reduction of the Commitments................... 17 SECTION 2.06. Repayment of Revolving Credit Advances........................ 18 SECTION 2.07. Interest on Revolving Credit Advances......................... 18 SECTION 2.08. Additional Interest on Eurocurrency Rate Advances............. 18 SECTION 2.09. Interest Rate Determination................................... 19 SECTION 2.10. Prepayments of Advances....................................... 20 SECTION 2.11. Increased Costs............................................... 21 SECTION 2.12. Illegality.................................................... 22 SECTION 2.13. Payments and Computations..................................... 22 SECTION 2.14. Taxes......................................................... 24 SECTION 2.15. Sharing of Payments, Etc...................................... 25 SECTION 2.16. Evidence of Debt.............................................. 25 SECTION 2.17. Use of Proceeds............................................... 26 ARTICLE III CONDITIONS TO EFFECTIVENESS AND LENDING SECTION 3.01. Conditions Precedent to Effectiveness......................... 26 SECTION 3.02. Initial Advance to Each Designated Subsidiary................. 27 SECTION 3.03. Conditions Precedent to Each Revolving Credit Borrowing....... 28 SECTION 3.04. Conditions Precedent to Each Competitive Bid Borrowing........ 29 SECTION 3.05. Determinations Under Section 3.01............................. 29 ARTICLE IV REPRESENTATIONS AND WARRANTIES SECTION 4.01. Representations and Warranties of PM Companies................ 29 ii TABLE OF CONTENTS Page ARTICLE V COVENANTS OF PM COMPANIES SECTION 5.01. Affirmative Covenants......................................... 30 SECTION 5.02. Negative Covenants............................................ 31 ARTICLE VI EVENTS OF DEFAULT SECTION 6.01. Events of Default............................................. 32 ARTICLE VII THE ADMINISTRATIVE AGENTS SECTION 7.01. Authorization and Action...................................... 34 SECTION 7.02. Administrative Agents' Reliance, Etc.......................... 34 SECTION 7.03. Citibank, Chase and Affiliates................................ 35 SECTION 7.04. Lender Credit Decision........................................ 35 SECTION 7.05. Indemnification............................................... 35 SECTION 7.06. Successor Administrative Agents............................... 35 SECTION 7.07. Administrative Sub-Agent...................................... 36 SECTION 7.08. Syndication and Documentation Agents.......................... 36 ARTICLE VIII GUARANTY SECTION 8.01. Guaranty...................................................... 36 SECTION 8.02. Guaranty Absolute............................................. 36 SECTION 8.03. Waivers....................................................... 37 SECTION 8.04. Continuing Guaranty........................................... 37 ARTICLE IX MISCELLANEOUS SECTION 9.01. Amendments, Etc............................................... 38 SECTION 9.02. Notices, Etc.................................................. 38 SECTION 9.03. No Waiver; Remedies........................................... 38 SECTION 9.04. Costs and Expenses............................................ 38 SECTION 9.05. Right of Set-off.............................................. 39 SECTION 9.06. Binding Effect................................................ 40 SECTION 9.07. Assignments and Participations................................ 40 iii TABLE OF CONTENTS Page SECTION 9.08. Designated Subsidiaries....................................... 42 SECTION 9.09. Governing Law................................................. 42 SECTION 9.10. Execution in Counterparts..................................... 42 SECTION 9.11. Judgment...................................................... 42 SECTION 9.12. Jurisdiction, Etc............................................. 43 SECTION 9.13. Substitution of Currency...................................... 43 SECTION 9.14. Confidentiality............................................... 44 SECTION 9.15. Integration................................................... 44 Schedules Schedule I - List of Applicable Lending Offices [Intentionally Omitted] Exhibits Exhibit A-1 - Form of Revolving Credit Note Exhibit A-2 - Form of Competitive Bid Note Exhibit B-1 - Form of Notice of Revolving Credit Borrowing Exhibit B-2 - Form of Notice of Competitive Bid Borrowing Exhibit C - Form of Assignment and Acceptance Exhibit D - Form of Designation Agreement Exhibit E-1 - Form of Opinion of Counsel for PM Companies Exhibit E-2 - Form of Opinion of Counsel for PM Companies Exhibit F - Form of Opinion of Counsel for Designated Subsidiary Exhibit G - Form of Opinion of Counsel for Citibank, as Administrative Agent 5-YEAR REVOLVING CREDIT AGREEMENT Dated as of October 14, 1997 PHILIP MORRIS COMPANIES INC., a Virginia corporation ("PM Companies"), the banks, financial institutions and other institutional lenders (the "Initial Lenders") listed on the signature pages hereof, and CITIBANK, N.A. ("Citibank") and THE CHASE MANHATTAN BANK ("Chase"), as administrative agents (each, in such capacity, an "Administrative Agent"), CREDIT SUISSE FIRST BOSTON, as syndication agent (in such capacity, the "Syndication Agent") and DEUTSCHE BANK AG, NEW YORK BRANCH, as documentation agent (in such capacity, the "Documentation Agent") for the Lenders (as hereinafter defined), agree as follows: ARTICLE I DEFINITIONS AND ACCOUNTING TERMS SECTION 1.01. Certain Defined Terms. As used in this Agreement, the following terms shall have the following meanings (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Administrative Sub-Agent" means Citibank International plc. "Advance" means a Revolving Credit Advance or a Competitive Bid Advance. "Agents" means each Administrative Agent, the Syndication Agent, the Documentation Agent and the Administrative Sub-Agent. "Applicable Facility Fee Rate" means for any period a percentage per annum equal to the percentage set forth below determined by reference to the higher of (i) the rating of PM Companies' long-term senior unsecured Debt from Standard & Poor's Ratings Group and (ii) the rating of PM Companies' long-term senior unsecured Debt from Moody's Investors Service, in each case in effect from time to time during such period: Long-Term Applicable Senior Unsecured Facility Debt Rating Fee Rate ---------------- ---------- AA- and Aa3 (or higher) 0.0550% A- and A3 or higher, but lower than AA- and Aa3 0.0750% BBB and Baa2 or higher, but lower than A- and A3 0.1000% Lower than BBB and Baa2 0.1500%; provided that if no rating is available on any date of determination from Moody's Investors Service and Standard & Poor's Ratings Group or any other nationally recognized statistical rating organization designated by PM Companies and approved in writing by the Required Lenders, the Applicable Facility Fee Rate shall be 0.150%. 2 "Applicable Interest Rate Margin" means for any Interest Period a percentage per annum equal to the percentage set forth below determined by reference to the higher of (i) the rating of PM Companies' long-term senior unsecured Debt from Standard & Poor's Ratings Group and (ii) the rating of PM Companies' long-term senior unsecured Debt from Moody's Investors Service, in each case from time to time during such Interest Period: Long-Term Applicable Senior Unsecured Interest Rate Debt Rating Margin ---------------- ------------- AA- and Aa3 (or higher) 0.0950% A- and A3 or higher but lower than AA- and Aa3 0.1250% BBB and Baa2 or higher, but lower than A- and A3 0.2000% Lower than BBB and Baa2 0.3000%; provided that if no rating is available on any date of determination from Moody's Investors Service and Standard & Poor's Ratings Group or any other nationally recognized statistical rating organization designated by PM Companies and approved in writing by the Required Lenders, the Applicable Interest Rate Margin shall be 0.300%. "Applicable Lending Office" means, with respect to each Lender, such Lender's Domestic Lending Office in the case of a Base Rate Advance and such Lender's Eurocurrency Lending Office in the case of a Eurocurrency Rate Advance and, in the case of a Competitive Bid Advance, the office of such Lender notified by such Lender to Citibank, as Administrative Agent, as its Applicable Lending Office with respect to such Competitive Bid Advance. "Asset Disposition" means any sale, lease, transfer, spin-off or other disposition ("Disposition") to any Person (including any shareholder of PM Companies), voluntarily or involuntarily, of any of the Tobacco Assets (whether now owned or hereafter acquired) of PM Companies and its directly and indirectly owned Subsidiaries, provided that "Asset Disposition" shall not mean (i) any Disposition of Tobacco Assets to PM Companies or any Subsidiary directly or indirectly wholly owned by PM Companies, (ii) any sale and lease-back of Tobacco Assets which, together with all such sale and lease-back transactions occurring from and after June 30, 1997, does not exceed an aggregate amount equal to $500,000,000, provided that the lease term related to such sale and lease-back transaction has a duration approximately equal to the useful life of such Tobacco Assets, (iii) any Disposition of Tobacco Assets in the ordinary course of business and (iv) any Disposition which, together with all such other Dispositions (excluding all Dispositions described in clauses (i), (ii) and (iii) of this definition) occurring from and after June 30, 1997, does not exceed an aggregate amount equal to $1,100,000,000 net after-tax proceeds calculated in accordance with the provisions of Section 2.05(b). "Assignment and Acceptance" means an assignment and acceptance entered into by a Lender and an Eligible Assignee, and accepted by Citibank, as Administrative Agent, in substantially the form of Exhibit C hereto. 3 "Base Rate" means a fluctuating interest rate per annum in effect from time to time, which rate per annum shall at all times be equal to the highest of: (a) the rate of interest announced publicly by Citibank in New York, New York, from time to time, as Citibank's base rate; (b) the sum (adjusted to the nearest 1/4 of 1% or, if there is no nearest 1/4 of 1%, to the next higher 1/4 of 1%) of 1/2 of 1% per annum, plus the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks, such three-week moving average being determined weekly on each Monday (or, if such day is not a Business Day, on the next succeeding Business Day) for the three-week period ending on the previous Friday by Citibank on the basis of such rates reported by certificate of deposit dealers to and published by the Federal Reserve Bank of New York or, if such publication shall be suspended or terminated, on the basis of quotations for such rates received by Citibank from three New York certificate of deposit dealers of recognized standing selected by Citibank; and (c) 1/2 of one percent per annum above the Federal Funds Rate. "Base Rate Advance" means a Revolving Credit Advance denominated in Dollars that bears interest as provided in Section 2.07(a)(i). "Borrowers" means, collectively, PM Companies and each Designated Subsidiary that shall become a party to this Agreement pursuant to Section 9.08. "Borrowing" means a Revolving Credit Borrowing or a Competitive Bid Borrowing. "Business Day" means a day of the year on which banks are not required or authorized by law to close in New York City and, if the applicable Business Day relates to any Eurocurrency Rate Advances or LIBO Rate Advances on which dealings are carried on in the London interbank market and banks are open for business in London and in the country of issue of the currency of such Eurocurrency Rate Advance or LIBO Rate Advance (or, in the case of an Advance denominated in the euro, in Frankfurt, Germany) and, if the applicable Business Day relates to any Local Rate Advances on which banks are open for business in the country of issue of the currency of such Local Rate Advance. "Citibank's Administrative Agent Account" means (a) in the case of Advances denominated in Dollars, the account of Citibank, as Administrative Agent, maintained by Citibank, as Administrative Agent, at Citibank at its office at Two Penns Way, Suite 200, New Castle, Delaware 19720, Account No. 36852248, Attention: Dave Meckler, (b) in the case of Advances denominated in any Foreign Currency, the account of the Administrative Sub-Agent, designated in writing from time to time by Citibank, as Administrative Agent, to PM Companies and the Lenders for such purpose and (c) in any such case, such other account of Citibank, as Administrative Agent, as is designated in writing from time to time by Citibank, as Administrative Agent, to PM Companies and the Lenders for such purpose. "Committed Currencies" means lawful currency of the United Kingdom of Great Britain and Northern Ireland, lawful currency of the Federal Republic of Germany, lawful currency of the Republic of France, lawful currency of The Swiss Federation, lawful currency of The Netherlands, lawful currency of Japan and lawful currency of the European Economic and Monetary Union. 4 "Commitment" means as to any Lender (a) the Dollar amount set forth opposite such Lender's name on the signature pages hereof or (b) if such Lender has entered into any Assignment and Acceptance, the Dollar amount set forth for such Lender in the Register maintained by Citibank, as Administrative Agent, pursuant to Section 9.07(d), as such amount may be reduced pursuant to Section 2.05. "Competitive Bid Advance" means an advance by a Lender to any Borrower as part of a Competitive Bid Borrowing resulting from the competitive bidding procedure described in Section 2.03 and refers to a Fixed Rate Advance, a LIBO Rate Advance or a Local Rate Advance. "Competitive Bid Borrowing" means a borrowing consisting of simultaneous Competitive Bid Advances from each of the Lenders whose offer to make one or more Competitive Bid Advances as part of such borrowing has been accepted under the competitive bidding procedure described in Section 2.03. "Competitive Bid Note" means a promissory note of any Borrower payable to the order of any Lender, in substantially the form of Exhibit A-2 hereto, evidencing the indebtedness of such Borrower to such Lender resulting from a Competitive Bid Advance made by such Lender to such Borrower. "Competitive Bid Reduction" has the meaning specified in Section 2.01. "Consolidated Tangible Assets" means all assets properly appearing on a consolidated balance sheet of PM Companies and its Subsidiaries after deducting goodwill, trademarks, patents, other like intangibles, and the minority interests of other Persons in such Subsidiaries, all as determined in accordance with generally accepted accounting principles, except that if there has been a material change in an accounting principle as compared to that applied in the preparation of the financial statements of PM Companies and its Subsidiaries as at and for the six months ended June 30, 1997, then such new accounting principle shall not be used in the determination of Consolidated Tangible Assets. A material change in an accounting principle is one that in the year of its adoption changes Consolidated Tangible Assets at such year-end by more than 10%. "Convert", "Conversion" and "Converted" each refers to a conversion of Revolving Credit Advances of one Type into Revolving Credit Advances of the other Type pursuant to Section 2.07, 2.09 or 2.12. "Debt" means (i) indebtedness for borrowed money or for the deferred purchase price of property or services, whether or not evidenced by bonds, debentures, notes or similar instruments, (ii) obligations as lessee under leases which shall have been or should be, in accordance with generally accepted accounting principles, recorded as capital leases, and (iii) obligations under direct or indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of any other Person of the kinds referred to in clause (i) or (ii) above. "Default" means any Event of Default or any event that would constitute an Event of Default but for the requirement that notice be given or time elapse or both. "Designated Subsidiary" means any wholly-owned Subsidiary of PM Companies designated for borrowing privileges under this Agreement pursuant to Section 9.08. "Designation Agreement" means, with respect to any Designated Subsidiary, an agreement in the form of Exhibit D hereto signed by such Designated Subsidiary and PM Companies. 5 "Dollars" and the "$" sign each means lawful currency of the United States of America. "Domestic Lending Office" means, with respect to any Lender, the office of such Lender specified as its "Domestic Lending Office" opposite its name on Schedule I hereto or in the Assignment and Acceptance pursuant to which it became a Lender, or such other office of such Lender as such Lender may from time to time specify to PM Companies and Citibank, as Administrative Agent. "Effective Date" has the meaning specified in Section 3.01. "Eligible Assignee" means (i) a commercial bank organized under the laws of the United States, or any State thereof, and having total assets in excess of $5,000,000,000; (ii) a commercial bank organized under the laws of any other country which is a member of the OECD, or a political subdivision of any such country, and having total assets in excess of $5,000,000,000, provided that such bank is acting through a branch or agency located in the country in which it is organized or another country which is also a member of the OECD or the Cayman Islands; (iii) the central bank of any country which is a member of the OECD; (iv) a commercial finance company or finance Subsidiary of a corporation organized under the laws of the United States, or any State thereof, and having total assets in excess of $3,000,000,000; (v) an insurance company organized under the laws of the United States, or any State thereof, and having total assets in excess of $5,000,000,000; (vi) any Lender; (vii) an affiliate of any Lender; and (viii) any other bank, commercial finance company, insurance company or other Person approved in writing by PM Companies, which approval shall be notified to Citibank, as Administrative Agent. "Equivalent" in Dollars of any Foreign Currency on any date means the equivalent in Dollars of such Foreign Currency determined by using the quoted spot rate at which the Administrative Sub-Agent's principal office in London offers to exchange Dollars for such Foreign Currency in London prior to 4:00 P.M. (London time) (unless otherwise indicated by the terms of this Agreement) on such date as is required pursuant to the terms of this Agreement, and the "Equivalent" in any Foreign Currency of Dollars means the equivalent in such Foreign Currency of Dollars determined by using the quoted spot rate at which the Administrative Sub-Agent's principal office in London offers to exchange such Foreign Currency for Dollars in London prior to 4:00 P.M. (London time) (unless otherwise indicated by the terms of this Agreement) on such date as is required pursuant to the terms of this Agreement. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations promulgated and rulings issued thereunder. "ERISA Affiliate" means any Person that for purposes of Title IV of ERISA is a member of any Borrower's controlled group, or under common control with any Borrower, within the meaning of Section 414 of the Internal Revenue Code. "ERISA Event" means (a) (i) the occurrence with respect to a Plan of a reportable event, within the meaning of Section 4043 of ERISA, unless the 30-day notice requirement with respect thereto has been waived by the PBGC, or (ii) the requirements of subsection (1) of Section 4043(b) of ERISA (without regard to subsection (2) of such section) are met with respect to a contributing sponsor, as defined in Section 4001(a)(13) of ERISA, of a Plan, and an event described in paragraph (9), (10), (11), (12) or (13) of Section 4043(c) of ERISA is reasonably expected to occur with respect to such Plan within the following 30 days; (b) the application for a minimum funding waiver with respect to a Plan; (c) the provision by the administrator of any Plan of a notice of intent to terminate such Plan, pursuant to Section 4041(a)(2) of ERISA (including any such notice with respect to a plan amendment referred to in Section 4041(e) of ERISA); (d) the cessation of operations at a facility of any Borrower or PM Companies or any of their 6 ERISA Affiliates in the circumstances described in Section 4062(e) of ERISA; (e) the withdrawal by any Borrower or PM Companies or any of their ERISA Affiliates from a Multiple Employer Plan during a plan year for which it was a substantial employer, as defined in Section 4001(a)(2) of ERISA; (f) the conditions set forth in Section 302(f)(1)(A) and (B) of ERISA to the creation of a lien upon property or rights to property of any Borrower or PM Companies or any of their ERISA Affiliates for failure to make a required payment to a Plan are satisfied; (g) the adoption of an amendment to a Plan requiring the provision of security to such Plan, pursuant to Section 307 of ERISA; or (h) the institution by the PBGC of proceedings to terminate a Plan pursuant to Section 4042 of ERISA, or the occurrence of any event or condition described in Section 4042 of ERISA that constitutes grounds for the termination of, or the appointment of a trustee to administer, a Plan. "Eurocurrency Liabilities" has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Eurocurrency Lending Office" means, with respect to any Lender, the office of such Lender specified as its "Eurocurrency Lending Office" opposite its name on Schedule I hereto or in the Assignment and Acceptance pursuant to which it became a Lender (or, if no such office is specified, its Domestic Lending Office), or such other office of such Lender as such Lender may from time to time specify to PM Companies and Citibank, as Administrative Agent. "Eurocurrency Rate" means, for any Interest Period for each Eurocurrency Rate Advance comprising part of the same Revolving Credit Borrowing, an interest rate per annum determined by Citibank, as Administrative Agent, to be the offered rate per annum at which deposits in Dollars or in the applicable Committed Currency appear on Telerate Pages 3740 and 3750 (or any successor pages, respectively) as of 11:00 A.M. (London time) two Business Days before the first day of such Interest Period, or in the event such offered rate is not available from the Telerate Pages, the interest rate per annum equal to the average (rounded upward to the nearest whole multiple of 1/16 of 1% per annum, if such average is not such a multiple) of the rate per annum at which deposits in Dollars or in the applicable Committed Currency are offered by the principal office of each of the Reference Banks in London, England to prime banks in the London interbank market at 11:00 A.M. (London time) two Business Days before the first day of such Interest Period in an amount substantially equal to such Reference Bank's Eurocurrency Rate Advance comprising part of such Revolving Credit Borrowing to be outstanding during such Interest Period and for a period equal to such Interest Period. If the Eurocurrency Rate does not appear on Telerate Pages 3740 and 3750 (or any successor pages, respectively), the Eurocurrency Rate for any Interest Period for each Eurocurrency Rate Advance comprising part of the same Revolving Credit Borrowing shall be determined by Citibank, as Administrative Agent, on the basis of applicable rates furnished to and received by Citibank, as Administrative Agent, from the Reference Banks two Business Days before the first day of such Interest Period, subject, however, to the provisions of Section 2.08. "Eurocurrency Rate Advance" means a Revolving Credit Advance denominated in Dollars or in a Committed Currency that bears interest as provided in Section 2.07(a)(ii). "Eurocurrency Rate Reserve Percentage" for any Interest Period for all Eurocurrency Rate Advances or LIBO Rate Advances comprising part of the same Borrowing means the reserve percentage applicable two Business Days before the first day of such Interest Period under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) for a member bank of the Federal Reserve System in New York City with respect to liabilities or assets consisting of or including Eurocurrency Liabilities (or with respect to any 7 other category of liabilities that includes deposits by reference to which the interest rate on Eurocurrency Rate Advances or LIBO Rate Advances is determined) having a term equal to such Interest Period. "Events of Default" has the meaning specified in Section 6.01. "Federal Bankruptcy Code" means the Bankruptcy Reform Act of 1978, as amended from time to time. "Federal Funds Rate" means, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day on such transactions received by Citibank, as Administrative Agent, from three Federal funds brokers of recognized standing selected by it. "Fixed Charges" means, for any accounting period, the sum of (i) interest, whether expensed or capitalized, in respect of any Debt outstanding during such period, plus (ii) amortization of debt expense and discount or premium relating to any Debt outstanding during such period, whether expensed or capitalized, plus (iii) such portion of rental expense as can be demonstrated to be representative of the interest factor in the particular case, all as to be applicable to continuing operations and determined in accordance with generally accepted accounting principles, except that if there has been a material change in an accounting principle as compared to that applied in the preparation of the financial statements of PM Companies as at and for the six months ended June 30, 1997, then such new accounting principle shall not be used in the determination of Fixed Charges. A material change in an accounting principle is one that, in the year of its adoption, changes Net Income Before Tax or Fixed Charges for any quarter in such year by more than 10%. "Fixed Rate Advances" has the meaning specified in Section 2.03(a)(i), which Advance shall be denominated in Dollars or in any Foreign Currency. "Foreign Currency" means any Committed Currency, the lawful currency of Canada and any other lawful currency (other than Dollars) that is freely transferable or convertible into Dollars. "Home Jurisdiction Withholding Taxes" means (a) in the case of PM Companies, withholding for United States income taxes, United States back-up withholding taxes and United States withholding taxes and (b) in the case of a Designated Subsidiary, withholding taxes imposed by the jurisdiction under the laws of which such Designated Subsidiary is organized or any political subdivision thereof. "Interest Period" means, for each Eurocurrency Rate Advance comprising part of the same Revolving Credit Borrowing and each LIBO Rate Advance comprising part of the same Competitive Bid Borrowing, the period commencing on the date of such Eurocurrency Rate Advance or LIBO Rate Advance or the date of the Conversion of any Base Rate Advance into such Eurocurrency Rate Advance and ending on the last day of the period selected by the Borrower requesting such Borrowing pursuant to the provisions below and, thereafter, with respect to Eurocurrency Rate Advances, each subsequent period commencing on the last day of the immediately preceding Interest Period and ending on the last day of the period selected by such Borrower pursuant to the provisions below. The duration of each such Interest Period shall be one, two, three or six months, or, if acceptable to all Lenders, nine or twelve months, as such Borrower may select upon notice received by Citibank, as Administrative Agent, not later than 11:00 A.M. 8 (New York City time) on the third Business Day prior to the first day of such Interest Period; provided, however, that: (i) such Borrower may not select any Interest Period that ends after the Termination Date; (ii) whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day, provided, however, that, if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day; and (iii) whenever the first day of any Interest Period occurs on a day of an initial calendar month for which there is no numerically corresponding day in the calendar month that succeeds such initial calendar month by the number of months equal to the number of months in such Interest Period, such Interest Period shall end on the last Business Day of such succeeding calendar month. "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended from time to time, and the regulations promulgated and rulings issued thereunder. "Lenders" means the Initial Lenders and each Eligible Assignee that shall become a party hereto pursuant to Section 9.07. "LIBO Rate" means, for any Interest Period for all LIBO Rate Advances comprising part of the same Competitive Bid Borrowing, an interest rate per annum determined by Citibank, as Administrative Agent, to be the offered rate per annum at which deposits in Dollars or in the relevant Foreign Currency appear on Telerate Pages 3740 and 3750 (or any successor pages, respectively) as of 11:00 A.M. (London time) two Business Days before the first day of such Interest Period, or in the event such offered rate is not available from the Telerate Pages, the interest rate per annum equal to the average (rounded upward to the nearest whole multiple of 1/16 of 1% per annum, if such average is not such a multiple) of the rate per annum at which deposits in Dollars or in the relevant Foreign Currency are offered by the principal office of each of the Reference Banks in London, England to prime banks in the London interbank market at 11:00 A.M. (London time) two Business Days before the first day of such Interest Period in an amount substantially equal to the amount that would be the Reference Banks' respective ratable shares of such Borrowing if such Borrowing were to be a Revolving Credit Borrowing to be outstanding during such Interest Period and for a period equal to such Interest Period. If the LIBO Rate does not appear on the Telerate Pages 3740 and 3750 (or any successor pages, respectively), the LIBO Rate for any Interest Period for each LIBO Rate Advance comprising part of the same Competitive Bid Borrowing shall be determined by Citibank, as Administrative Agent, on the basis of applicable rates furnished to and received by Citibank, as Administrative Agent, from the Reference Banks two Business Days before the first day of such Interest Period, subject, however, to the provisions of Section 2.08. "LIBO Rate Advances" means a Competitive Bid Advance denominated in Dollars or in any Foreign Currency and bearing interest based on the LIBO Rate. "Local Rate Advances" means a Competitive Bid Advance denominated in any Foreign Currency sourced from the jurisdiction of issuance of such Foreign Currency and bearing interest at a fixed rate. 9 "Major Subsidiary" means any Subsidiary (a) more than 50% of the voting securities of which is owned directly or indirectly by PM Companies, (b) which is organized and existing under, or has its principal place of business in, the United States or any political subdivision thereof, Canada or any political subdivision thereof, any country which is a member of the European Union on the date hereof (other than Greece, Portugal or Spain) or any political subdivision thereof, Sweden, Switzerland, Norway or Australia or any of their respective political subdivisions, and (c) which has at any time total assets (after intercompany eliminations) exceeding $1,000,000,000. "Multiemployer Plan" means a multiemployer plan, as defined in Section 4001(a)(3) of ERISA, to which any Borrower or any ERISA Affiliate is making or accruing an obligation to make contributions, or has within any of the preceding five plan years made or accrued an obligation to make contributions, such plan being maintained pursuant to one or more collective bargaining agreements. "Multiple Employer Plan" means a single employer plan, as defined in Section 4001(a)(15) of ERISA, that (a) is maintained for employees of any Borrower or any ERISA Affiliate and at least one Person other than such Borrower and the ERISA Affiliates or (b) was so maintained and in respect of which such Borrower or any ERISA Affiliate could have liability under Section 4064 or 4069 of ERISA in the event such plan has been or were to be terminated. "Net Income Before Tax" means, for any accounting period, income or loss from continuing operations for such period, as determined in accordance with generally accepted accounting principles, plus total federal, state and foreign income taxes which have been included in the determination of income or loss from continuing operations for such period in accordance with generally accepted accounting principles and amounts which, in the determination of income or loss from continuing operations for such period, have been deducted for the items referred to in the definition of "Fixed Charges" in this Section, except that if there has been a material change in an accounting principle as compared to that applied in the preparation of the financial statements of PM Companies as at and for the six months ended June 30, 1997, then such new accounting principle shall not be used in the determination of Net Income Before Tax. A material change in an accounting principle is one that, in the year of its adoption, changes Net Income Before Tax or Fixed Charges for any quarter in such year by more than 10%. "1995 Loan Agreements" has the meaning specified in Section 3.01(c). "Note" means a Revolving Credit Note or a Competitive Bid Note. "Notice of Competitive Bid Borrowing" has the meaning specified in Section 2.03(a). "Notice of Revolving Credit Borrowing" has the meaning specified in Section 2.02(a). "Obligations" has the meaning specified in Section 8.01. "OECD" means the Organization for Economic Cooperation and Development. "Other Taxes" has the meaning specified in Section 2.14(b). "Payment Office" means, for any Foreign Currency, such office of Citibank as shall be from time to time selected by Citibank, as Administrative Agent, and notified by Citibank, as Administrative Agent, to PM Companies and the Lenders. 10 "PBGC" means the Pension Benefit Guaranty Corporation (or any successor). "Person" means an individual, partnership, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture, limited liability company or other entity, or a government or any political subdivision or agency thereof. "Philip Morris" means Philip Morris Incorporated, a Virginia corporation wholly owned by PM Companies. "Plan" means a Single Employer Plan or a Multiple Employer Plan. "Proceeding" has the meaning specified in Section 4.01(f). "Reference Banks" means Citibank, Chase, Credit Suisse First Boston and Deutsche Bank AG, New York Branch. "Register" has the meaning specified in Section 9.07(d). "Required Lenders" means at any time Lenders owed at least 66-2/3% of the then aggregate unpaid principal amount (based on the Equivalent in Dollars at such time) of the Revolving Credit Advances owing to Lenders, or, if no such principal amount is then outstanding, Lenders having at least 66-2/3% of the Commitments (provided that, for purposes hereof, neither PM Companies nor any Borrower, nor any of their respective affiliates, if a Lender, shall be included in (i) the Lenders holding such amount of the Revolving Credit Advances or having such amount of the Commitments or (ii) determining the aggregate unpaid principal amount of the Revolving Credit Advances or the total Commitments). "Revolving Credit Advance" means an advance by a Lender to any Borrower as part of a Revolving Credit Borrowing and refers to a Base Rate Advance or a Eurocurrency Rate Advance (each of which shall be a "Type" of Revolving Credit Advance). "Revolving Credit Borrowing" means a borrowing consisting of simultaneous Revolving Credit Advances of the same Type made by each of the Lenders pursuant to Section 2.01. "Revolving Credit Note" means a promissory note of any Borrower payable to the order of any Lender, delivered pursuant to a request made under Section 2.16 in substantially the form of Exhibit A-1 hereto, evidencing the aggregate indebtedness of such Borrower to such Lender resulting from the Revolving Credit Advances made by such Lender to such Borrower. "Single Employer Plan" means a single employer plan, as defined in Section 4001(a)(15) of ERISA, that (a) is maintained for employees of any Borrower or any ERISA Affiliate and no Person other than such Borrower and the ERISA Affiliates or (b) was so maintained and in respect of which such Borrower or any ERISA Affiliate could have liability under Section 4069 of ERISA in the event such plan has been or were to be terminated. "Subsidiary" of any Person means any corporation of which (or in which) more than 50% of (a) the outstanding capital stock having voting power to elect a majority of the Board of Directors of such corporation (irrespective of whether at the time capital stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency) is at the time 11 directly or indirectly owned or controlled by such Person, by such Person and one or more of its other Subsidiaries or by one or more of such Person's other Subsidiaries. "Termination Date" means the earlier of October 14, 2002 and the date of termination in whole of the Commitments pursuant to Section 2.05 or 6.01. "Tobacco Assets" means all assets consisting of tobacco and tobacco related assets, including, without limitation, all tobacco inventory, aging warehouses, cigarette manufacturing facilities, distribution warehouses, trademarks, tradenames and know-how and which relate to the domestic and United States export business of PM Companies and its Subsidiaries. "Withdrawal Liability" shall have the meaning given such term under Part I of Subtitle E of Title IV of ERISA. SECTION 1.02. Computation of Time Periods. In this Agreement in the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including" and the words "to" and "until" each mean "to but excluding". SECTION 1.03. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles, except that if there has been a material change in an accounting principle affecting the definition of an accounting term as compared to that applied in the preparation of the financial statements of PM Companies as at and for the six months ended June 30, 1997, then such new accounting principle shall not be used in the determination of the amount associated with that accounting term. A material change in an accounting principle is one that, in the year of its adoption, changes the amount associated with the relevant accounting term for such year by more than 10%. ARTICLE II AMOUNTS AND TERMS OF THE ADVANCES SECTION 2.01. The Revolving Credit Advances. Each Lender severally agrees, on the terms and conditions hereinafter set forth, to make Revolving Credit Advances to any Borrower from time to time on any Business Day during the period from the Effective Date until the Termination Date in an aggregate amount (based in respect of any Revolving Credit Advances to be denominated in a Committed Currency on the Equivalent in Dollars determined on the date of delivery of the applicable Notice of Revolving Credit Borrowing) for all of the Borrowers not to exceed at any time outstanding such Lender's Commitment, provided, however, that the aggregate amount of the Commitments of the Lenders shall be deemed used from time to time to the extent of the aggregate amount (based in respect of any Competitive Bid Advance denominated in a Foreign Currency on the Equivalent in Dollars at such time) of the Competitive Bid Advances then outstanding and such deemed use of the aggregate amount of the Commitments shall be allocated among the Lenders ratably according to their respective Commitments (such deemed use of the aggregate amount of the Commitments being a "Competitive Bid Reduction"); provided further that the aggregate amount of Revolving Credit Borrowings and Competitive Bid Borrowings denominated in Foreign Currencies (based on the Equivalent in Dollars on the Business Day of each Notice of Revolving Credit Borrowing or Notice of Competitive Bid Borrowing) shall not exceed $2,000,000,000 at any time outstanding. Each Revolving Credit Borrowing shall be in an aggregate amount of no less than $50,000,000 (or the Equivalent thereof in any Committed Currency determined on the date of delivery of the applicable Notice of Revolving Credit Borrowing) and shall consist of Revolving Credit Advances of the same Type made on the same day by the Lenders ratably according to their respective Commitments. Within the limits of each Lender's Commitment and subject 12 to this Section 2.01, any Borrower may borrow under this Section 2.01, prepay pursuant to Section 2.10 and reborrow under this Section 2.01. SECTION 2.02. Making the Revolving Credit Advances. (a) Each Revolving Credit Borrowing shall be made on notice, given not later than (x) 11:00 A.M. (New York City time) on the third Business Day prior to the date of the proposed Revolving Credit Borrowing in the case of a Revolving Credit Borrowing consisting of Eurocurrency Rate Advances denominated in Dollars, (y) 4:00 P.M. (London time) on the third Business Day prior to the date of the proposed Revolving Credit Borrowing in the case of a Revolving Credit Borrowing consisting of Eurocurrency Rate Advances denominated in any Committed Currency, or (z) 11:00 A.M. (New York City time) on the first Business Day prior to the date of the proposed Revolving Credit Borrowing in the case of a Revolving Credit Borrowing consisting of Base Rate Advances, by any Borrower to Citibank, as Administrative Agent (and, in the case of a Revolving Credit Borrowing consisting of Eurocurrency Rate Advances, simultaneously to the Administrative Sub-Agent), which shall give to each Lender prompt notice thereof by telecopier or telex. Each such notice of a Revolving Credit Borrowing (a "Notice of Revolving Credit Borrowing") shall be by telephone, confirmed immediately in writing, or telecopier or telex in substantially the form of Exhibit B-1 hereto, specifying therein the requested (i) date of such Revolving Credit Borrowing, (ii) Type of Advances comprising such Revolving Credit Borrowing, (iii) aggregate amount of such Revolving Credit Borrowing, and (iv) in the case of a Revolving Credit Borrowing consisting of Eurocurrency Rate Advances, initial Interest Period and currency for each such Revolving Credit Advance. Each Borrower agrees that each Notice of Revolving Credit Borrowing shall be delivered by PM Companies from its office in New York, New York or its office in Zug, Switzerland. Each Lender shall, before 11:00 A.M. (New York City time) on the date of such Revolving Credit Borrowing, in the case of a Revolving Credit Borrowing consisting of Advances denominated in Dollars, and before 11:00 A.M. (London time) on the date of such Revolving Credit Borrowing, in the case of a Revolving Credit Borrowing consisting of Eurocurrency Rate Advances denominated in any Committed Currency, make available for the account of its Applicable Lending Office to Citibank, as Administrative Agent, at the applicable Citibank's Administrative Agent Account, in same day funds, such Lender's ratable portion of such Revolving Credit Borrowing. After receipt of such funds by Citibank, as Administrative Agent, and upon fulfillment of the applicable conditions set forth in Article III, Citibank, as Administrative Agent, will make such funds available to the Borrower requesting the Revolving Credit Borrowing at the address of Citibank, as Administrative Agent, referred to in Section 9.02 or at the applicable Payment Office, as the case may be. (b) Anything in subsection (a) above to the contrary notwithstanding, no Borrower may select Eurocurrency Rate Advances for any Revolving Credit Borrowing if the obligation of the Lenders to make Eurocurrency Rate Advances shall then be suspended pursuant to Section 2.09 or 2.12. (c) Each Notice of Revolving Credit Borrowing of any Borrower shall be irrevocable and binding on such Borrower. In the case of any Revolving Credit Borrowing that the related Notice of Revolving Credit Borrowing specifies is to be comprised of Eurocurrency Rate Advances, the Borrower requesting such Revolving Credit Borrowing shall indemnify each Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill on or before the date specified in such Notice of Revolving Credit Borrowing for such Revolving Credit Borrowing the applicable conditions set forth in Article III, including, without limitation, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Revolving Credit Advance to be made by such Lender as part of such Revolving Credit Borrowing when such Revolving Credit Advance, as a result of such failure, is not made on such date. (d) Unless Citibank, as Administrative Agent, shall have received notice from a Lender prior to the date of any Revolving Credit Borrowing that such Lender will not make available to Citibank, as Administrative Agent, such Lender's ratable portion of such Revolving Credit Borrowing, Citibank, as Administrative Agent, may 13 assume that such Lender has made such portion available to Citibank, as Administrative Agent, on the date of such Revolving Credit Borrowing in accordance with subsection (a) of this Section 2.02 and Citibank, as Administrative Agent, may, in reliance upon such assumption, make available to the Borrower proposing such Revolving Credit Borrowing on such date a corresponding amount. If and to the extent that such Lender shall not have so made such ratable portion available to Citibank, as Administrative Agent, such Lender and such Borrower severally agree to repay to Citibank, as Administrative Agent, forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to such Borrower until the date such amount is repaid to Citibank, as Administrative Agent, at (i) in the case of such Borrower, the higher of (A) the interest rate applicable at the time to Revolving Credit Advances comprising such Revolving Credit Borrowing and (B) the cost of funds incurred by Citibank, as Administrative Agent, in respect of such amount and (ii) in the case of such Lender, (A) the Federal Funds Rate in the case of Advances denominated in Dollars or (B) the cost of funds incurred by Citibank, as Administrative Agent, in respect of such amount in the case of Advances denominated in Committed Currencies. If such Lender shall repay to Citibank, as Administrative Agent, such corresponding amount, such amount so repaid shall constitute such Lender's Revolving Credit Advance as part of such Revolving Credit Borrowing for purposes of this Agreement. (e) The failure of any Lender to make the Revolving Credit Advance to be made by it as part of any Revolving Credit Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Revolving Credit Advance on the date of such Revolving Credit Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Revolving Credit Advance to be made by such other Lender on the date of any Revolving Credit Borrowing. SECTION 2.03. The Competitive Bid Advances. (a) Each Lender severally agrees that any Borrower may make Competitive Bid Borrowings under this Section 2.03 from time to time on any Business Day during the period from the date hereof until the date occurring 30 days prior to the Termination Date in the manner set forth below; provided that, following the making of each Competitive Bid Borrowing, (x) the aggregate amount of the Advances denominated in a Foreign Currency (based on the Equivalent in Dollars at the time such Competitive Bid Borrowing is requested) then outstanding shall not exceed $2,000,000,000 and (y) the aggregate amount of the Advances (based in respect of any Advance denominated in a Foreign Currency on the Equivalent in Dollars at the time such Competitive Bid Borrowing is requested) then outstanding shall not exceed the aggregate amount of the Commitments of the Lenders. (i) Any Borrower may request a Competitive Bid Borrowing under this Section 2.03 by delivering to Citibank, as Administrative Agent (and, in the case of a Competitive Bid Borrowing not consisting of Fixed Rate Advances or LIBO Rate Advances to be denominated in Dollars, simultaneously to the Administrative Sub-Agent), by telecopier or telex, a notice of a Competitive Bid Borrowing (a "Notice of Competitive Bid Borrowing"), in substantially the form of Exhibit B-2 hereto, specifying therein the requested (A) date of such proposed Competitive Bid Borrowing, (B) aggregate amount of such proposed Competitive Bid Borrowing, (C) interest rate basis and day count convention to be offered by the Lenders, (D) currency of such proposed Competitive Bid Borrowing, (E) in the case of a Competitive Bid Borrowing consisting of LIBO Rate Advances, Interest Period, or in the case of a Competitive Bid Borrowing consisting of Fixed Rate Advances or Local Rate Advances, maturity date for repayment of each Fixed Rate Advance or Local Rate Advance to be made as part of such Competitive Bid Borrowing (which maturity date may not be earlier than the date occurring seven days after the date of such Competitive Bid Borrowing or later than the earlier of (I) 360 days after the date of such Competitive Bid Borrowing and (II) the Termination Date), (F) interest payment date or dates relating thereto, (G) location of such Borrower's account to which funds are to be advanced and (H) other terms (if any) to be applicable to such Competitive Bid Borrowing, not later than (w) 10:00 A.M. (New York City time) at least two Business Days prior to the date of the proposed Competitive Bid Borrowing, if such Borrower shall specify in the 14 Notice of Competitive Bid Borrowing that the rates of interest to be offered by the Lenders shall be fixed rates per annum (the Advances comprising any such Competitive Bid Borrowing being referred to herein as "Fixed Rate Advances") and that the Advances comprising such proposed Competitive Bid Advances shall be denominated in Dollars, (x) 10:00 A.M. (New York City time) at least four Business Days prior to the date of the proposed Competitive Bid Borrowing, if such Borrower shall specify in the Notice of Competitive Bid Borrowing that the Competitive Bid Borrowing shall be LIBO Rate Advances denominated in Dollars, (y) 10:00 A.M. (London time) at least two Business Days prior to the date of the proposed Competitive Bid Borrowing, if such Borrower shall specify in the Notice of Competitive Bid Borrowing that the Advances comprising such proposed Competitive Bid Advances shall be either Fixed Rate Advances denominated in any Foreign Currency or Local Rate Advances denominated in any Foreign Currency and (z) 10:00 A.M. (London time) at least four Business Days prior to the date of the proposed Competitive Bid Borrowing, if such Borrower shall instead specify in the Notice of Competitive Bid Borrowing that the Advances comprising such Competitive Bid Borrowing shall be LIBO Rate Advances denominated in any Foreign Currency. Each Notice of Competitive Bid Borrowing shall be irrevocable and binding on such Borrower. Any Notice of Competitive Bid Borrowing by a Designated Subsidiary shall be given to Citibank, as Administrative Agent, or to the Administrative Sub-Agent, as the case may be, in accordance with the preceding sentence through PM Companies from its office in New York, New York or its office in Zug, Switzerland on behalf of such Designated Subsidiary. Citibank, as Administrative Agent, shall in turn promptly notify each Lender of each request for a Competitive Bid Borrowing received by it from such Borrower by sending such Lender a copy of the related Notice of Competitive Bid Borrowing. (ii) Each Lender may, if, in its sole discretion, it elects to do so, irrevocably offer to make one or more Competitive Bid Advances to the Borrower proposing the Competitive Bid Borrowing as part of such proposed Competitive Bid Borrowing at a rate or rates of interest specified by such Lender in its sole discretion, by notifying Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be (which shall give prompt notice thereof to such Borrower), (A) before 9:30 A.M. (New York City time) on the Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of Fixed Rate Advances denominated in Dollars, (B) before 9:30 A.M. (New York City time) on the third Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of LIBO Rate Advances denominated in Dollars, (C) before 12:00 noon (London time) on the Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of either Fixed Rate Advances denominated in any Foreign Currency or Local Rate Advances denominated in any Foreign Currency and (D) before 12:00 noon (London time) on the third Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of LIBO Rate Advances denominated in any Foreign Currency, of the minimum amount and maximum amount of each Competitive Bid Advance which such Lender would be willing to make as part of such proposed Competitive Bid Borrowing (which amounts or the Equivalent thereof in Dollars, as the case may be, may, subject to the proviso to the first sentence of this Section 2.03(a), exceed such Lender's Commitment) the rate or rates of interest therefor and such Lender's Applicable Lending Office with respect to such Competitive Bid Advance; provided that, if Citibank in its capacity as a Lender shall, in its sole discretion, elect to make any such offer, it shall notify such Borrower of such offer at least 30 minutes before the time and on the date on which notice of such election is to be given to Citibank, as Administrative Agent, or to the Administrative Sub-Agent, as the case may be, by the other Lenders. If any Lender shall elect not to make such an offer, such Lender shall so notify Citibank, as Administrative Agent, before 9:30 A.M. (New York City time) or the Administrative Sub-Agent before 12:00 noon (London time) on the date on which notice of such election is to be given to Citibank, as Administrative Agent, or to the Administrative Sub-Agent, as the case may be, by the other Lenders, and such Lender 15 shall not be obligated to, and shall not, make any Competitive Bid Advance as part of such Competitive Bid Borrowing; provided further that the failure by any Lender to give such notice shall not cause such Lender to be obligated to make any Competitive Bid Advance as part of such proposed Competitive Bid Borrowing. (iii) The Borrower proposing the Competitive Bid Borrowing shall, in turn, (A) before 12:00 noon (New York City time) on the Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of Fixed Rate Advances denominated in Dollars, (B) before 12:00 noon (New York City time) on the third Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of LIBO Rate Advances denominated in Dollars, (C) before 3:00 P.M. (London time) on the Business Day prior to the date of such proposed Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of either Fixed Rate Advances denominated in any Foreign Currency or Local Rate Advances denominated in any Foreign Currency and (D) before 3:00 P.M. (London time) on the third Business Day prior to the date of such Competitive Bid Borrowing, in the case of a Competitive Bid Borrowing consisting of LIBO Rate Advances denominated in any Foreign Currency, either: (x) cancel such Competitive Bid Borrowing by giving Citibank, as Administrative Agent, notice to that effect, or (y) accept one or more of the offers made by any Lender or Lenders pursuant to paragraph (ii) above, in its sole discretion, by giving notice to Citibank, as Administrative Agent, or to the Administrative Sub-Agent, as the case may be, of the amount of each Competitive Bid Advance (which amount shall be equal to or greater than the minimum amount, and equal to or less than the maximum amount, notified to such Borrower by Citibank, as Administrative Agent, or by the Administrative Sub-Agent, as the case may be, on behalf of such Lender for such Competitive Bid Advance pursuant to paragraph (ii) above) to be made by each Lender as part of such Competitive Bid Borrowing, and reject any remaining offers made by Lenders pursuant to paragraph (ii) above by giving Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, notice to that effect. Such Borrower shall accept the offers made by any Lender or Lenders to make Competitive Bid Advances in order of the lowest to the highest rates of interest offered by such Lenders. If two or more Lenders have offered the same interest rate, the amount to be borrowed at such interest rate will be allocated among such Lenders in proportion to the maximum amount that each such Lender offered at such interest rate. (iv) If the Borrower proposing the Competitive Bid Borrowing notifies Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, that such Competitive Bid Borrowing is cancelled pursuant to paragraph (iii)(x) above, or if such Borrower fails to give timely notice in accordance with paragraph (iii) above, Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, shall give prompt notice thereof to the Lenders and such Competitive Bid Borrowing shall not be made. (v) If the Borrower proposing the Competitive Bid Borrowing accepts one or more of the offers made by any Lender or Lenders pursuant to paragraph (iii)(y) above, Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, shall in turn promptly notify (A) each Lender that has made an offer as described in paragraph (ii) above, of the date and aggregate amount of such Competitive Bid Borrowing and whether or not any offer or offers made by such Lender pursuant to paragraph (ii) above have been accepted by such Borrower, (B) each Lender that is to make a Competitive Bid Advance as part of such Competitive Bid Borrowing, of the amount of each Competitive Bid Advance 16 to be made by such Lender as part of such Competitive Bid Borrowing, and (C) each Lender that is to make a Competitive Bid Advance as part of such Competitive Bid Borrowing, upon receipt, that Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, has received forms of documents appearing to fulfill the applicable conditions set forth in Article III. Each Lender that is to make a Competitive Bid Advance as part of such Competitive Bid Borrowing shall, before 11:00 A.M. (New York City time), in the case of Competitive Bid Advances to be denominated in Dollars or 11:00 A.M. (London time), in the case of Competitive Bid Advances to be denominated in any Foreign Currency, on the date of such Competitive Bid Borrowing specified in the notice received from Citibank, as Administrative Agent, or from the Administrative Sub-Agent, as the case may be, pursuant to clause (A) of the preceding sentence or any later time when such Lender shall have received notice from Citibank, as Administrative Agent, pursuant to clause (C) of the preceding sentence, make available for the account of its Applicable Lending Office to Citibank, as Administrative Agent, (x) in the case of a Competitive Bid Borrowing denominated in Dollars, at its address referred to in Section 9.02, in same day funds, such Lender's portion of such Competitive Bid Borrowing in Dollars and (y) in the case of a Competitive Bid Borrowing in a Foreign Currency, at the Payment Office for such Foreign Currency as shall have been notified by Citibank, as Administrative Agent, to the Lenders prior thereto, in same day funds, such Lender's portion of such Competitive Bid Borrowing in such Foreign Currency. Upon fulfillment of the applicable conditions set forth in Article III and after receipt by Citibank, as Administrative Agent, of such funds, Citibank, as Administrative Agent, will make such funds available to such Borrower at the location specified by such Borrower in its Notice of Competitive Bid Borrowing. Promptly after each Competitive Bid Borrowing Citibank, as Administrative Agent, will notify each Lender of the amount of the Competitive Bid Borrowing, the consequent Competitive Bid Reduction and the dates upon which such Competitive Bid Reduction commenced and will terminate. (vi) If the Borrower proposing the Competitive Bid Borrowing notifies Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, that it accepts one or more of the offers made by any Lender or Lenders pursuant to paragraph (iii)(y) above, such notice of acceptance shall be irrevocable and binding on such Borrower. Such Borrower shall indemnify each Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill on or before the date specified in the related Notice of Competitive Bid Borrowing for such Competitive Bid Borrowing the applicable conditions set forth in Article III, including, without limitation, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Competitive Bid Advance to be made by such Lender as part of such Competitive Bid Borrowing when such Competitive Bid Advance, as a result of such failure, is not made on such date. (b) Each Competitive Bid Borrowing shall be in an aggregate amount of $50,000,000 (or the Equivalent thereof in any Foreign Currency, determined as of the time of the applicable Notice of Competitive Bid Borrowing) or an integral multiple of $1,000,000 (or the Equivalent thereof in any Foreign Currency, determined as of the time of the applicable Notice of Competitive Bid Borrowing) in excess thereof and, following the making of each Competitive Bid Borrowing, the Borrower that has borrowed such Competitive Bid Borrowing shall be in compliance with the limitations set forth in the proviso to the first sentence of subsection (a) above. (c) Within the limits and on the conditions set forth in this Section 2.03, any Borrower may from time to time borrow under this Section 2.03, repay or prepay pursuant to subsection (d) below, and reborrow under this Section 2.03, provided that a Competitive Bid Borrowing shall not be made within two Business Days of the date of any other Competitive Bid Borrowing. 17 (d) Each Borrower that has borrowed through a Competitive Bid Borrowing shall repay to Citibank, as Administrative Agent, for the account of each Lender that has made a Competitive Bid Advance, on the maturity date of each Competitive Bid Advance (such maturity date being that specified by such Borrower for repayment of such Competitive Bid Advance in the related Notice of Competitive Bid Borrowing delivered pursuant to subsection (a)(i) above and provided in the Competitive Bid Note evidencing such Competitive Bid Advance), the then unpaid principal amount of such Competitive Bid Advance. Except as required by Section 2.10(b), no Borrower shall have any right to prepay any principal amount of any Competitive Bid Advance unless, and then only on the terms, specified by such Borrower for such Competitive Bid Advance in the related Notice of Competitive Bid Borrowing delivered pursuant to subsection (a)(i) above and set forth in the Competitive Bid Note evidencing such Competitive Bid Advance. (e) Each Borrower that has borrowed through a Competitive Bid Borrowing shall pay interest on the unpaid principal amount of each Competitive Bid Advance from the date of such Competitive Bid Advance to the date the principal amount of such Competitive Bid Advance is repaid in full, at the rate of interest for such Competitive Bid Advance specified by the Lender making such Competitive Bid Advance in its notice with respect thereto delivered pursuant to subsection (a)(ii) above, payable on the interest payment date or dates specified by such Borrower for such Competitive Bid Advance in the related Notice of Competitive Bid Borrowing delivered pursuant to subsection (a)(i) above, as provided in the Competitive Bid Note evidencing such Competitive Bid Advance. Upon the occurrence and during the continuance of an Event of Default, such Borrower shall pay interest on the amount of unpaid principal of each Competitive Bid Advance owing to a Lender, payable in arrears on the date or dates interest is payable thereon, at a rate per annum equal at all times to 1% per annum above the rate per annum required to be paid on such Competitive Bid Advance under the terms of the Competitive Bid Note evidencing such Competitive Bid Advance unless otherwise agreed in such Competitive Bid Note. (f) The indebtedness of any Borrower resulting from each Competitive Bid Advance made to such Borrower as part of a Competitive Bid Borrowing shall be evidenced by a separate Competitive Bid Note of such Borrower payable to the order of the Lender making such Competitive Bid Advance. SECTION 2.04. Fees. (a) Facility Fee. PM Companies agrees to pay to Citibank, as Administrative Agent, for the account of each Lender a facility fee on the aggregate amount of such Lender's Commitment (whether or not used and without giving effect to any Competitive Bid Reduction) from the date hereof in the case of each Initial Lender and from the effective date specified in the Assignment and Acceptance pursuant to which it became a Lender in the case of each other Lender until the Termination Date at the Applicable Facility Fee Rate, in each case payable on the last day of each March, June, September and December until the Termination Date and on the Termination Date. (b) Agents' Fees. PM Companies shall pay to each Administrative Agent, the Syndication Agent and the Documentation Agent for their respective own accounts such fees as may from time to time be agreed between PM Companies and each such Agent. SECTION 2.05. Termination or Reduction of the Commitments. (a) Optional. PM Companies shall have the right, upon at least three Business Days' notice to Citibank, as Administrative Agent, to terminate in whole or reduce ratably in part the unused portions of the respective Commitments of the Lenders, provided that each partial reduction shall be in the aggregate amount of no less than $50,000,000 and provided further that the aggregate amount of the Commitments of the Lenders shall not be reduced to an amount that is less than the aggregate principal amount of the Competitive Bid Advances denominated in Dollars then outstanding plus the Equivalent in Dollars (determined as of the date of the notice of prepayment) of the aggregate principal amount of the Competitive Bid Advances denominated in Foreign Currencies then outstanding. 18 (b) Mandatory. In the event that there shall be an Asset Disposition, the respective Commitments of the Lenders shall be reduced ratably by an aggregate amount equal to 100% of the net after-tax proceeds of such Asset Disposition. For the purpose of this subsection (b) any net after-tax non-cash proceeds or spin-off shall be valued at (i) the greater of (x) the book value and (y) the fair market value (as determined in good faith by the Board of Directors of PM Companies) of the assets subject to such Asset Disposition, less (ii) the cash proceeds, if any, received as a result of such Asset Disposition. In the event that the purchase price of assets subject to an Asset Disposition is subject to adjustment, as a result of which PM Companies reasonably believes that the proceeds ultimately to be received therefrom will be reduced, then until such time as such adjustment is finalized, for purposes of this subsection (b) the "net after-tax proceeds" shall include only the amount of those proceeds actually received by PM Companies or any affiliate of PM Companies, less an adjustment reserve in an amount reasonably determined by PM Companies to be equivalent to such adjustment therein. As soon as such adjustment is finalized, any further reduction in the Commitments shall be made as above provided in this subsection (b). Any reduction pursuant to this subsection (b) shall be effective on a date selected by PM Companies but in any event no later than the last day of the calendar quarter during which the Asset Disposition occurs; provided that any reduction which would be in amount less than $50,000,000 shall not be made but shall be included in the calculation of the subsequent reduction or reductions provided for in this subsection (b) until the aggregate amount of any such subsequent reduction shall be at least equal to $50,000,000, and such reduction shall then be made as above provided in this subsection (b). SECTION 2.06. Repayment of Revolving Credit Advances. Each Borrower shall repay to Citibank, as Administrative Agent, for the ratable account of the Lenders on the Termination Date the aggregate principal amount of the Revolving Credit Advances then outstanding. SECTION 2.07. Interest on Revolving Credit Advances. (a) Scheduled Interest. Each Borrower shall pay interest on the unpaid principal amount of each Revolving Credit Advance owing by such Borrower to each Lender from the date of such Revolving Credit Advance until such principal amount shall be paid in full, at the following rates per annum: (i) Base Rate Advances. During such periods as such Revolving Credit Advance is a Base Rate Advance, a rate per annum equal at all times to the Base Rate in effect from time to time, payable in arrears monthly on the 20th day of each month and on the date such Base Rate Advance shall be Converted or paid in full. (ii) Eurocurrency Rate Advances. During such periods as such Revolving Credit Advance is a Eurocurrency Rate Advance, a rate per annum equal at all times during each Interest Period for such Revolving Credit Advance to the sum of (x) the Eurocurrency Rate for such Interest Period for such Revolving Credit Advance plus (y) the Applicable Interest Rate Margin in effect from time to time, payable in arrears on the last day of such Interest Period and, if such Interest Period has a duration of more than three months, on each day that occurs during such Interest Period every three months from the first day of such Interest Period and on the date such Eurocurrency Rate Advance shall be Converted or paid in full. (b) Default Interest. Upon the occurrence and during the continuance of an Event of Default, each Borrower shall pay interest on the unpaid principal amount of each Revolving Credit Advance owing to each Lender, payable in arrears on the dates referred to in clause (a)(i) or (a)(ii) above, at a rate per annum equal at all times to 1% per annum above the Base Rate in effect from time to time. SECTION 2.08. Additional Interest on Eurocurrency Rate Advances. Each Borrower shall pay to each Lender, so long as such Lender shall be required under regulations of the Board of Governors of the Federal Reserve System to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency 19 Liabilities, additional interest on the unpaid principal amount of each Eurocurrency Rate Advance of such Lender to such Borrower, from the date of such Advance until such principal amount is paid in full, at an interest rate per annum equal at all times to the remainder obtained by subtracting (i) the Eurocurrency Rate for the Interest Period for such Advance from (ii) the rate obtained by dividing such Eurocurrency Rate by a percentage equal to 100% minus the Eurocurrency Rate Reserve Percentage of such Lender for such Interest Period, payable on each date on which interest is payable on such Advance. Such additional interest shall be determined by such Lender and notified to PM Companies through Citibank, as Administrative Agent. SECTION 2.09. Interest Rate Determination. (a) (i) In the event that the relevant Eurocurrency Rate or LIBO Rate does not appear on the Telerate Pages 3740 and 3750 (or any successor pages, respectively), each Reference Bank agrees to furnish to Citibank, as Administrative Agent, timely information for the purpose of determining each Eurocurrency Rate and each LIBO Rate. If any one or more of the Reference Banks shall not furnish such timely information to Citibank, as Administrative Agent, for the purpose of determining any such interest rate, Citibank, as Administrative Agent, shall determine such interest rate on the basis of timely information furnished by the remaining Reference Banks. (ii) Citibank, as Administrative Agent, shall give prompt notice to PM Companies and the Lenders of the applicable interest rate determined by Citibank, as Administrative Agent, for purposes of Section 2.07(a)(i) or (ii) or the determination of the applicable LIBO Rate, and the rate, if any, furnished by each Reference Bank for the purpose of determining the interest rate under Section 2.07(a)(ii) or the applicable LIBO Rate. (b) If, with respect to any Eurocurrency Rate Advances, the Required Lenders notify Citibank, as Administrative Agent, that (i) they are unable to obtain matching deposits in the London inter-bank market at or about 11:00 A.M. (London time) on the second Business Day before the making of a Borrowing in sufficient amounts to fund their respective Revolving Credit Advances as a part of such Borrowing during its Interest Period or (ii) the Eurocurrency Rate for any Interest Period for such Advances will not adequately reflect the cost to such Required Lenders of making, funding or maintaining their respective Eurocurrency Rate Advances for such Interest Period, Citibank, as Administrative Agent, shall forthwith so notify PM Companies and the Lenders, whereupon (A) the Borrower of such Eurocurrency Rate Advances will, on the last day of the then existing Interest Period therefor, (1) if such Eurocurrency Rate Advances are denominated in Dollars, either (x) prepay such Advances or (y) Convert such Advances into Base Rate Advances and (2) if such Eurocurrency Rate Advances are denominated in any Committed Currency, either (x) prepay such Advances or (y) redenominate such Advances into an Equivalent amount of Dollars and Convert such Advances into Base Rate Advances and (B) the obligation of the Lenders to make, or to Convert Revolving Credit Advances into, Eurocurrency Rate Advances shall be suspended until Citibank, as Administrative Agent, shall notify PM Companies and the Lenders that the circumstances causing such suspension no longer exist; provided that, if the circumstances set forth in clause (ii) above are applicable, the applicable Borrower may elect, by notice to Citibank, as Administrative Agent, and the Lenders, to continue such Advances in such Committed Currency for Interest Periods of not longer than one month, which Advances shall thereafter bear interest at a rate per annum equal to the Applicable Margin plus, for each Lender, the cost to such Lender (expressed as a rate per annum) of funding its Eurocurrency Rate Advances by whatever means it reasonably determines to be appropriate. Each Lender shall certify its cost of funds for each Interest Period to Citibank, as Administrative Agent, and the PM Companies as soon as practicable (but in any event not later than ten Business Days after the first day of such Interest Period). (c) If any Borrower shall fail to select the duration of any Interest Period for any Eurocurrency Rate Advances in accordance with the provisions contained in the definition of "Interest Period" in Section 1.01, Citibank, as Administrative Agent, will forthwith so notify such Borrower and the Lenders and such Advances will automatically, on the last day of the then existing Interest Period therefor, (i) if such Eurocurrency Rate Advances 20 are denominated in Dollars, Convert into Base Rate Advances and (ii) if such Eurocurrency Rate Advances are denominated in a Committed Currency, be redenominated into an Equivalent amount of Dollars and be Converted into Base Rate Advances. (d) Upon the occurrence and during the continuance of any Event of Default under Section 6.01(a), (i) each Eurocurrency Rate Advance will automatically, on the last day of the then existing Interest Period therefor, (A) if such Eurocurrency Rate Advances are denominated in Dollars, be Converted into Base Rate Advances and (B) if such Eurocurrency Rate Advances are denominated in any Committed Currency, be redenominated into an Equivalent amount of Dollars and be Converted into Base Rate Advances and (ii) the obligation of the Lenders to make, or to Convert Advances into, Eurocurrency Rate Advances shall be suspended; provided that PM Companies and the applicable Borrower may elect, by notice to Citibank, as Administrative Agent, and the Lenders within one Business Day of such Event of Default, to continue such Advances in such Committed Currency, whereupon Citibank, as Administrative Agent, may require that each Interest Period relating to such Eurocurrency Rate Advances shall bear interest at the Overnight Eurocurrency Rate for a period of three Business Days and thereafter, each such Interest Period shall have a duration of not longer than one month. "Overnight Eurocurrency Rate" means the rate per annum applicable to an overnight period beginning on one Business Day and ending on the next Business Day equal to the sum of 1%, the Applicable Interest Rate Margin and the average, rounded upward to the nearest whole multiple of 1/16 of 1%, if such average is not such a multiple, of the respective rates per annum quoted by each Reference Bank to Citibank, as Administrative Agent, on request as the rate at which it is offering overnight deposits in the relevant currency in amounts comparable to such Reference Bank's Eurocurrency Rate Advances. (e) If fewer than two Reference Banks furnish timely information to Citibank, as Administrative Agent, for determining the Eurocurrency Rate or LIBO Rate for any Eurocurrency Rate Advances or LIBO Rate Advances, as the case may be, (i) Citibank, as Administrative Agent, shall forthwith notify PM Companies and the Lenders that the interest rate cannot be determined for such Eurocurrency Rate Advances or LIBO Rate Advances, as the case may be, (ii) with respect to Eurocurrency Rate Advances, each such Advance will, on the last day of the then existing Interest Period therefor, (A) if such Eurocurrency Rate Advance is denominated in Dollars, be prepaid by the applicable Borrower or be automatically Converted into a Base Rate Advance and (B) if such Eurocurrency Rate Advance is denominated in any Committed Currency, be prepaid by the applicable Borrower or be automatically redenominated into an Equivalent amount of Dollars and be Converted into a Base Rate Advance (or if such Advance is then a Base Rate Advance, will continue as a Base Rate Advance), and (iii) the obligation of the Lenders to make Eurocurrency Rate Advances or LIBO Rate Advances or to Convert Revolving Credit Advances into Eurocurrency Rate Advances shall be suspended until Citibank, as Administrative Agent, shall notify PM Companies and the Lenders that the circumstances causing such suspension no longer exist. SECTION 2.10. Prepayments of Advances. (a) Optional Prepayments of Revolving Credit Advances. Each Borrower may, in the case of any Eurocurrency Rate Advance upon at least three Business Days' notice to Citibank, as Administrative Agent, or, in the case of any Base Rate Advance, upon notice given to Citibank, as Administrative Agent, not later than 11:00 A.M. (New York City time) on the date of the proposed prepayment, in each case stating the proposed date and aggregate principal amount of the prepayment, and if such notice is given such Borrower shall, prepay the outstanding principal amount of the Revolving Credit Advances 21 comprising part of the same Revolving Credit Borrowing in whole or ratably in part, together with accrued interest to the date of such prepayment on the principal amount prepaid; provided, however, that (x) each partial prepayment shall be in an aggregate principal amount of no less than $50,000,000 or the Equivalent thereof in a Committed Currency (determined on the date notice of prepayment is given) and (y) in the event of any such prepayment of a Eurocurrency Rate Advance, such Borrower shall be obligated to reimburse the Lenders in respect thereof pursuant to Section 9.04(b). (b) Mandatory Prepayments. (i) If Citibank, as Administrative Agent, notifies PM Companies that, on any interest payment date, the sum of (A) the aggregate principal amount of all Advances denominated in Dollars then outstanding plus (B) the Equivalent in Dollars (determined on the third Business Day prior to such interest payment date) of the aggregate principal amount of all Advances denominated in Foreign Currencies then outstanding exceeds 105% of the aggregate Commitments of the Lenders on such date, PM Companies and each other Borrower shall, within two Business Days after receipt of such notice, prepay the outstanding principal amount of any Advances owing by such Borrower in an aggregate amount sufficient to reduce such sum to an amount not to exceed 100% of the aggregate Commitments of the Lenders on such date. (ii) If Citibank, as Administrative Agent, notifies PM Companies that, on any interest payment date, the Equivalent in Dollars (determined on the third Business Day prior to such interest payment date) of the aggregate principal amount of all Advances denominated in Foreign Currencies outstanding exceeds 105% of $2,000,000,000, PM Companies and each other Borrower shall, within two Business Days after receipt of such notice, prepay the outstanding principal amount of any Advances denominated in a Foreign Currency owing by such Borrower in an aggregate amount sufficient to reduce such amount to $2,000,000,000 or less. (iii) The Borrower shall, on each Business Day, prepay an aggregate principal amount of the Advances equal to the amount by which (A) the aggregate principal amount of the Advances then outstanding exceeds (B) the aggregate of the Commitments (after giving effect to the Competitive Bid Reduction) on such Business Day. (iv) Each prepayment made pursuant to this Section 2.10(b) shall be made together with any interest accrued to the date of such prepayment on the principal amounts prepaid and, in the case of any prepayment of a Eurocurrency Rate Advance, a LIBO Rate Advance or a Local Rate Advance on a date other than the last day of an Interest Period or at its maturity, any additional amounts which such Borrower shall be obligated to reimburse to the Lenders in respect thereof pursuant to Section 9.04(b). Citibank, as Administrative Agent, shall give prompt notice of any prepayment required under this Section 2.10(b) to the Borrowers and the Lenders. SECTION 2.11. Increased Costs. (a) If, due to either (i) the introduction of or any change (other than any change by way of imposition or increase of reserve requirements included in the Eurocurrency Rate Reserve Percentage) in or in the interpretation of any law or regulation or (ii) the compliance with any guideline or request from any central bank or other governmental authority (whether or not having the force of law), there shall be any increase in the cost to any Lender of agreeing to make or making, funding or maintaining Eurocurrency Rate Advances or LIBO Rate Advances (excluding for purposes of this Section 2.11 any such increased costs resulting from (i) Taxes or Other Taxes (as to which Section 2.14 shall govern) and (ii) changes in the basis of taxation of overall net income or overall gross income by the United States or by the foreign jurisdiction or state under the laws of which such Lender is organized or has its Applicable Lending Office or any political subdivision thereof), then the Borrower of the affected Advances shall from time to time, upon demand by such Lender (with a copy of such demand to Citibank, as Administrative Agent), pay to Citibank, as Administrative Agent, for the account of such Lender additional amounts sufficient to compensate such Lender for such increased cost; provided, however, that before making any such demand, each Lender agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Applicable Lending Office if the making 22 of such a designation would avoid the need for, or reduce the amount of, such increased cost and would not, in the reasonable judgment of such Lender, be otherwise disadvantageous to such Lender. A certificate as to the amount of such increased cost, submitted to PM Companies, such Borrower and Citibank, as Administrative Agent, by such Lender, shall be conclusive and binding for all purposes, absent manifest error. (b) In the event that after the date hereof the implementation of or any change in any law or regulation, or any guideline or directive (whether or not having the force of law) or the interpretation or administration thereof by any central bank or other authority charged with the administration thereof, imposes, modifies or deems applicable any capital adequacy or similar requirement (including, without limitation, a request or requirement which affects the manner in which any Lender allocates capital resources to its commitments, including its obligations hereunder) and as a result thereof, in the sole opinion of such Lender, the rate of return on such Lender's capital as a consequence of its obligations hereunder is reduced to a level below that which such Lender could have achieved but for such circumstances, but reduced to the extent that Borrowings are outstanding from time to time, then in each such case upon demand from time to time PM Companies shall pay to such Lender such additional amount or amounts as shall compensate such Lender for such reduction in rate of return, provided that, in the case of each Lender, such additional amount or amounts shall not exceed 0.15 of 1% per annum on such Lender's Commitment. A certificate of such Lender as to any such additional amount or amounts shall be conclusive and binding for all purposes, absent manifest error. Except as provided below, in determining any such amount or amounts each Lender may use any reasonable averaging and attribution methods. Notwithstanding the foregoing, each Lender shall take all reasonable actions to avoid the imposition of, or reduce the amounts of, such increased costs, provided that such actions, in the reasonable judgment of such Lender, will not be otherwise disadvantageous to such Lender, and, to the extent possible, each Lender will calculate such increased costs based upon the capital requirements for its commitment hereunder and not upon the average or general capital requirements imposed upon such Lender. SECTION 2.12. Illegality. Notwithstanding any other provision of this Agreement, if any Lender shall notify Citibank, as Administrative Agent, that the introduction of or any change in or in the interpretation of any law or regulation makes it unlawful, or any central bank or other governmental authority asserts that it is unlawful, for any Lender or its Eurocurrency Lending Office to perform its obligations hereunder to make Eurocurrency Rate Advances in Dollars or any Committed Currency or LIBO Rate Advances in Dollars or any Foreign Currency or to fund or maintain Eurocurrency Rate Advances in Dollars or any Committed Currency or LIBO Rate Advances in Dollars or any Foreign Currency hereunder, (a) each Eurocurrency Rate Advance or LIBO Rate Advance, as the case may be, will automatically, upon such demand, if such Eurocurrency Rate Advance or LIBO Rate Advance is denominated in Dollars, be Converted into a Base Rate Advance or an Advance that bears interest at the rate set forth in Section 2.07(a)(i), as the case may be, and (ii) if such Eurocurrency Rate Advance or LIBO Rate Advance is denominated in any Foreign Currency, be redenominated into an Equivalent amount of Dollars and be Converted into a Base Rate Advance or an Advance that bears interest at the rate set forth in Section 2.07(a)(i), as the case may be, and (b) the obligation of the Lenders to make Eurocurrency Rate Advances or LIBO Rate Advances or to Convert Revolving Credit Advances into Eurocurrency Rate Advances shall be suspended until Citibank, as Administrative Agent, shall notify PM Companies and the Lenders that the circumstances causing such suspension no longer exist; provided, however, that before making any such demand, each Lender agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Eurocurrency Lending Office if the making of such a designation would allow such Lender or its Eurocurrency Lending Office to continue to perform its obligations to make Eurocurrency Rate Advances or to continue to fund or maintain Eurocurrency Rate Advances and would not, in the judgment of such Lender, be otherwise disadvantageous to such Lender. SECTION 2.13. Payments and Computations. (a) PM Companies and each Borrower shall make each payment hereunder, except with respect to principal of, interest on, and other amounts relating to, Advances 23 denominated in a Foreign Currency, not later than 11:00 A.M. (New York City time) on the day when due in Dollars to Citibank, as Administrative Agent, at the applicable Citibank's Administrative Agent Account in same day funds. PM Companies and each Borrower shall make each payment hereunder with respect to principal of, interest on, and other amounts relating to, Advances denominated in a Foreign Currency, not later than 11:00 A.M. (at the Payment Office for such Foreign Currency) on the day when due in such Foreign Currency to Citibank, as Administrative Agent, in same day funds, by deposit of such funds to the applicable Citibank's Administrative Agent Account in same day funds. Citibank, as Administrative Agent, will promptly thereafter cause to be distributed like funds relating to the payment of principal or interest or facility fees ratably (other than amounts payable pursuant to Section 2.03, 2.11, 2.14 or 9.04(b)) to the Lenders for the account of their respective Applicable Lending Offices, and like funds relating to the payment of any other amount payable to any Lender to such Lender for the account of its Applicable Lending Office, in each case to be applied in accordance with the terms of this Agreement. Upon its acceptance of an Assignment and Acceptance and recording of the information contained therein in the Register pursuant to Section 9.07(c), from and after the effective date specified in such Assignment and Acceptance, Citibank, as Administrative Agent, shall make all payments hereunder in respect of the interest assigned thereby to the Lender assignee thereunder, and the parties to such Assignment and Acceptance shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves. (b) Each Borrower hereby authorizes each Lender, if and to the extent payment owed to such Lender is not made to Citibank, as Administrative Agent, when due hereunder, to charge from time to time against any or all of such Borrower's accounts with such Lender any amount so due. (c) All computations of interest based on the Base Rate shall be made by Citibank, as Administrative Agent, on the basis of a year of 365 or 366 days, as the case may be, all computations of interest based on the Eurocurrency Rate or the Federal Funds Rate and of facility fees shall be made by Citibank, as Administrative Agent, on the basis of a year of 360 days and computations in respect of Competitive Bid Advances shall be made by Citibank, as Administrative Agent, or the Administrative Sub-Agent, as the case may be, as specified in the applicable Notice of Competitive Bid Notice (or, in each case of Advances denominated in Foreign Currencies where market practice differs, in accordance with market practice), in each case for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest or facility fees are payable. Each determination by Citibank, as Administrative Agent (or, in the case of Section 2.08, by a Lender), of an interest rate hereunder shall be conclusive and binding for all purposes, absent manifest error. (d) Whenever any payment hereunder shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest or facility fee, as the case may be; provided, however, that, if such extension would cause payment of interest on or principal of Eurocurrency Rate Advances or LIBO Rate Advances to be made in the next following calendar month, such payment shall be made on the next preceding Business Day. (e) Unless Citibank, as Administrative Agent, shall have received notice from any Borrower prior to the date on which any payment is due to the Lenders hereunder that such Borrower will not make such payment in full, Citibank, as Administrative Agent, may assume that such Borrower has made such payment in full to Citibank, as Administrative Agent, on such date and Citibank, as Administrative Agent, may, in reliance upon such assumption, cause to be distributed to each Lender on such due date an amount equal to the amount then due such Lender. If and to the extent such Borrower shall not have so made such payment in full to Citibank, as Administrative Agent, each Lender shall repay to Citibank, as Administrative Agent, forthwith on demand such amount distributed to such Lender together with interest thereon, for each day from the date such amount is distributed to such Lender until the date such Lender repays such amount to Citibank, as Administrative Agent, at (i) the Federal Funds Rate in the case of Advances denominated in Dollars or (ii) the cost of funds incurred by 24 Citibank, as Administrative Agent, in respect of such amount in the case of Advances denominated in Foreign Currencies. SECTION 2.14. Taxes. (a) Any and all payments by each Borrower and PM Companies hereunder shall be made, in accordance with Section 2.13, free and clear of and without deduction for any and all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding, (i) in the case of each Lender and Citibank, as Administrative Agent, taxes imposed on its net income, and franchise taxes imposed on it, by the jurisdiction under the laws of which such Lender or Citibank, as Administrative Agent (as the case may be), is organized or any political subdivision thereof, (ii) in the case of each Lender, taxes imposed on its net income, and franchise taxes imposed on it, by the jurisdiction of such Lender's Applicable Lending Office or any political subdivision thereof, and (iii) in the case of each Lender and Citibank, as Administrative Agent, taxes imposed by the United States by means of withholding tax if and to the extent that such taxes shall be in effect and shall be applicable on the date hereof, to payments to be made to such Lender's Applicable Lending Office or to Citibank, as Administrative Agent (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities in respect of payments hereunder being hereinafter referred to as "Taxes"). If any Borrower or PM Companies shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Lender or Citibank, as Administrative Agent, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 2.14) such Lender or Citibank, as Administrative Agent (as the case may be), receives an amount equal to the sum it would have received had no such deductions been made, (ii) such Borrower or PM Companies shall make such deductions and (iii) such Borrower or PM Companies shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. (b) In addition, each Borrower or PM Companies shall pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies that arise from any payment made hereunder or from the execution, delivery or registration of, performing under, or otherwise with respect to, this Agreement (hereinafter referred to as "Other Taxes"). (c) Each Borrower and PM Companies shall indemnify each Lender and Citibank, as Administrative Agent, for and hold it harmless against the full amount of Taxes or Other Taxes (including, without limitation, Taxes and Other Taxes imposed by any jurisdiction on amounts payable under this Section 2.14) paid by such Lender or Citibank, as Administrative Agent (as the case may be), and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted. This indemnification shall be made within 30 days from the date such Lender or Citibank, as Administrative Agent (as the case may be), makes written demand therefor. (d) Within 30 days after the date of any payment of Taxes, each Borrower and PM Companies shall furnish to Citibank, as Administrative Agent, at its address referred to in Section 9.02, the original or a certified copy of a receipt evidencing such payment. If any Borrower or PM Companies determines that no Taxes are payable in respect thereof, such Borrower or PM Companies shall, at the request of Citibank, as Administrative Agent, furnish or cause the payor to furnish, Citibank, as Administrative Agent, and each Lender an opinion of counsel reasonably acceptable to Citibank, as Administrative Agent, stating that such payment is exempt from Taxes. (e) Each Lender, on or prior to the date of its execution and delivery of this Agreement in the case of each Initial Lender and on the date of the Assignment and Acceptance pursuant to which it becomes a Lender in the case of each other Lender, and from time to time thereafter as requested in writing by any Borrower, PM Companies or Citibank, as Administrative Agent (but only so long as such Lender remains lawfully able to do so), shall provide each of Citibank, as Administrative Agent, PM Companies and such Borrower with any form or certificate that is required by any taxing authority (including, if applicable, two original Internal Revenue Service 25 Form 1001 or 4224, as appropriate, or any successor or other form prescribed by the Internal Revenue Service), certifying that such Lender is exempt from or entitled to a reduced rate of Home Jurisdiction Withholding Taxes on payments pursuant to this Agreement. Unless the Borrowers, PM Companies and Citibank, as Administrative Agent, have received forms or other documents satisfactory to them indicating that payments hereunder are not subject to Home Jurisdiction Withholding Taxes or are subject to such tax at a rate reduced by an applicable tax treaty, such Borrower, PM Companies or Citibank, as Administrative Agent, shall withhold taxes from such payments at the applicable statutory rate in the case of payments to or for any Lender. (f) Each Initial Lender hereby confirms as of the Effective Date, and each other Lender confirms as of the effective date of the Assignment and Acceptance pursuant to which it becomes a party hereto, in favor of Citibank, as Administrative Agent, that either (i) such Lender is not resident in the United Kingdom and is beneficially entitled to the Advances and the interest thereon or (ii) it is a bank as defined for the purposes of Section 349 of the Income and Corporation Taxes Act of 1988 of the United Kingdom and is beneficially entitled to the Advances and the interest thereon, and each Lender agrees to notify Citibank, as Administrative Agent, if there is any change in its position from that set forth in this clause (f). (g) Any Lender claiming any additional amounts payable pursuant to this Section 2.14 agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to change the jurisdiction of its Applicable Lending Office if the making of such a change would avoid the need for, or reduce the amount of, any such additional amounts that may thereafter accrue and would not, in the reasonable judgment of such Lender, be otherwise disadvantageous to such Lender. SECTION 2.15. Sharing of Payments, Etc. If any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) on account of the Revolving Credit Advances owing to it (other than pursuant to Section 2.11, 2.14 or 9.04(b)) in excess of its ratable share of payments on account of the Revolving Credit Advances obtained by all the Lenders, such Lender shall forthwith purchase from the other Lenders such participations in the Revolving Credit Advances owing to them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each Lender shall be rescinded and such Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such Lender's ratable share (according to the proportion of (i) the amount of such Lender's required repayment to (ii) the total amount so recovered from the purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered. Each Borrower agrees that any Lender so purchasing a participation from another Lender pursuant to this Section 2.14 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were the direct creditor of such Borrower in the amount of such participation. SECTION 2.16. Evidence of Debt. (a) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of each Borrower to such Lender resulting from each Revolving Credit Advance owing to such Lender from time to time, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder in respect of Revolving Credit Advances. Each Borrower agrees that upon notice by any Lender to such Borrower (with a copy of such notice to Citibank, as Administrative Agent) to the effect that a Revolving Credit Note is required or appropriate in order for such Lender to evidence (whether for purposes of pledge, enforcement or otherwise) the Revolving Credit Advances owing to, or to be made by, such Lender, such Borrower shall promptly execute and deliver to such Lender a Revolving Credit Note payable to the order of such Lender in a principal amount up to the Commitment of such Lender. 26 (b) The Register maintained by Citibank, as Administrative Agent, pursuant to Section 9.07(d) shall include a control account, and a subsidiary account for each Lender, in which accounts (taken together) shall be recorded (i) the date and amount of each Borrowing made hereunder, the Type of Advances comprising such Borrowing and, if appropriate, the Interest Period applicable thereto, (ii) the terms of each Assignment and Acceptance delivered to and accepted by it, (iii) the amount of any principal or interest due and payable or to become due and payable from each Borrower to each Lender hereunder and (iv) the amount of any sum received by Citibank, as Administrative Agent, from the Borrowers hereunder and each Lender's share thereof. (c) Entries made in good faith by Citibank, as Administrative Agent, in the Register pursuant to subsection (b) above, and by each Lender in its account or accounts pursuant to subsection (a) above, shall be prima facie evidence of the amount of principal and interest due and payable or to become due and payable from each Borrower to, in the case of the Register, each Lender and, in the case of such account or accounts, such Lender, under this Agreement, absent manifest error; provided, however, that the failure of Citibank, as Administrative Agent, or such Lender to make an entry, or any finding that an entry is incorrect, in the Register or such account or accounts shall not limit or otherwise affect the obligations of any Borrower under this Agreement. SECTION 2.17. Use of Proceeds. The proceeds of the Advances shall be available (and each Borrower agrees that it shall use such proceeds) for general corporate purposes of PM Companies and its Subsidiaries. ARTICLE III CONDITIONS TO EFFECTIVENESS AND LENDING SECTION 3.01. Conditions Precedent to Effectiveness. This Agreement shall become effective on and as of the first date (the "Effective Date") on which the following conditions precedent have been satisfied: (a) PM Companies shall have notified each Lender and Citibank, as Administrative Agent, in writing as to the proposed Effective Date. (b) On the Effective Date, the following statements shall be true and Citibank, as Administrative Agent, shall have received for the account of each Lender a certificate signed by a duly authorized officer of PM Companies, dated the Effective Date, stating that: (i) The representations and warranties contained in Section 4.01 are correct on and as of the Effective Date, and (ii) No event has occurred and is continuing that constitutes a Default. (c) Citibank, as Administrative Agent, shall have received on or before the Effective Date a letter from PM Companies dated on or before such day, terminating in whole the commitments of the banks parties to (i) the 5-Year Loan and Guaranty Agreement dated as of October 26, 1995 (the "PMC Agreement") among PM Companies, the banks parties thereto and Citibank, as agent, and (ii) the 5-Year Revolving Credit Agreement dated as of October 26, 1995 (the "PMCC Agreement") among PM Companies, Philip Morris Capital Corporation, the banks parties thereto and Citibank, as agent (collectively, the "1995 Loan Agreements") and each of the Initial Lenders that is a party to the 1995 Loan Agreements hereby waives, upon execution of this Agreement, the five Business Days' notice required by 27 Section 2.05(a) of the PMC Agreement and Section 2.04 of the PMCC Agreement, respectively, relating to the termination of the commitments under such 1995 Loan Agreement. (d) PM Companies and its Subsidiaries shall have satisfied all of their respective obligations under the 1995 Loan Agreements including, without limitation, the payment of all fees under such agreements. (e) Citibank, as Administrative Agent, shall have received on or before the Effective Date the following, each dated such day, in form and substance satisfactory to Citibank, as Administrative Agent: (i) Certified copies of the resolutions of the Board of Directors of PM Companies approving this Agreement, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement. (ii) A certificate of the Secretary or an Assistant Secretary of PM Companies certifying the names and true signatures of the officers of PM Companies authorized to sign this Agreement and the other documents to be delivered hereunder. (iii) Favorable opinions of counsel (which may be in-house counsel) for PM Companies, substantially in the form of Exhibits E-1 and E-2 hereto. (iv) A favorable opinion of Shearman & Sterling, counsel for Citibank, as Administrative Agent, substantially in the form of Exhibit G hereto. (v) A certificate of the chief financial officer of PM Companies certifying that as of June 30, 1997 (A) the aggregate amount of Debt, payment of which is secured by any lien, security interest or other charge or encumbrance referred to in clause (iii) of Section 5.02(a) hereof, does not exceed $400,000,000 and (B) the aggregate amount of Debt included in clause (A) of this subsection (v) payment of which is secured by any lien, security interest or other charge or encumbrance referred to in clause (iv) of Section 5.02(a), does not exceed $200,000,000. (f) This Agreement shall have been executed by PM Companies, Citibank and Chase, as Administrative Agents, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent, and Citibank, as Administrative Agent, shall have been notified by each Initial Lender that such Initial Lender has executed this Agreement. SECTION 3.02. Initial Advance to Each Designated Subsidiary. The obligation of each Lender to make an initial Advance to each Designated Subsidiary following any designation of such Designated Subsidiary as a Borrower hereunder pursuant to Section 9.08 is subject to the receipt by Citibank, as Administrative Agent, on or before the date of such initial Advance of each of the following, in form and substance satisfactory to Citibank, as Administrative Agent, and dated such date, and in sufficient copies for each Lender: (a) Certified copies of the resolutions of the Board of Directors of such Designated Subsidiary (with a certified English translation if the original thereof is not in English) approving this Agreement, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement. 28 (b) A certificate of a proper officer of such Designated Subsidiary certifying the names and true signatures of the officers of such Designated Subsidiary authorized to sign this Agreement and the other documents to be delivered hereunder. (c) A certificate signed by a duly authorized officer of the Designated Subsidiary, dated as of the date of such initial Advance, certifying that such Designated Subsidiary shall have obtained all governmental and third party authorizations, consents, approvals (including exchange control approvals) and licenses required under applicable laws and regulations necessary for such Designated Subsidiary to execute and deliver this Agreement and to perform its obligations thereunder. (d) The Designation Agreement of such Designated Subsidiary, substantially in the form of Exhibit D hereto. (e) A favorable opinion of counsel (which may be in-house counsel) to such Designated Subsidiary, dated the date of such initial Advance, covering, to the extent customary and appropriate for the relevant jurisdiction, the opinions outlined on Exhibit F hereto. (f) Such other approvals, opinions or documents as any Lender, through Citibank, as Administrative Agent, may reasonably request. SECTION 3.03. Conditions Precedent to Each Revolving Credit Borrowing. The obligation of each Lender to make a Revolving Credit Advance on the occasion of each Revolving Credit Borrowing shall be subject to the conditions precedent that the Effective Date shall have occurred and on the date of such Revolving Credit Borrowing the following statements shall be true (and each of the giving of the applicable Notice of Revolving Credit Borrowing and the acceptance by the Borrower requesting such Revolving Credit Borrowing of the proceeds of such Revolving Credit Borrowing shall constitute a representation and warranty by such Borrower that on the date of such Borrowing such statements are true): (a) the representations and warranties contained in Section 4.01 (except the representations set forth in the last sentence of subsection (e) and in subsection (f) thereof (other than clause (i) thereof)) are correct on and as of the date of such Revolving Credit Borrowing, before and after giving effect to such Revolving Credit Borrowing and to the application of the proceeds therefrom, as though made on and as of such date, and additionally, if such Revolving Credit Borrowing shall have been requested by a Designated Subsidiary, the representations and warranties of such Designated Subsidiary contained in its Designation Agreement are correct on and as of the date of such Revolving Credit Borrowing, before and after giving effect to such Revolving Credit Borrowing and to the application of the proceeds therefrom, as though made on and as of such date; (b) no event has occurred and is continuing, or would result from such Revolving Credit Borrowing or from the application of the proceeds therefrom, that constitutes a Default; and (c) If such Revolving Credit Borrowing is in an aggregate principal amount equal to or greater than $500,000,000 and is being made in connection with any purchase of shares of such Borrower's or PM Companies's capital stock or the capital stock of any other Person, or any purchase of all or substantially all of the assets of any Person (whether in one transaction or a series of transactions) or any transaction of the type referred to in Section 5.02(b), the statement in (b) above shall also be true on a pro forma basis as if such transaction or purchase shall have been completed. 29 SECTION 3.04. Conditions Precedent to Each Competitive Bid Borrowing. The obligation of each Lender that is to make a Competitive Bid Advance on the occasion of a Competitive Bid Borrowing to make such Competitive Bid Advance as part of such Competitive Bid Borrowing is subject to the conditions precedent that (i) Citibank, as Administrative Agent, shall have received the written confirmatory Notice of Competitive Bid Borrowing with respect thereto, (ii) on or before the date of such Competitive Bid Borrowing, but prior to such Competitive Bid Borrowing, Citibank, as Administrative Agent, shall have received a Competitive Bid Note payable to the order of such Lender for each of the one or more Competitive Bid Advances to be made by such Lender as part of such Competitive Bid Borrowing, in a principal amount equal to the principal amount of the Competitive Bid Advance to be evidenced thereby and otherwise on such terms as were agreed to for such Competitive Bid Advance in accordance with Section 2.03, and (iii) on the date of such Competitive Bid Borrowing the following statements shall be true (and each of the giving of the applicable Notice of Competitive Bid Borrowing and the acceptance by the Borrower requesting such Competitive Bid Borrowing of the proceeds of such Competitive Bid Borrowing shall constitute a representation and warranty by such Borrower that on the date of such Competitive Bid Borrowing such statements are true): (a) the representations and warranties contained in Section 4.01 are correct on and as of the date of such Competitive Bid Borrowing, before and after giving effect to such Competitive Bid Borrowing and to the application of the proceeds therefrom, as though made on and as of such date, and, if such Competitive Bid Borrowing shall have been requested by a Designated Subsidiary, the representations and warranties of such Designated Subsidiary contained in its Designation Agreement are correct in on and as of the date of such Competitive Bid Borrowing, before and after giving effect to such Competitive Bid Borrowing and to the application of the proceeds therefrom, as though made on and as of such date, and (b) no event has occurred and is continuing, or would result from such Competitive Bid Borrowing or from the application of the proceeds therefrom, that constitutes a Default. SECTION 3.05. Determinations Under Section 3.01. For purposes of determining compliance with the conditions specified in Section 3.01, each Lender shall be deemed to have consented to, approved or accepted or to be satisfied with each document or other matter required thereunder to be consented to or approved by or acceptable or satisfactory to the Lenders unless an officer of Citibank, as Administrative Agent, responsible for the transactions contemplated by this Agreement shall have received notice from such Lender prior to the date that PM Companies, by notice to the Lenders, designates as the proposed Effective Date, specifying its objection thereto. Citibank, as Administrative Agent, shall promptly notify the Lenders of the occurrence of the Effective Date. ARTICLE IV REPRESENTATIONS AND WARRANTIES SECTION 4.01. Representations and Warranties of PM Companies. PM Companies represents and warrants as follows: (a) It is a corporation duly organized, validly existing and in good standing under the laws of Virginia. (b) The execution, delivery and performance of this Agreement and the Notes to be delivered by it are within its corporate powers, have been duly authorized by all necessary corporate action, and do 30 not contravene (i) its charter or by-laws or (ii) in any material respect, any law, rule, regulation or order of any court or governmental agency or any contractual restriction binding on or affecting it. (c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by it of this Agreement or the Notes to be delivered by it. (d) This Agreement is, and each of the Notes to be delivered by it when delivered hereunder will be, a legal, valid and binding obligation of PM Companies enforceable against PM Companies in accordance with its terms, subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and to the effect of general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). (e) The consolidated balance sheet of PM Companies and its Subsidiaries as at June 30, 1997 and the consolidated statements of earnings of PM Companies and its Subsidiaries for the six months then ended fairly present, in all material respects and subject to year-end audit adjustments, the consolidated financial condition of PM Companies and its Subsidiaries as at such date and the consolidated results of the operations of PM Companies and its Subsidiaries for the six-month period ended on such date, all in accordance with generally accepted accounting principles consistently applied. Except as disclosed in PM Companies' quarterly report on Form 10-Q for the quarter ended June 30, 1997, and in any Current Report on Form 8-K filed subsequent to June 30, 1997 but prior to October 14, 1997, since June 30, 1997 there has been no material adverse change in such condition or operations. (f) There is no pending or threatened action or proceeding affecting it or any of its Subsidiaries before any court, governmental agency or arbitrator (a "Proceeding"), (i) that purports to affect the legality, validity or enforceability of this Agreement or (ii) except for Proceedings disclosed in PM Companies' Quarterly Reports on Form 10-Q for the quarters ended March 31, 1997 and June 30, 1997, its Annual Report on Form 10-K for the year ended December 31, 1996, its Current Reports on Form 8-K dated June 20, 1997, June 25, 1997, July 2, 1997 and August 25, 1997 and in any Current Report on Form 8-K filed subsequent to August 25, 1997 but prior to the Effective Date or, with respect to events occurring after the date of the most recent such document but prior to October 14, 1997, a certificate delivered to the Lenders, that may materially adversely affect the financial condition or operations of PM Companies and its Subsidiaries taken as a whole. (g) It owns directly or indirectly 100% of the capital stock of each other Borrower and 100% of the capital stock of Philip Morris. ARTICLE V COVENANTS OF PM COMPANIES SECTION 5.01. Affirmative Covenants. So long as any Advance shall remain unpaid or any Lender shall have any Commitment hereunder, PM Companies will: (a) Compliance with Laws, Etc. Comply, and cause each Major Subsidiary to comply, in all material respects, with all applicable laws, rules, regulations and orders (such compliance to include, without limitation, complying with ERISA and paying before the same become delinquent all taxes, assessments and governmental charges imposed upon it or upon its property except to the extent contested 31 in good faith), noncompliance with which would materially adversely affect the financial condition or operations of PM Companies and its Subsidiaries taken as a whole. (b) Maintenance of Ratio of Net Income Before Tax to Fixed Charges. Maintain a ratio of aggregate consolidated Net Income Before Tax for the four most recent fiscal quarters for which consolidated statements of earnings have been delivered pursuant to Section 5.01(c)(i) or (ii) hereof to consolidated Fixed Charges for such four most recent fiscal quarters of not less than 2.5 to 1.0; provided that, if under the proposed Memorandum of Understanding and proposed resolution attached thereto, or under federal legislation implementing similar terms, entered into on June 20, 1997 by Philip Morris, an initial payment is made by or on behalf of Philip Morris as part of the aggregate $10,000,000,000 initial payment proposed to be made by the tobacco industry on the date federal legislation implementing the terms of the above mentioned resolution (or federal legislation implementing similar terms) is signed, such payment will not be included in such calculation. (c) Reporting Requirements. Furnish to the Lenders: (i) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of PM Companies, a consolidated balance sheet of PM Companies and its Subsidiaries as of the end of such quarter and consolidated statements of earnings of PM Companies and its Subsidiaries for the period commencing at the end of the previous fiscal year and ending with the end of such quarter, certified by the chief financial officer of PM Companies; (ii) as soon as available and in any event within 100 days after the end of each fiscal year of PM Companies, a copy of the financial statements for such year for PM Companies and its Subsidiaries, audited by Coopers & Lybrand L.L.P. (or other independent accountants which, as of the date of this Agreement, are one of the "big six" accounting firms); (iii) as soon as possible and in any event within five days after the occurrence of each Event of Default and each event which, with the giving of notice or lapse of time, or both, would constitute an Event of Default, continuing on the date of such statement, a statement of the chief financial officer of PM Companies setting forth details of such Event of Default or event and the action which PM Companies has taken and proposes to take with respect thereto; (iv) promptly after the sending or filing thereof, copies of all reports which PM Companies sends to any of its shareholders, and copies of all periodic reports on Forms 10-K, 10-Q and 8-K (or any successor forms adopted by the Securities and Exchange Commission) which PM Companies files with the Securities and Exchange Commission; and (v) such other information respecting the condition or operations, financial or otherwise, of PM Companies or any Major Subsidiary as any Lender through Citibank, as Administrative Agent, may from time to time reasonably request. SECTION 5.02. Negative Covenants. So long as any Advance shall remain unpaid or any Lender shall have any Commitment hereunder, PM Companies will not: (a) Liens, Etc. Create or suffer to exist, or permit any Major Subsidiary to create or suffer to exist, any lien, security interest or other charge or encumbrance, or any other type of preferential arrangement, upon or with respect to any of its properties, whether now owned or hereafter acquired, or 32 assign, or permit any Major Subsidiary to assign, any right to receive income, in each case to secure or provide for the payment of any Debt of any Person, other than (i) purchase money liens or purchase money security interests upon or in any property acquired or held by it or any Major Subsidiary in the ordinary course of business to secure the purchase price of such property or to secure indebtedness incurred solely for the purpose of financing the acquisition of such property, (ii) liens or security interests existing on such property at the time of its acquisition (other than any such lien or security interest created in contemplation of such acquisition), (iii) liens or security interests existing on the date hereof securing Debt, (iv) liens or security interests on property financed through the issuance of industrial revenue bonds in favor of the holders of such bonds or any agent or trustee therefor, (v) liens or security interests existing on property of any Person acquired by it or any Major Subsidiary, (vi) liens or security interests securing Debt in an aggregate amount not in excess of 10% of PM Companies' Consolidated Tangible Assets or (vii) liens or security interests upon or with respect to "margin stock" as that term is defined in Regulation U issued by the Board of Governors of the Federal Reserve System. (b) Mergers, Etc. Consolidate with or merge into, or convey or transfer its properties and assets substantially as an entirety to, any Person, or permit any Subsidiary directly or indirectly owned by it to do so, unless, immediately after giving effect thereto, no Default would exist and, in the case of any merger or consolidation to which it is a party, it is the surviving corporation and, in the case of any merger or consolidation to which a Borrower other than PM Companies is a party, the corporation formed by such consolidation or into which such Borrower shall be merged shall be a corporation organized and existing under the laws of the United States of America or any State thereof, or the District of Columbia, and shall assume such Borrower's obligations under this Agreement by the execution and delivery of an instrument in form and substance satisfactory to the Required Lenders. (c) Maintenance of Ownership of Philip Morris. Sell or otherwise dispose of any shares of capital stock of Philip Morris. ARTICLE VI EVENTS OF DEFAULT SECTION 6.01. Events of Default. If any of the following events ("Events of Default") shall occur and be continuing: (a) Any Borrower or PM Companies shall fail to pay any principal of any Advance when the same becomes due and payable; or any Borrower shall fail to pay interest on any Advance, or PM Companies shall fail to pay any fees payable under Section 2.04, within ten days after the same becomes due and payable; or (b) Any representation or warranty made or deemed to have been made by any Borrower or PM Companies herein or by any Borrower or PM Companies (or any of their respective officers) in connection with this Agreement shall prove to have been incorrect in any material respect when made or deemed to have been made; or (c) Any Borrower or PM Companies shall fail to perform or observe (i) any term, covenant or agreement contained in Section 5.01(b), 5.02(b) or 5.02(c), (ii) any term covenant or agreement contained in Section 5.02(a) if such failure shall remain unremedied for 15 days after written notice thereof shall have been given to PM Companies by Citibank, as Administrative Agent, or any Lender or (iii) any 33 other term, covenant or agreement contained in this Agreement on its part to be performed or observed if such failure shall remain unremedied for 30 days after written notice thereof shall have been given to PM Companies by Citibank, as Administrative Agent, or any Lender; or (d) Any Borrower or PM Companies or any Major Subsidiary shall fail to pay any principal of or premium or interest on any Debt which is outstanding in a principal amount of at least $100,000,000 in the aggregate (but excluding Debt arising under this Agreement) of such Borrower or PM Companies or such Major Subsidiary (as the case may be), when the same becomes due and payable (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise), and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt unless adequate provision for any such payment has been made in form and substance satisfactory to the Required Lenders; or any Debt of any Borrower or PM Companies or any Major Subsidiary which is outstanding in a principal amount of at least $100,000,000 in the aggregate (but excluding Debt arising under this Agreement) shall be declared to be due and payable, or required to be prepaid (other than by a scheduled required prepayment), redeemed, purchased or defeased, or an offer to prepay, redeem, purchase or defease such Debt shall be required to be made, in each case prior to the stated maturity thereof unless adequate provision for the payment of such Debt has been made in form and substance satisfactory to the Required Lenders; or (e) Any Borrower or PM Companies or any Major Subsidiary shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted by or against any Borrower or PM Companies or any Major Subsidiary seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial part of its property, and, in the case of any such proceeding instituted against it (but not instituted by it), either such proceeding shall remain undismissed or unstayed for a period of 60 days or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against it or the appointment of a receiver, trustee, custodian or other similar official for it or for any of its property constituting a substantial part of the property of PM Companies and its Subsidiaries taken as a whole) shall occur; or any Borrower or PM Companies or any Major Subsidiary shall take any corporate action to authorize any of the actions set forth above in this subsection (e); or (f) Any judgment or order for the payment of money in excess of $100,000,000 shall be rendered against any Borrower or PM Companies or any Major Subsidiary and there shall be any period of 45 consecutive days during which a stay of enforcement of such unsatisfied judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; or (g) Any Borrower, PM Companies or any ERISA Affiliate shall incur, or shall be reasonably likely to incur, liability in excess of $500,000,000 in the aggregate as a result of one or more of the following: (i) the occurrence of any ERISA Event; (ii) the partial or complete withdrawal of any Borrower, PM Companies or any ERISA Affiliate from a Multiemployer Plan; or (iii) the reorganization or termination of a Multiemployer Plan; provided, however, that no Event of Default under this clause (g) shall be deemed to have occurred if the Borrower, PM Companies or any ERISA Affiliate shall have made arrangements satisfactory to the Lenders to discharge or otherwise satisfy such liability (including the posting of a bond or other security); or 34 (h) So long as any Subsidiary of PM Companies is a Designated Subsidiary, the guaranty provided by PM Companies under Article VIII hereof shall for any reason cease to be valid and binding on PM Companies or PM Companies shall so state in writing; then, and in any such event, Citibank, as Administrative Agent, (i) shall at the request, or may with the consent, of the Required Lenders, by notice to PM Companies and the Borrowers, declare the obligation of each Lender to make Advances to be terminated, whereupon the same shall forthwith terminate, and (ii) shall at the request, or may with the consent, of the Required Lenders, by notice to PM Companies and the Borrowers, declare all the Advances then outstanding, all interest thereon and all other amounts payable under this Agreement to be forthwith due and payable, whereupon the Advances then outstanding, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrowers; provided, however, that in the event of an actual or deemed entry of an order for relief with respect to any Borrower, PM Companies or any Major Subsidiary under the Federal Bankruptcy Code, (A) the obligation of each Lender to make Advances shall automatically be terminated and (B) the Advances then outstanding, all such interest and all such amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by the Borrowers. ARTICLE VII THE ADMINISTRATIVE AGENTS SECTION 7.01. Authorization and Action. Each Lender hereby appoints and authorizes the Administrative Agents to take such action as agent on its behalf and to exercise such powers and discretion under this Agreement as are delegated to the Administrative Agents by the terms hereof, together with such powers and discretion as are reasonably incidental thereto. As to any matters not expressly provided for by this Agreement (including, without limitation, enforcement or collection of the Notes), the Administrative Agents shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Required Lenders, and such instructions shall be binding upon all Lenders and all holders of Notes; provided, however, that no Administrative Agent shall be required to take any action that exposes such Administrative Agent to personal liability or that is contrary to this Agreement or applicable law. Each of the Administrative Agents agrees to give to each Lender prompt notice of each notice given to it by PM Companies or any Borrower pursuant to the terms of this Agreement. SECTION 7.02. Administrative Agents' Reliance, Etc. Neither the Administrative Agents nor any of their directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or them under or in connection with this Agreement, except for its or their own gross negligence or willful misconduct. Without limitation of the generality of the foregoing, the Administrative Agents: (i) may treat the Lender that made any Advance as the holder of the Debt resulting therefrom until Citibank, as Administrative Agent, receives and accepts an Assignment and Acceptance entered into by such Lender, as assignor, and an Eligible Assignee, as assignee, as provided in Section 9.07; (ii) may consult with legal counsel (including counsel for PM Companies or any Borrower), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (iii) makes no warranty or representation to any Lender and shall not be responsible to any Lender for any statements, warranties or representations (whether written or oral) made in or in connection with this Agreement; (iv) shall not have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of this Agreement on the part of PM Companies or any Borrower or to 35 inspect the property (including the books and records) of PM Companies or such Borrower; (v) shall not be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement or any other instrument or document furnished pursuant hereto; and (vi) shall incur no liability under or in respect of this Agreement by acting upon any notice, consent, certificate or other instrument or writing (which may be by telecopier, telegram or telex) believed by it to be genuine and signed or sent by the proper party or parties. SECTION 7.03. Citibank, Chase and Affiliates. With respect to its Commitment and the Advances made by it, each of Citibank and Chase shall have the same rights and powers under this Agreement as any other Lender and may exercise the same as though it were not an Administrative Agent; and the term "Lender" or "Lenders" shall, unless otherwise expressly indicated, include Citibank and Chase in their individual capacities. Citibank and Chase and their affiliates may accept deposits from, lend money to, act as trustee under indentures of, accept investment banking engagements from and generally engage in any kind of business with, PM Companies, any Borrower, any of its Subsidiaries and any Person who may do business with or own securities of PM Companies, any Borrower or any such Subsidiary, all as if Citibank and Chase were not Administrative Agents and without any duty to account therefor to the Lenders. SECTION 7.04. Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon an Administrative Agent, the Syndication Agent, the Documentation Agent or any other Lender and based on the financial statements referred to in Section 4.01 and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon any Administrative Agent, the Syndication Agent, the Documentation Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. SECTION 7.05. Indemnification. The Lenders agree to indemnify each Administrative Agent (to the extent not reimbursed by PM Companies or the Borrowers), ratably according to the respective principal amounts of the Revolving Credit Advances then owing to each of them (or if no Revolving Credit Advances are at the time outstanding, ratably according to the respective amounts of their Commitments), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever that may be imposed on, incurred by, or asserted against such Administrative Agent in any way relating to or arising out of this Agreement or any action taken or omitted by such Administrative Agent under this Agreement (collectively, the "Indemnified Costs"), provided that no Lender shall be liable for any portion of the Indemnified Costs resulting from such Administrative Agent's gross negligence or willful misconduct. Without limitation of the foregoing, each Lender agrees to reimburse such Administrative Agent promptly upon demand for its ratable share of any out-of-pocket expenses (including counsel fees) incurred by such Administrative Agent in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of rights or responsibilities under, this Agreement, to the extent that such Administrative Agent is not reimbursed for such expenses by PM Companies or the Borrowers. In the case of any investigation, litigation or proceeding giving rise to any Indemnified Costs, this Section 7.05 applies whether any such investigation, litigation or proceeding is brought by any Administrative Agent, any Lender or a third party. SECTION 7.06. Successor Administrative Agents. An Administrative Agent may resign at any time by giving written notice thereof to the Lenders and PM Companies and may be removed at any time with or without cause by the Required Lenders. Upon the resignation or removal of Citibank, as Administrative Agent, Chase, as Administrative Agent, shall succeed to and become vested with all the rights, powers, discretion, privileges and duties of Citibank, as Administrative Agent, and Citibank, as Administrative Agent shall be 36 discharged from its duties and obligations under this Agreement. Upon any other such resignation or removal which results in there being no Administrative Agent hereunder, the Required Lenders shall have the right to appoint a successor Administrative Agent. If no successor Administrative Agent shall have been so appointed by the Required Lenders, and shall have accepted such appointment, within 30 days after the retiring Administrative Agent's giving of notice of resignation or the Required Lenders' removal of the retiring Administrative Agent, then the retiring Administrative Agent may, on behalf of the Lenders, appoint a successor Administrative Agent, which shall be a commercial bank organized under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $500,000,000. Upon the acceptance of any appointment as Administrative Agent hereunder by a successor Administrative Agent, such successor Administrative Agent shall thereupon succeed to and become vested with all the rights, powers, discretion, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations under this Agreement. After any retiring Administrative Agent's resignation or removal hereunder as Administrative Agent, the provisions of this Article VII shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent under this Agreement. SECTION 7.07. Administrative Sub-Agent. The Administrative Sub-Agent has been designated under this Agreement to carry out duties of Citibank, as Administrative Agent. The Administrative Sub-Agent shall be subject to each of the obligations in this Agreement to be performed by the Administrative Sub-Agent, and each of the Borrowers and the Lenders agrees that the Administrative Sub-Agent shall be entitled to exercise each of the rights and shall be entitled to each of the benefits of Citibank, as Administrative Agent, under this Agreement as relate to the performance of its obligations hereunder. SECTION 7.08. Syndication and Documentation Agents. Credit Suisse First Boston and Deutsche Bank AG, New York Branch have been designated as Syndication Agent and Documentation Agent, respectively, under this Agreement, but the use of such titles does not impose on either of them any duties or obligations greater than those of any other Lender. ARTICLE VIII GUARANTY SECTION 8.01. Guaranty. PM Companies hereby unconditionally and irrevocably guarantees (the undertaking of the Guarantor contained in this Article VIII being the "Guaranty") the punctual payment when due, whether at stated maturity, by acceleration or otherwise, of all obligations of each Borrower now or hereafter existing under this Agreement, whether for principal, interest, fees, expenses or otherwise (such obligations being the "Obligations"), and any and all expenses (including counsel fees and expenses) incurred by Citibank, as Administrative Agent, or the Lenders in enforcing any rights under the Guaranty. SECTION 8.02. Guaranty Absolute. PM Companies guarantees that the Obligations will be paid strictly in accordance with the terms of this Agreement, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of Citibank, as Administrative Agent, or the Lenders with respect thereto. The liability of PM Companies under this Guaranty shall be absolute and unconditional irrespective of: (i) any lack of validity, enforceability or genuineness of any provision of this Agreement or any other agreement or instrument relating thereto; 37 (ii) any change in the time, manner or place of payment of, or in any other term of, all or any of the Obligations, or any other amendment or waiver of or any consent to departure from this Agreement; (iii) any exchange, release or non-perfection of any collateral, or any release or amendment or waiver of or consent to departure from any other guaranty, for all or any of the Obligations; or (iv) any other circumstance which might otherwise constitute a defense available to, or a discharge of, a Borrower or the Guarantor. This Guaranty shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Obligations is rescinded or must otherwise be returned by Citibank, as Administrative Agent, or any Lender upon the insolvency, bankruptcy or reorganization of a Borrower or otherwise, all as though such payment had not been made. SECTION 8.03. Waivers. (a) PM Companies hereby waives promptness, diligence, notice of acceptance and any other notice with respect to any of the Obligations and this Guaranty and any requirement that Citibank, as Administrative Agent, or any Lender protect, secure, perfect or insure any security interest or lien or any property subject thereto or exhaust any right or take any action against a Borrower or any other Person or any collateral. (b) PM Companies hereby irrevocably waives any claims or other rights that it may now or hereafter acquire against any Borrower that arise from the existence, payment, performance or enforcement of PM Companies's obligations under this Guaranty or this Agreement, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution or indemnification and any right to participate in any claim or remedy of Citibank, as Administrative Agent, or any Lender against such Borrower or any collateral, whether or not such claim, remedy or right arises in equity or under contract, statute or common law, including, without limitation, the right to take or receive from such Borrower, directly or indirectly, in cash or other property or by set-off or in any other manner, payment or security on account of such claim, remedy or right. If any amount shall be paid to PM Companies in violation of the preceding sentence at any time prior to the later of the cash payment in full of the Obligations and all other amounts payable under this Guaranty and the Termination Date, such amount shall be held in trust for the benefit of Citibank, as Administrative Agent, and the Lenders and shall forthwith be paid to Citibank, as Administrative Agent, to be credited and applied to the Obligations and all other amounts payable under this Guaranty, whether matured or unmatured, in accordance with the terms of this Agreement and this Guaranty, or to be held as collateral for any Obligations or other amounts payable under this Guaranty thereafter arising. PM Companies acknowledges that it will receive direct and indirect benefits from the financing arrangements contemplated by this Agreement and this Guaranty and that the waiver set forth in this subsection is knowingly made in contemplation of such benefits. SECTION 8.04. Continuing Guaranty. This Guaranty is a continuing guaranty and shall (a) remain in full force and effect until payment in full (after the Termination Date) of the Obligations and all other amounts payable under this Guaranty, (b) be binding upon PM Companies, its successors and assigns, and (c) inure to the benefit of and be enforceable by the Lenders, Citibank, as Administrative Agent, and their respective successors, transferees and assigns. 38 ARTICLE IX MISCELLANEOUS SECTION 9.01. Amendments, Etc. No amendment or waiver of any provision of this Agreement, nor consent to any departure by any Borrower or PM Companies therefrom, shall in any event be effective unless the same shall be in writing and signed by the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all the Lenders, do any of the following: (a) waive any of the conditions specified in Sections 3.01 and 3.02, (b) increase the Commitments of the Lenders or subject the Lenders to any additional obligations, (c) reduce the principal of, or interest on, the Revolving Credit Advances or any fees or other amounts payable hereunder, (d) postpone any date fixed for any payment of principal of, or interest on, the Revolving Credit Advances or any fees or other amounts payable hereunder, (e) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Revolving Credit Advances, or the number of Lenders, that shall be required for the Lenders or any of them to take any action hereunder, (f) release PM Companies from any of its obligations under Article VIII or (g) amend this Section 9.01; provided further that no waiver of the conditions specified in Section 3.04 in connection with any Competitive Bid Borrowing shall be effective unless consented to by all Lenders making Competitive Bid Advances as part of such Competitive Bid Borrowing; and provided further that no amendment, waiver or consent shall, unless in writing and signed by Citibank, as Administrative Agent, in addition to the Lenders required above to take such action, affect the rights or duties of Citibank, as Administrative Agent, under this Agreement or any Revolving Credit Advance. SECTION 9.02. Notices, Etc. All notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic or telex communication) and mailed, telecopied, telegraphed, telexed or delivered, if to any Borrower, at its address c/o Philip Morris Companies Inc., 120 Park Avenue, New York, New York 10017, Attention: Treasurer; if to PM Companies in its capacity as the guarantor under Article VIII, at its address at 120 Park Avenue, New York, New York 10017, Attention: Secretary; if to any Initial Lender, at its Domestic Lending Office specified opposite its name on Schedule I hereto; if to any other Lender, at its Domestic Lending Office specified in the Assignment and Acceptance pursuant to which it became a Lender; and if to Citibank, as Administrative Agent, at its address at Two Penns Way, Suite 200, New Castle, Delaware 19720, Attention: Dave Meckler; or, as to any Borrower, PM Companies or Citibank, as Administrative Agent, at such other address as shall be designated by such party in a written notice to the other parties and, as to each other party, at such other address as shall be designated by such party in a written notice to PM Companies and Citibank, as Administrative Agent. All such notices and communications shall, when mailed, telecopied, telegraphed or telexed, be effective when deposited in the mails, telecopied, delivered to the telegraph company or confirmed by telex answerback, respectively, except that notices and communications to Citibank, as Administrative Agent, pursuant to Article II, III or VII shall not be effective until received by Citibank, as Administrative Agent. Delivery by telecopier of an executed counterpart of any amendment or waiver of any provision of this Agreement or of any Exhibit hereto to be executed and delivered hereunder shall be effective as delivery of a manually executed counterpart thereof. SECTION 9.03. No Waiver; Remedies. No failure on the part of any Lender or Citibank, as Administrative Agent, to exercise, and no delay in exercising, any right hereunder or under any Note shall operate as a waiver thereof; nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. SECTION 9.04. Costs and Expenses. (a) PM Companies agrees to pay on demand all costs and expenses in connection with the preparation, execution, delivery, administration (excluding any cost or expenses 39 for administration related to the overhead of Citibank, as Administrative Agent), modification and amendment of this Agreement and the documents to be delivered hereunder, including, without limitation, the reasonable fees and out-of-pocket expenses of counsel for Citibank, as Administrative Agent, with respect thereto and with respect to advising Citibank, as Administrative Agent, as to its rights and responsibilities under this Agreement, and all costs and expenses of the Lenders and Citibank, as Administrative Agent, if any (including, without limitation, reasonable counsel fees and expenses of the Lenders and Citibank, as Administrative Agent), in connection with the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement and the other documents to be delivered hereunder. (b) If any payment of principal of any Eurocurrency Rate Advance, LIBO Rate Advance or Local Rate Advance is made other than on the last day of the Interest Period for such Advance or at its maturity, as a result of a payment pursuant to Section 2.10, acceleration of the maturity of the Advances pursuant to Section 6.01, an assignment made as a result of a demand by PM Companies pursuant to Section 9.07(a) or for any other reason, PM Companies shall, upon demand by any Lender (with a copy of such demand to Citibank, as Administrative Agent), pay to Citibank, as Administrative Agent, for the account of such Lender any amounts required to compensate such Lender for any additional losses, costs or expenses which it may reasonably incur as a result of such payment, including, without limitation, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by any Lender to fund or maintain such Advance. Without prejudice to the survival of any other agreement of any Borrower or PM Companies hereunder, the agreements and obligations of each Borrower and PM Companies contained in Section 2.02(c), 2.08, 2.10(b)(iii), 2.11, 2.14 and this Section 9.04(b) shall survive the payment in full of principal and interest hereunder. (c) Each Borrower and PM Companies jointly and severally agree to indemnify and hold harmless Citibank, as Administrative Agent, and each Lender and each of their respective affiliates, control persons, directors, officers, employees, attorneys and agents (each, an "Indemnified Party") from and against any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and disbursements of counsel) which may be incurred by or asserted against any Indemnified Party, in each case in connection with or arising out of, or in connection with the preparation for or defense of, any investigation, litigation, or proceeding (i) related to any transaction or proposed transaction (whether or not consummated) in which any proceeds of any Borrowing are applied or proposed to be applied, directly or indirectly, by any Borrower, whether or not such Indemnified Party is a party to such transaction or (ii) related to any Borrower's or PM Companies's entering into this Agreement, or to any actions or omissions of any Borrower or PM Companies, any of their respective Subsidiaries or affiliates or any of its or their respective officers, directors, employees or agents in connection therewith, in each case whether or not an Indemnified Party is a party thereto and whether or not such investigation, litigation or proceeding is brought by PM Companies or any Borrower or any other Person; provided, however, that neither any Borrower nor PM Companies shall be required to indemnify any such Indemnified Party from or against any portion of such claims, damages, losses, liabilities or expenses that is found in a final, non-appealable judgment by a court of competent jurisdiction to have resulted from the gross negligence or wilful misconduct of such Indemnified Party. SECTION 9.05. Right of Set-off. Upon (i) the occurrence and during the continuance of any Event of Default and (ii) the making of the request or the granting of the consent specified by Section 6.01 to authorize Citibank, as Administrative Agent, to declare the Advances due and payable pursuant to the provisions of Section 6.01, each Lender is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender to or for the credit or the account of PM Companies or any Borrower against any and all of the obligations of any Borrower or PM Companies now or hereafter existing under this Agreement, whether or not such Lender shall have made any demand under this Agreement and although such obligations may be unmatured. Each Lender agrees promptly to notify the appropriate 40 Borrower or PM Companies, as the case may be, after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender and its Affiliates under this Section are in addition to other rights and remedies (including, without limitation, other rights of set-off) that such Lender and its Affiliates may have. SECTION 9.06. Binding Effect. This Agreement shall be binding upon and inure to the benefit of PM Companies, Citibank, as Administrative Agent, Chase, as Administrative Agent, and each Lender and their respective successors and assigns, except that neither any Borrower nor PM Companies shall have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lenders. SECTION 9.07. Assignments and Participations. (a) Each Lender may and, if demanded by PM Companies upon at least five Business Days' notice to such Lender and Citibank, as Administrative Agent, will assign to one or more Persons all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitment and the Revolving Credit Advances owing to it); provided, however, that (i) each such assignment shall be of a constant, and not a varying, percentage of all rights and obligations under this Agreement (other than, except in the case of an assignment made as a result of a demand by PM Companies pursuant to this Section 9.07(a), any Competitive Bid Advances owing to such Lender or any Competitive Bid Notes held by it), (ii) the amount of the Commitment of the assigning Lender being assigned pursuant to each such assignment (determined as of the date of the Assignment and Acceptance with respect to such assignment) shall in no event be less than $25,000,000 (subject to reduction at the sole discretion of PM Companies) and shall be an integral multiple of $1,000,000, (iii) each such assignment shall be to an Eligible Assignee, (iv) each such assignment made as a result of a demand by PM Companies pursuant to this Section 9.07(a) shall be arranged by PM Companies after consultation with Citibank, as Administrative Agent, and shall be either an assignment of all of the rights and obligations of the assigning Lender under this Agreement or an assignment of a portion of such rights and obligations made concurrently with another such assignment or other such assignments which together cover all of the rights and obligations of the assigning Lender under this Agreement, (v) no Lender shall be obligated to make any such assignment as a result of a demand by PM Companies pursuant to this Section 9.07(a) unless and until such Lender shall have received one or more payments from either the Borrowers to which it has outstanding Advances or one or more Eligible Assignees in an aggregate amount at least equal to the aggregate outstanding principal amount of the Advances owing to such Lender, together with accrued interest thereon to the date of payment of such principal amount and all other amounts payable to such Lender under this Agreement and (vi) the parties to each such assignment shall execute and deliver to Citibank, as Administrative Agent, for its acceptance and recording in the Register, an Assignment and Acceptance, together with a processing and recordation fee of $3,500, provided that, if such assignment is made as a result of a demand by PM Companies under this Section 9.07(a), PM Companies shall pay or cause to be paid such $3,500 fee. Upon such execution, delivery, acceptance and recording, from and after the effective date specified in each Assignment and Acceptance, (x) the assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Assignment and Acceptance, have the rights and obligations of a Lender hereunder and (y) the Lender assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it pursuant to such Assignment and Acceptance, relinquish its rights (other than those provided under Section 9.04) and be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto). (b) By executing and delivering an Assignment and Acceptance, the Lender assignor thereunder and the assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Assignment and Acceptance, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of this 41 Agreement or any other instrument or document furnished pursuant hereto; (ii) such assigning Lender makes no representation or warranty and assumes no responsibility with respect to the financial condition of any Borrower or PM Companies or the performance or observance by any Borrower or PM Companies of any of its obligations under this Agreement or any other instrument or document furnished pursuant hereto; (iii) such assignee confirms that it has received a copy of this Agreement, together with copies of the financial statements referred to in Section 4.01 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (iv) such assignee will, independently and without reliance upon Citibank, as Administrative Agent, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (v) such assignee confirms that it is an Eligible Assignee; (vi) such assignee appoints and authorizes Citibank, as Administrative Agent, to take such action as agent on its behalf and to exercise such powers and discretion under this Agreement as are delegated to Citibank, as Administrative Agent, by the terms hereof, together with such powers and discretion as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all of the obligations that by the terms of this Agreement are required to be performed by it as a Lender. (c) Upon its receipt of an Assignment and Acceptance executed by an assigning Lender and an assignee representing that it is an Eligible Assignee, together with any Revolving Credit Note or Notes subject to such assignment, Citibank, as Administrative Agent, shall, if such Assignment and Acceptance has been completed and is in substantially the form of Exhibit C hereto, (i) accept such Assignment and Acceptance, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to PM Companies. (d) Citibank, as Administrative Agent, shall maintain at its address referred to in Section 9.02 a copy of each Assignment and Acceptance delivered to and accepted by it and a register for the recordation of the names and addresses of the Lenders and the Commitment of, and principal amount of the Advances owing to, each Lender from time to time (the "Register"). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and PM Companies, the Borrowers, Citibank, as Administrative Agent, and the Lenders may treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by PM Companies, any Borrower or any Lender at any reasonable time and from time to time upon reasonable prior notice. (e) Each Lender may sell participations to one or more banks or other entities in or to all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitment, the Advances owing to it and any Note or Notes held by it); provided, however, that (i) such Lender's obligations under this Agreement (including, without limitation, its Commitment to PM Companies hereunder) shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) PM Companies, the other Borrowers, Citibank, as Administrative Agent, and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement and (iv) no participant under any such participation shall have any right to approve any amendment or waiver of any provision of this Agreement, or any consent to any departure by any Borrower or PM Companies therefrom, except to the extent that such amendment, waiver or consent would reduce the principal of, or interest on, the Advances or any fees or other amounts payable hereunder, in each case to the extent subject to such participation, or postpone any date fixed for any payment of principal of, or interest on, the Advances or any fees or other amounts payable hereunder, in each case to the extent subject to such participation. (f) Any Lender may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 9.07, disclose to the assignee or participant or proposed assignee or participant, any information relating to PM Companies or any Borrower furnished to such Lender by or on behalf of PM Companies or any Borrower; provided that, prior to any such disclosure, the assignee or participant or proposed 42 assignee or participant shall agree to preserve the confidentiality of any confidential information relating to PM Companies received by it from such Lender. (g) Notwithstanding any other provision set forth in this Agreement, any Lender may at any time create a security interest in all or any portion of its rights under this Agreement (including, without limitation, the Advances owing to it and any Note or Notes held by it) in favor of any Federal Reserve Bank in accordance with Regulation A of the Board of Governors of the Federal Reserve System. SECTION 9.08. Designated Subsidiaries. (a) Designation. PM Companies may at any time, and from time to time, by delivery to Citibank, as Administrative Agent, of a Designation Agreement duly executed by PM Companies and the respective Subsidiary and substantially in the form of Exhibit D hereto, designate such Subsidiary as a "Designated Subsidiary" for purposes of this Agreement and such Subsidiary shall thereupon become a "Designated Subsidiary" for purposes of this Agreement and, as such, shall have all of the rights and obligations of a Borrower hereunder. Citibank, as Administrative Agent, shall promptly notify each Lender of each such designation by PM Companies and the identity of the respective Subsidiary. (b) Termination. Upon the payment and performance in full of all of the indebtedness, liabilities and obligations under this Agreement of any Designated Subsidiary then, so long as at the time no Notice of Revolving Credit Borrowing or Notice of Competitive Bid Borrowing in respect of such Designated Subsidiary is outstanding, such Subsidiary's status as a "Designated Subsidiary" shall terminate upon notice to such effect from Citibank, as Administrative Agent, to the Lenders (which notice Citibank, as Administrative Agent, shall give promptly, and only upon its receipt of a request therefor from PM Companies). Thereafter, the Lenders shall be under no further obligation to make any Advance hereunder to such Designated Subsidiary. SECTION 9.09. Governing Law. This Agreement and the Notes shall be governed by, and construed in accordance with, the laws of the State of New York, except as referred to in Section 9.13. SECTION 9.10. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by telecopier shall be effective as delivery of a manually executed counterpart of this Agreement. SECTION 9.11. Judgment. (a) If for the purposes of obtaining judgment in any court it is necessary to convert a sum due hereunder in Dollars into another currency, the parties hereto agree, to the fullest extent that they may effectively do so, that the rate of exchange used shall be that at which in accordance with normal banking procedures Citibank, as Administrative Agent, could purchase Dollars with such other currency at Citibank's principal office in London at 11:00 A.M. (London time) on the Business Day preceding that on which final judgment is given. (b) If for the purposes of obtaining judgment in any court it is necessary to convert a sum due hereunder in a Foreign Currency into Dollars, the parties agree to the fullest extent that they may effectively do so, that the rate of exchange used shall be that at which in accordance with normal banking procedures Citibank, as Administrative Agent, could purchase such Foreign Currency with Dollars at Citibank's principal office in London at 11:00 A.M. (London time) on the Business Day preceding that on which final judgment is given. (c) The obligation of any Borrower in respect of any sum due from it in any currency (the "Primary Currency") to any Lender or Citibank, as Administrative Agent, hereunder shall, notwithstanding any judgment in any other currency, be discharged only to the extent that on the Business Day following receipt by such Lender or 43 Citibank, as Administrative Agent (as the case may be), of any sum adjudged to be so due in such other currency, such Lender or Citibank, as Administrative Agent (as the case may be), may in accordance with normal banking procedures purchase the applicable Primary Currency with such other currency; if the amount of the applicable Primary Currency so purchased is less than such sum due to such Lender or Citibank, as Administrative Agent (as the case may be), in the applicable Primary Currency, such Borrower agrees, as a separate obligation and notwithstanding any such judgment, to indemnify such Lender or Citibank, as Administrative Agent (as the case may be), against such loss, and if the amount of the applicable Primary Currency so purchased exceeds such sum due to any Lender or Citibank, as Administrative Agent (as the case may be), in the applicable Primary Currency, such Lender or Citibank, as Administrative Agent (as the case may be), agrees to remit to such Borrower such excess. SECTION 9.12. Jurisdiction, Etc. (a) Each of the parties hereto hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State court or, to the extent permitted by law, in such federal court. Each Borrower (other than PM Companies) hereby agrees that service of process in any such action or proceeding brought in any such New York State court or in such federal court may be made upon PM Companies at its offices at 120 Park Avenue, New York, New York 10017, Attention: Secretary (the "Process Agent") and each Designated Subsidiary hereby irrevocably appoints the Process Agent its authorized agent to accept such service of process, and agrees that the failure of the Process Agent to give any notice of any such service shall not impair or affect the validity of such service or of any judgment rendered in any action or proceeding based thereon. Each Borrower hereby further irrevocably consents to the service of process in any action or proceeding in such courts by the mailing thereof by any parties hereto by registered or certified mail, postage prepaid, to such Borrower at its address specified pursuant to Section 9.02. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that any party may otherwise have to serve legal process in any other manner permitted by law or to bring any action or proceeding relating to this Agreement or the Notes in the courts of any jurisdiction. (b) PM Companies hereby accepts its appointment as Process Agent and agrees that (i) it will maintain an office in New York, New York through the Termination Date and will give Citibank, as Administrative Agent, prompt notice of any change of its address, (ii) it will perform its duties as Process Agent to receive on behalf of each Designated Subsidiary and its property service of copies of the summons and complaint and any other process which may be served in any action or proceeding in any New York State or Federal court sitting in New York City arising out of or relating to this Agreement and (iii) it will forward forthwith to each Designated Subsidiary at its then current address copies of any summons, complaint and other process which PM Companies receives in connection with its appointment as Process Agent. (c) Each of the parties hereto irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement or the Notes in any New York State or federal court. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. SECTION 9.13. Substitution of Currency. If any countries parties to the Treaty on the European Economic and Monetary Union adopts the Euro in substitution for its national currency in effect on the date hereof, the regulations of the European Commission relating to the Euro shall apply to this Agreement and the Notes. The circumstances and consequences described in this Section 9.13 entitle none of the Borrowers, PM Companies, any Agent nor any Lender to rescission, notice, repudiation, adjustment or renegotiation of the terms and conditions of this Agreement or the Notes or to raise other defenses or to request any compensation claim, nor will they affect any of the other obligations of any Borrower or PM Companies under this Agreement and the Notes. SECTION 9.14. Confidentiality. None of the Agents nor any Lender shall disclose any confidential information relating to PM Companies or any Borrower to any other Person without the consent of PM Companies, other than (a) to such Agent's or such Lender's affiliates and their officers, directors, employees, agents and advisors and, as contemplated by Section 9.07(f), to actual or prospective assignees and participants, and then, in each such case, only on a confidential basis, provided, however, that such actual or prospective assignee or participant shall have been made aware of this Section 9.14 and shall have agreed to be bound by its provisions as if it were a party to this Agreement, (b) as required by any law, rule or regulation or judicial process and (c) as requested or required by any state, federal or foreign authority or examiner regulating banks or banking. SECTION 9.15. Integration. This Agreement and the Notes represent the agreement of PM Companies, the other Borrowers, the Administrative Agents and the Lenders with respect to the subject matter hereof, and there are no promises, undertakings, representations or warranties by the Administrative Agents, PM Companies, the other Borrowers or any Lender relative to the subject matter hereof not expressly set forth or referred to herein or in the Notes other than the matters referred to in Section 2.04(b). IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. PHILIP MORRIS COMPANIES INC. By ---------------------------------------- Title: CITIBANK, N.A., as Administrative Agent By ---------------------------------------- Title: THE CHASE MANHATTAN BANK, as Administrative Agent By ---------------------------------------- Title: CREDIT SUISSE FIRST BOSTON, as Syndication Agent By ---------------------------------------- Title: By ---------------------------------------- Title: DEUTSCHE BANK AG, NEW YORK BRANCH AND/OR CAYMAN ISLANDS BRANCH, as Documentation Agent By ---------------------------------------- Title: By ---------------------------------------- Title: Initial Lenders Commitment $320,000,000.00 ABN AMRO BANK N.V., NEW YORK BRANCH By ---------------------------------------- Title: $40,000,000.00 BANCA MONTE DEI PASCHI DI SIENA, S.p.A. By ---------------------------------------- Title: By ---------------------------------------- Title: $64,000,000.00 BANCA DI ROMA By ---------------------------------------- Title: By ---------------------------------------- Title: $120,000,000.00 BANCA COMMERICALE ITALIANA- NEW YORK BRANCH By ---------------------------------------- By ---------------------------------------- $80,000,000.00 BANCA POPOLARE DI MILANO By ---------------------------------------- Title: By ---------------------------------------- Title: $180,000,000.00 BANCO BILBAO VIZCAYA By ---------------------------------------- Title: $20,000,000.00 BANCO COMERCIAL PORTUGUES, SFE By ---------------------------------------- Title: $20,000,000.00 BANCO ESPIRITO SANTO E COMERICAL By ---------------------------------------- Title: $20,000,000.00 BANCO EXTERIOR DE ESPANA S.A., NEW YORK BRANCH By ---------------------------------------- Title: $140,000,000.00 BANK OF AMERICA NT&SA By ---------------------------------------- Title: $53,066,666.40 BANK BRUSSELS LAMBERT, NEW YORK BRANCH By ---------------------------------------- Title: $56,000,000.00 BANKBOSTON, N.A. By ---------------------------------------- Title: $8,000,000.00 BANK OF LOUISVILLE AND TRUST CO. By ---------------------------------------- Title: $120,000,000.00 THE BANK OF NEW YORK By ---------------------------------------- Title: $160,000,000.00 THE BANK OF TOKYO- MITSUBISHI, LTD, NEW YORK BRANCH By ---------------------------------------- Title: $180,000,000.00 BANKERS TRUST COMPANY By ---------------------------------------- Title: $106,000,000.00 BANQUE PARIBAS By ---------------------------------------- Title: By ---------------------------------------- Title: $200,000,000.00 BANQUE NATIONALE DE PARIS By ---------------------------------------- Title: By ---------------------------------------- Title: $80,000,000.00 BERLINER BANK AG/ BB-KN By ---------------------------------------- Title: $40,000,000.00 CAISSE NATIONALE DE CREDIT AGRICOLE By ---------------------------------------- Title: By ---------------------------------------- Title: $96,000,000.00 CARIPLO-CASSA DI RISPARMIO DELLE PROVINCIE LOMBARDE SPA By ---------------------------------------- Title: $603,432,666.60 CITIBANK, N.A. By ---------------------------------------- Title: $603,432,666.60 THE CHASE MANHATTAN BANK By ---------------------------------------- Title: $100,000,000.00 CIBC INC. By ---------------------------------------- Title: $60,000,000.00 CORESTATES BANK, N.A. By ---------------------------------------- Title: $20,000,000.00 CREDIT COMMERICAL DE FRANCE By ---------------------------------------- Title: $20,000,000.00 CREDIT LYONNAIS NEW YORK BRANCH By ---------------------------------------- Title: $603,432,666.60 CREDIT SUISSE FIRST BOSTON By ---------------------------------------- Title: By ---------------------------------------- Title: $40,000,000.00 CREDITO ITALIANO, S.p.A By ---------------------------------------- Title: By ---------------------------------------- Title: $40,000,000.00 CRESTAR BANK By ---------------------------------------- Title: $200,000,000.00 THE DAI-ICHI KANGYO BANK, LTD By ---------------------------------------- Title: $64,000,000.00 DEN DANSKE BANK AKTIESELSKAB, CAYMAN ISLANDS BRANCH By ---------------------------------------- Title: By ---------------------------------------- Title: $33,333,333.60 DEN NORSKE BANK ASA By ---------------------------------------- Title: By ---------------------------------------- Title: $603,432,666.60 DEUTSCHE BANK AG, NEW YORK BRANCH AND/OR CAYMAN ISLANDS BRANCH By ---------------------------------------- Title: By ---------------------------------------- Title: $280,000,000.00 DRESDNER BANK AG, NEW YORK BRANCH AND GRAND CAYMAN BRANCH By ---------------------------------------- Title: ---------------------------------------- $40,000,000.00 FIRSTAR BANK MILWAUKEE, N.A. By ---------------------------------------- Title: $40,000,000.00 FIRST BANK NATIONAL ASSOCIATION By ---------------------------------------- Title: $92,000,000.00 THE FIRST NATIONAL BANK OF CHICAGO By ---------------------------------------- Title: $72,000,000.00 FLEET NATIONAL BANK By ---------------------------------------- Title: $80,000,000.00 THE FUJI BANK, LIMITED, NEW YORK BRANCH By ---------------------------------------- Title: $120,000,000.00 GENERALE BANK By ---------------------------------------- Title: $200,000,000.00 ING BANK, N.V. By ---------------------------------------- Title: By ---------------------------------------- Title: $80,000,000.00 ISTITUTO BANCARIO SAN PAOLO DI TORINO SPA By ---------------------------------------- Title: $29,200,000.00 M&I MARSHALL & ILSLEY BANK By ---------------------------------------- Title: $320,000,000.00 MARINE MIDLAND BANK By ---------------------------------------- Title: $85,333,333.60 NATIONAL AUSTRALIA BANK LIMITED By ---------------------------------------- Title: $168,000,000.00 NATIONSBANK, N.A. By ---------------------------------------- Title: $92,000,000.00 NORDDEUTSCHE LANDSBANK GIROZENTRALE CAYMAN ISLANDS BRANCH By ---------------------------------------- Title: $64,000,000.00 NORINCHUKIN BANK, NEW YORK BRANCH By ---------------------------------------- Title: $20,000,000.00 THE NORTHERN TRUST COMPANY By ---------------------------------------- Title: $92,000,000.00 PNC BANK, NATIONAL ASSOCIATION By ---------------------------------------- Title: $33,336,000.00 RZB FINANCE LLC By ---------------------------------------- Title: $160,000,000.00 THE SAKURA BANK, LIMITED By ---------------------------------------- Title: $80,000,000.00 THE SANWA BANK LIMITED By ---------------------------------------- Title: $20,000,000.00 STANDARD CHARTERED BANK By ---------------------------------------- Title: $34,000,000.00 STATE STREET BANK AND TRUST COMPANY By ---------------------------------------- Title: $48,000,000.00 SVENSKA HANDELSBANKEN By ---------------------------------------- Title: $320,000,000.00 SOCIETE GENERALE FINANCE (IRELAND) LIMITED By ---------------------------------------- Title: $80,000,000.00 UNION BANK OF SWITZERLAND, NEW YORK BRANCH By ---------------------------------------- Title: By ---------------------------------------- Title: $136,000,000.00 WACHOVIA BANK, N.A. By ---------------------------------------- Title: $40,000,000.00 WELLS FARGO BANK By ---------------------------------------- Title: $20,000,000.00 WESTDEUTSCHE LANDESBANK GIROZENTRALE By ---------------------------------------- Title: $60,000,000.00 THE YASUDA TRUST & BANKING COMPANY., LTD., NEW YORK BRANCH By ---------------------------------------- Title: $8,000,000,000 Total of the Commitments EXHIBIT A-1 - FORM OF REVOLVING CREDIT PROMISSORY NOTE Dated: _______________, 199_ FOR VALUE RECEIVED, the undersigned, [NAME OF BORROWER], a __________ corporation (the "Borrower"), HEREBY PROMISES TO PAY to the order of __________ (the "Lender") for the account of its Applicable Lending Office on the Termination Date (each as defined in the Credit Agreement referred to below) the principal sum of U.S. $[amount of the Lender's Commitment in figures] or, if less, the aggregate principal amount of the Revolving Credit Advances made by the Lender to the Borrower pursuant to the 5-Year Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc., [the Borrower,] the Lender and certain other lenders parties thereto, Citibank,N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for the Lender and such other lenders (as amended or modified from time to time, the "Credit Agreement"; the terms defined therein being used herein as therein defined) outstanding on the Termination Date. The Borrower promises to pay interest on the unpaid principal amount of each Revolving Credit Advance from the date of such Revolving Credit Advance until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement. Both principal and interest in respect of each Revolving Credit Advance (i) in Dollars are payable in lawful money of the United States of America to Citibank, as Administrative Agent, at its account maintained at Two Penns Way, New Castle, Delaware, 19720, in same day funds and (ii) in any Committed Currency are payable in such currency at the applicable Payment Office in same day funds. Each Revolving Credit Advance owing to the Lender by the Borrower pursuant to the Credit Agreement, and all payments made on account of principal thereof, shall be recorded by the Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Promissory Note. This Promissory Note is one of the Revolving Credit Notes referred to in, and is entitled to the benefits of, the Credit Agreement. The Credit Agreement, among other things, (i) provides for the making of Revolving Credit Advances by the Lender to the Borrower from time to time in an aggregate amount not to exceed at any time outstanding the Dollar amount first above mentioned or the Equivalent thereof in one or more Committed Currencies, the indebtedness of the Borrower resulting from each such Revolving Credit Advance being evidenced by this Promissory Note, (ii) contains provisions for determining the Dollar Equivalent of Revolving Credit Advances denominated in Committed Currencies and (iii) contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified. [NAME OF BORROWER] By ---------------------------------------- Name: Title: LOANS AND PAYMENTS OF PRINCIPAL
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EXHIBIT A-2 - FORM OF COMPETITIVE BID PROMISSORY NOTE U.S.$_______________ Dated: _______________, 199_ FOR VALUE RECEIVED, the undersigned, [NAME OF BORROWER], a _________________________ corporation (the "Borrower"), HEREBY PROMISES TO PAY to the order of _________________________ (the "Lender") for the account of its Applicable Lending Office (as defined in the 5-Year Revolving Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc., [the Borrower,] the Lender and certain other lenders parties thereto, Citibank,N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for the Lender and such other lenders (as amended or modified from time to time, the "Credit Agreement"; the terms defined therein being used herein as therein defined)), on _______________, 199_, the principal amount of [U.S.$_______________][ for a Competitive Bid Advance in a Foreign Currency, list currency and amount of such Advance]. The Borrower promises to pay interest on the unpaid principal amount hereof from the date hereof until such principal amount is paid in full, at the interest rate and payable on the interest payment date or dates provided below: Interest Rate: _____% per annum (calculated on the basis of a year of _____ days for the actual number of days elapsed). Both principal and interest are payable in lawful money of __________ to Citibank, N.A., as Administrative Agent, for the account of the Lender at the office of _________________________, at _________________________ in same day funds. This Promissory Note is one of the Competitive Bid Notes referred to in, and is entitled to the benefits of, the Credit Agreement. The Credit Agreement, among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events. The Borrower hereby waives presentment, demand, protest and notice of any kind. No failure to exercise, and no delay in exercising, any rights hereunder on the part of the holder hereof shall operate as a waiver of such rights. This Promissory Note shall be governed by, and construed in accordance with, the laws of the State of New York. [NAME OF BORROWER] By ------------------------------------- Title: EXHIBIT B-1 - FORM OF NOTICE OF REVOLVING CREDIT BORROWING Citibank, as Administrative Agent for the Lenders parties to the Credit Agreement referred to below _________________________ _________________________ [Date] Attention: _______________ Ladies and Gentlemen: The undersigned, Philip Morris Companies Inc., refers to the 5-Year Revolving Credit Agreement, dated as of October 14, 1997 (as amended or modified from time to time, the "Credit Agreement", the terms defined therein being used herein as therein defined), among the undersigned, certain Lenders parties thereto and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for said Lenders, and hereby gives you notice, irrevocably, pursuant to Section 2.02 of the Credit Agreement that the undersigned hereby requests a Revolving Credit Borrowing under the Credit Agreement, and in that connection sets forth below the information relating to such Revolving Credit Borrowing (the "Proposed Revolving Credit Borrowing") as required by Section 2.02(a) of the Credit Agreement: (i) The Business Day of the Proposed Revolving Credit Borrowing is _______________, 199_. (ii) The Type of Advances comprising the Proposed Revolving Credit Borrowing is [Base Rate Advances] [Eurocurrency Rate Advances]. (iii) The aggregate amount of the Proposed Revolving Credit Borrowing is [$_______________][for a Revolving Credit Borrowing in a Committed Currency, list currency and amount of Revolving Credit Borrowing]. [(iv) The initial Interest Period for each Eurocurrency Rate Advance made as part of the Proposed Revolving Credit Borrowing is _____ month[s].] [(v) The name of the Borrower is __________.] The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the Proposed Revolving Credit Borrowing: (A) the representations and warranties contained in Section 4.01 of the Credit Agreement (except the representations set forth in the last sentence of subsection (e) thereof and in subsection (f) thereof (other than clause (i) thereof)) and, if the Borrower is a Designated Subsidiary, the representations and warranties of such Designated Subsidiary contained in its Designation Agreement, are correct, before and after giving effect to the Proposed Revolving Credit Borrowing and to the application of the proceeds therefrom, as though made on and as of such date; 2 (B) no event has occurred and is continuing, or would result from such Proposed Revolving Credit Borrowing or from the application of the proceeds therefrom, that constitutes a Default; (C) if such Proposed Revolving Credit Borrowing is in an aggregate principal amount equal to or greater than $500,000,000 and is being made in connection with any purchase of shares of the Borrower's or PM Companies's capital stock or the capital stock of any other Person, or any purchase of all or substantially all of the assets of any Person (whether in one transaction or a series of transactions) or an transaction of the type referred to in Section 5.02(b) of the Credit Agreement, the statements in clause (B) above will be true and correct after giving effect to such transaction or purchase; and (D) the aggregate principal amount of the Proposed Revolving Credit Borrowing and all other Borrowings to be made on the same day under the Credit Agreement is within the applicable unused Commitments of the Lenders. Very truly yours, PHILIP MORRIS COMPANIES INC. By --------------------------------- Title: EXHIBIT B-2 - FORM OF NOTICE OF COMPETITIVE BID BORROWING Citibank, N.A., as Administrative Agent for the Lenders parties to the Credit Agreement referred to below ____________________ ____________________ [Date] Attention: _______________ Ladies and Gentlemen: The undersigned, Philip Morris Companies Inc., refers to the 5-Year Revolving Credit Agreement, dated as of October 14, 1997 (as amended or modified from time to time, the "Credit Agreement", the terms defined therein being used herein as therein defined), among the undersigned, certain Lenders parties thereto and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for said Lenders, and hereby gives you notice, irrevocably, pursuant to Section 2.03 of the Credit Agreement that the undersigned hereby requests a Competitive Bid Borrowing under the Credit Agreement, and in that connection sets forth the terms on which such Competitive Bid Borrowing (the "Proposed Competitive Bid Borrowing") is requested to be made: (A) Date of Competitive Bid Borrowing ________________________ (B) Amount of Competitive Bid Borrowing ________________________ (C) [Maturity Date] [Interest Period] ________________________ (D) Interest Rate Basis ________________________ (E) Day count convention ________________________ (F) Interest Payment Date(s) ________________________ (G) [Currency] ________________________ (H) Name of Borrower ________________________ (I) Borrower's Account Location ________________________ (J) ___________________ ________________________ The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the Proposed Competitive Bid Borrowing: (a) the representations and warranties contained in Section 4.01 of the Credit Agreement and, if the Borrower is a Designated Subsidiary, the representations and warranties of such Designated Subsidiary contained in its Designation Agreement, are correct, before and after giving effect to the Proposed Revolving Credit Borrowing and to the application of the proceeds therefrom, as though made on and as of such date; (b) no event has occurred and is continuing, or would result from such Proposed Revolving Credit Borrowing or from the application of the proceeds therefrom, that constitutes a Default; and 2 (c) the aggregate amount of the Proposed Competitive Bid Borrowing and all other Borrowings to be made on the same day under the Credit Agreement is within the aggregate amount of the unused Commitments of the Lenders. The undersigned hereby confirms that the Proposed Competitive Bid Borrowing is to be made available to it in accordance with Section 2.03(a)(v) of the Credit Agreement. Very truly yours, PHILIP MORRIS COMPANIES INC. By ---------------------------------- Title: EXHIBIT C - FORM OF ASSIGNMENT AND ACCEPTANCE Reference is made to the 5-Year Revolving Credit Agreement dated as of October 14, 1997 (as amended or modified from time to time, the "Credit Agreement") among Philip Morris Companies Inc., a Virginia corporation (the "Borrower"), the Lenders (as defined in the Credit Agreement) and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for the Lenders. Terms defined in the Credit Agreement are used herein with the same meaning. The "Assignor" and the "Assignee" referred to on Schedule I hereto agree as follows: 1. The Assignor hereby sells and assigns to the Assignee, and the Assignee hereby purchases and assumes from the Assignor, an interest in and to the Assignor's rights and obligations under the Credit Agreement as of the date hereof (other than in respect of Competitive Bid Advances and Competitive Bid Notes) equal to the percentage interest specified on Schedule 1 hereto of all outstanding rights and obligations under the Credit Agreement (other than in respect of Competitive Bid Advances and Competitive Bid Notes). After giving effect to such sale and assignment, the Assignee's Commitment and the amount of the Revolving Credit Advances owing to the Assignee will be as set forth on Schedule 1 hereto. Each of the Assignor and the Assignee represents and warrants that it is authorized to execute and deliver this Assignment and Acceptance. 2. The Assignor (i) represents and warrants that it is the legal and beneficial owner of the interest being assigned by it hereunder and that such interest is free and clear of any adverse claim; (ii) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Credit Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement or any other instrument or document furnished pursuant thereto; and (iii) makes no representation or warranty and assumes no responsibility with respect to the financial condition of PM Companies or any Borrower or the performance or observance by PM Companies or any Borrower of any of its obligations under the Credit Agreement or any other instrument or document furnished pursuant thereto. 3. The Assignee (i) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements referred to in Section 4.01 thereof and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Acceptance; (ii) agrees that it will, independently and without reliance upon Citibank, as Administrative Agent, any other Agent, the Assignor or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Agreement; (iii) confirms that it is an Eligible Assignee; (iv) appoints and authorizes Citibank, as Administrative Agent, and the other Agents to take such action as agent on its behalf and to exercise such powers and discretion under the Credit Agreement as are delegated to Citibank, as Administrative Agent, and the other Agents, as the case may be, by the terms thereof, together with such powers and discretion as are reasonably incidental thereto; (v) agrees that it will perform in accordance with their terms all of the obligations that by the terms of the Credit Agreement are required to be performed by it as a Lender; and (vi) attaches any U.S. Internal Revenue Service forms required under Section 2.14 of the Credit Agreement. 4. Following the execution of this Assignment and Acceptance, it will be delivered to Citibank, as Administrative Agent, for acceptance and recording by Citibank, as Administrative Agent. The effective date for this Assignment and Acceptance (the "Effective Date") shall be the date of acceptance hereof by Citibank, as Administrative Agent, unless otherwise specified on Schedule 1 hereto. 2 5. Upon such acceptance and recording by Citibank, as Administrative Agent, as of the Effective Date, (i) the Assignee shall be a party to the Credit Agreement and, to the extent provided in this Assignment and Acceptance, have the rights and obligations of a Lender thereunder and (ii) the Assignor shall, to the extent provided in this Assignment and Acceptance, relinquish its rights and be released from its obligations under the Credit Agreement. 6. Upon such acceptance and recording by Citibank, as Administrative Agent, from and after the Effective Date, Citibank, as Administrative Agent, shall make all payments under the Credit Agreement in respect of the interest assigned hereby (including, without limitation, all payments of principal, interest and facility fees with respect thereto) to the Assignee. The Assignor and Assignee shall make all appropriate adjustments in payments under the Credit Agreement for periods prior to the Effective Date directly between themselves. 7. This Assignment and Acceptance shall be governed by, and construed in accordance with, the laws of the State of New York. 8. This Assignment and Acceptance may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of Schedule 1 to this Assignment and Acceptance by telecopier shall be effective as delivery of a manually executed counterpart of this Assignment and Acceptance. IN WITNESS WHEREOF, the Assignor and the Assignee have caused Schedule 1 to this Assignment and Acceptance to be executed by their officers thereunto duly authorized as of the date specified thereon. Schedule 1 to Assignment and Acceptance Percentage interest assigned: _____% Assignee's Commitment: $__________ Aggregate outstanding principal amount of Revolving Credit Advances assigned: $__________ Effective Date*: _______________, 199_ [NAME OF ASSIGNOR], as Assignor By -------------------------------------- Title: Dated: _______________, 199_ [NAME OF ASSIGNEE], as Assignee By -------------------------------------- Title: Dated: _______________, 199_ Domestic Lending Office: [Address] Eurocurrency Lending Office: [Address] Accepted this __________ day of _______________, 199_ CITIBANK, N.A., as Administrative Agent By ------------------------------------ Title: - ---------- * This date should be no earlier than five Business Days after the delivery of this Assignment and Acceptance to Citibank, as Administrative Agent. 2 [Approved this __________ day of _______________, 199_ [NAME OF BORROWER] By ]* --------------------------------- Title: - ---------- * Required if the Assignee is an Eligible Assignee solely by reason of clause (viii) of the definition of "Eligible Assignee". EXHIBIT D - FORM OF DESIGNATION AGREEMENT [DATE] To each of the Lenders parties to the Credit Agreement (as defined below) and to Citibank, N.A. as Administrative Agent for such Lenders Ladies and Gentlemen: Reference is made to the 5-Year Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc. ("PM Companies"), certain other borrowers parties thereto, the Lenders named therein, Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent, for said Lenders (the "Credit Agreement"). Terms used herein and defined in the Credit Agreement shall have the respective meanings ascribed to such terms in the Credit Agreement. Please be advised that PM Companies hereby designates its undersigned Subsidiary, ____________ ("Designated Subsidiary"), as a "Designated Subsidiary" under and for all purposes of the Credit Agreement. The Designated Subsidiary, in consideration of each Lender's agreement to extend credit to it under and on the terms and conditions set forth in the Credit Agreement, does hereby assume each of the obligations imposed upon a "Designated Subsidiary" and a "Borrower" under the Credit Agreement and agrees to be bound by the terms and conditions of the Credit Agreement. In furtherance of the foregoing, the Designated Subsidiary hereby represents and warrants to each Lender as follows: (a) The Designated Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of ______________________. (b) The execution, delivery and performance by the Designated Subsidiary of this Designation Agreement, the Credit Agreement and the Notes to be delivered by it are within the Designated Subsidiary's corporate powers, have been duly authorized by all necessary corporate action and do not contravene (i) the Designated Subsidiary's charter or by-laws or (ii) any law, rule, regulation or order of any court or governmental agency or contractual restriction binding on or affecting it. (c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by the Designated Subsidiary of this Designation Agreement, the Credit Agreement or the Notes to be delivered by it. (d) This Designation Agreement is, and the Notes to be delivered by the Designated Subsidiary when delivered will be, legal, valid and binding obligations of the Designated Subsidiary enforceable against the Designated Subsidiary in accordance with their respective terms, subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting 2 creditors' rights generally and to the effect of general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). (e) There is no pending or threatened action or proceeding affecting the Designated Subsidiary or any of its Subsidiaries before any court, governmental agency or arbitrator which purports to affect the legality, validity or enforceability of this Designation Agreement, the Credit Agreement or any Note of the Designated Subsidiary. Very truly yours, PHILIP MORRIS COMPANIES INC. By ------------------------------ Name: Title: [THE DESIGNATED SUBSIDIARY] By ------------------------------ Name: Title: EXHIBIT E-1 - FORM OF OPINION OF COUNSEL FOR PM COMPANIES [Letterhead of Hunton & Williams] [Effective Date] To each of the Lenders parties to the 5-Year Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc., said Lenders and Citibank, N.A., as Administrative Agent for said Lenders, and to Citibank, N.A. as Administrative Agent Philip Morris Companies Inc. Ladies and Gentlemen: This opinion is furnished to you pursuant to Section 3.01(e)(iii) of the 5-Year Revolving Credit Agreement, dated as of October 14, 1997 (the "Credit Agreement"), among Philip Morris Companies Inc. ("PM Companies"), the Lenders parties thereto and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for said Lenders. Terms defined in the Credit Agreement are used herein as therein defined. We have acted as counsel for PM Companies in connection with the preparation, execution and delivery of the Credit Agreement. In that connection, we have examined: (1) The Credit Agreement. (2) The documents furnished by PM Companies pursuant to Article III of the Credit Agreement. (3) The Articles of Incorporation of PM Companies and all amendments thereto (the "Charter"). (4) The by-laws of PM Companies and all amendments thereto (the "By-laws"). We have also examined the originals, or copies certified to our satisfaction, of such corporate records of PM Companies, certificates of public officials and of officers of PM Companies, and agreements, instruments and other documents, as we have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, we have, when relevant facts were not independently established by us, relied upon certificates of PM Companies or its officers or of public officials. We have assumed the due execution and delivery, pursuant to due authorization, of the Credit Agreement by the Initial Lenders and Citibank, as Administrative Agent. Our opinions expressed below are limited to the law of the State of New York, the Commonwealth of Virginia and the Federal law of the United States. Based upon the foregoing and upon such investigation as we have deemed necessary, we are of the following opinion: 1. PM Companies is a corporation duly organized, validly existing and in good standing under the laws of the State of Virginia. 2. The execution, delivery and performance by PM Companies of the Credit Agreement and the Notes, and the consummation of the transactions contemplated thereby, are within PM Companies's corporate powers, have been duly authorized by all necessary corporate action, and do not contravene (i) the Charter or the By-laws or (ii) any law, rule or regulation applicable to PM Companies (including, without limitation, Regulation X of the Board of Governors of the Federal Reserve System) or (iii) to the best of our knowledge, any contractual or legal restriction binding on or affecting PM Companies. The Credit Agreement and any Notes delivered on the date hereof have been duly executed and delivered on behalf of PM Companies. 3. No authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for the due execution, delivery and performance by PM Companies of the Credit Agreement and the Notes. 4. The Credit Agreement is the legal, valid and binding obligation of PM Companies enforceable against PM Companies in accordance with its terms. The Notes issued on the date hereof are the legal, valid and binding obligations of PM Companies, enforceable against PM Companies in accordance with their respective terms. 5. PM Companies directly or indirectly owns 100% of the capital stock of Philip Morris. The opinion set forth in paragraph 4 above as to enforceability is subject to the effect of any applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or similar law affecting creditors' rights generally and to the effect of general principles of equity and any implied covenant of good faith and fair dealing. Very truly yours, EXHIBIT E-2 - FORM OF OPINION OF COUNSEL FOR PM COMPANIES [Effective Date] To each of the Lenders parties to the 5-Year Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc., said Lenders and Citibank, N.A., as Administrative Agent for said Lenders, and to Citibank, N.A. as Administrative Agent Philip Morris Companies Inc. Ladies and Gentlemen: This opinion is furnished to you pursuant to Section 3.01(e)(iii) of the 5-Year Revolving Credit Agreement, dated as of October 14, 1997 (the "Credit Agreement"), among Philip Morris Companies Inc. ("PM Companies"), the Lenders parties thereto and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for said Lenders. Terms defined in the Credit Agreement are used herein as therein defined. I have acted as counsel for PM Companies in connection with the preparation, execution and delivery of the Credit Agreement. In that connection, I have examined originals, or copies certified to our satisfaction, of such corporate records of PM Companies, certificates of public officials and of officers of PM Companies, and agreements, instruments and other documents, as I have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, I have, when relevant facts were not independently established by me, relied upon certificates of PM Companies or its officers or of public officials. Based upon the foregoing and upon such investigation as I have deemed necessary, I am of the opinion that there is, to the best of my knowledge, (i) no pending or threatened action or proceeding against PM Companies or any of its Subsidiaries before any court, governmental agency or arbitrator (a "Proceeding") that purport to affect the legality, validity, binding effect or enforceability of the Credit Agreement or any of the Notes or the consummation of the transactions contemplated thereby, and (ii) except for Proceedings disclosed in the Annual Report on Form 10-K of PM Companies for the fiscal year ended December 31, 1996, its Quarterly Reports on Form 10-Q for the quarters ended March 31, 1997 and June 30, 1997, its Current Reports on Form 8-K dated June 20, 1997, June 25, 1997, July 2, 1997 and August 25, 1997, any Current Reports on Form 8-K filed subsequent to August 25, 1997 or, with respect to events occurring after the date of the most recent such document, a certificate delivered to the Lenders and attached hereto, there are no Proceedings that are likely to have a materially adverse effect upon the financial condition or operations of PM Companies and its Subsidiaries taken as a whole. Very truly yours, EXHIBIT F - FORM OF OPINION OF COUNSEL FOR DESIGNATED SUBSIDIARY [Effective Date] To each of the Lenders parties to the 5-Year Credit Agreement dated as of October 14, 1997 among Philip Morris Companies Inc., said Lenders and Citibank, N.A., as Administrative Agent for said Lenders, and to Citibank, N.A. as Administrative Agent Philip Morris Companies Inc. Ladies and Gentlemen: This opinion is furnished to you pursuant to Section 3.02(e) of the 5-Year Revolving Credit Agreement, dated as of October 14, 1997 (the "Credit Agreement"), among Philip Morris Companies Inc. ("PM Companies"), the Lenders parties thereto and Citibank, N.A., as Administrative Agent, The Chase Manhattan Bank, as Administrative Agent, Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent for said Lenders. Terms defined in the Credit Agreement are used herein as therein defined. We have acted as counsel for __________ (the "Designated Subsidiary") in connection with the preparation, execution and delivery of the Designation Agreement. In that connection, we have examined: (1) The Designation Agreement. (2) The Credit Agreement. (3) The documents furnished by the Designated Subsidiary pursuant to Article III of the Credit Agreement. (4) The [Articles] [Certificate] of Incorporation of the Designated Subsidiary and all amendments thereto (the "Charter"). (5) The by-laws of the Designated Subsidiary and all amendments thereto (the "By-laws"). We have also examined the originals, or copies certified to our satisfaction, of such corporate records of the Designated Subsidiary, certificates of public officials and of officers of the Designated Subsidiary, and agreements, instruments and other documents, as we have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, we have, when relevant facts were not independently established by us, relied upon certificates of the Designated Subsidiary or its officers or of public officials. We have assumed the due execution and delivery, pursuant to due authorization, of the Credit Agreement by the Initial Lenders and Citibank, as Administrative Agent. 2 Based upon the foregoing and upon such investigation as we have deemed necessary, we are of the following opinion: 1. The Designated Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of ____________. 2. The execution, delivery and performance by the Designated Subsidiary of the Designation Agreement, the Credit Agreement and the Notes to be delivered by it, and the consummation of the transactions contemplated thereby, are within the Designated Subsidiary's corporate powers, have been duly authorized by all necessary corporate action, and do not contravene (i) the Charter or the By-laws or (ii) any law, rule or regulation applicable to the Designated Subsidiary (including, without limitation, Regulation X of the Board of Governors of the Federal Reserve System) or (iii) to the best of our knowledge, any contractual or legal restriction binding on or affecting the Designated Subsidiary. The Designation Agreement, the Credit Agreement and the Notes delivered by the Designated Subsidiary on the date hereof have been duly executed and delivered on behalf of the Designated Subsidiary. 3. No authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for the due execution, delivery and performance by the Designated Subsidiary of the Designation Agreement, the Credit Agreement and the Notes delivered by the Designated Subsidiary. 4. The Designation Agreement and the Credit Agreement are the legal, valid and binding obligations of the Designated Subsidiary enforceable against the Designated Subsidiary in accordance with their respective terms. The Notes issued on the date hereof by the Designated Subsidiary are the legal, valid and binding obligations of the Designated Subsidiary, enforceable against the Designated Subsidiary in accordance with their respective terms. 5. There is, to the best of my knowledge, no pending or threatened action or proceeding against the Designated Subsidiary or any of its Subsidiaries before any court, governmental agency or arbitrator that purport to affect the legality, validity, binding effect or enforceability of the Designation Agreement, the Credit Agreement or any of the Notes delivered by the Designated Subsidiary or the consummation of the transactions contemplated thereby. The opinion set forth in paragraph 4 above as to enforceability is subject to the effect of any applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or similar law affecting creditors' rights generally and to the effect of general principles of equity and any implied covenant of good faith and fair dealing. Very truly yours, EXHIBIT G FORM OF OPINION OF COUNSEL FOR CITIBANK, AS ADMINISTRATIVE AGENT [Letterhead of Shearman & Sterling] October __, 1997 To the Initial Lenders party to the Credit Agreement referred to below and to Citibank, N.A., as Administrative Agent Ladies and Gentlemen: We have acted as special New York counsel to Citibank, N.A., as Administrative Agent, in connection with the preparation, execution and delivery of the 5-Year Credit Agreement dated as of October 14, 1997 (the "Credit Agreement"), among Philip Morris Companies, Inc., a Virginia corporation (the "Borrower"), and each of you (each a "Lender"). Unless otherwise defined herein, terms defined in the Credit Agreement are used herein as therein defined. In that connection, we have examined a counterpart of the Credit Agreement executed by the Borrower and, to the extent relevant to our opinion expressed below, the other documents delivered by the Borrower pursuant to Section 3.01 of the Credit Agreement. In our examination of the Credit Agreement and such other documents, we have assumed, without independent investigation (a) the due execution and delivery of the Credit Agreement by all parties thereto, (b) the genuineness of all signatures, (c) the authenticity of the originals of the documents submitted to us and (d) the conformity to originals of any documents submitted to us as copies. In addition, we have assumed, without independent investigation, that (i) the Borrower is duly organized and validly existing under the laws of the jurisdiction of its organization and has full power and authority (corporate and otherwise) to execute, deliver and perform the Credit Agreement and the Notes and (ii) the execution, delivery and performance by the Borrower of the Credit Agreement have been duly authorized by all necessary action (corporate or otherwise) and do not (A) contravene the certificate of incorporation, bylaws or other constituent documents of the Borrower, (B) conflict with or result in the breach of any document or instrument binding on the Borrower or (C) violate or require any governmental or regulatory authorization or other action under any law, rule or regulation applicable to the Borrower other than New York law or United States federal law applicable to borrowers generally or, assuming the correctness of the Borrower's statements made as representations and warranties in Section 4.01(c) of the Credit Agreement, applicable to the Borrower. We have also assumed that the Credit Agreement is the legal, valid and binding obligation of each Lender, enforceable against such Lender in accordance with its terms. 4 Based upon the foregoing examination and assumptions and upon such other investigation as we have deemed necessary and subject to the qualifications set forth below, we are of the opinion that the Credit Agreement is the legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its terms. Our opinion above is subject to the following qualifications: (i) Our opinion above is subject to the effect of any applicable bankruptcy, insolvency (including, without limitation, all laws relating to fraudulent transfers), reorganization, moratorium or similar law affecting creditors' rights generally. (ii) Our opinion above is also subject to the effect of general principles of equity, including (without limitation) concepts of materiality, reasonableness, good faith and fair dealing (regardless of whether considered in a proceeding in equity or at law). (iii) We express no opinion as to the enforceability of the indemnification provisions set forth in Section 9.04 of the Credit Agreement to the extent enforcement thereof is contrary to public policy regarding the exculpation of criminal violations, intentional harm and acts of gross negligence or recklessness. (iv) Our opinion above is limited to the law of the State of New York and the federal law of the United States of America and we do not express any opinion herein concerning any other law. Without limiting the generality of the foregoing, we express no opinion as to the effect of the law of a jurisdiction other than the State of New York wherein any Lender may be located or wherein enforcement of the Credit Agreement or any of the Notes may be sought that limits the rates of interest legally chargeable or collectible. A copy of this opinion letter may be delivered by any of you to any Person that becomes a Lender in accordance with the provisions of the Credit Agreement. Any such Lender may rely on the opinion expressed above as if this opinion letter were addressed and delivered to such Lender on the date hereof. This opinion letter speaks only as of the date hereof. We expressly disclaim any responsibility to advise you or any other Lender who is permitted to rely on the opinion expressed herein as specified in the next preceding paragraph of any development or circumstance of any kind including any change of law or fact that may occur after the date of this opinion letter even though such development, circumstance or change may affect the legal analysis, a legal conclusion or any other matter set forth in or relating to this opinion letter. Accordingly, any Lender relying on this opinion letter at any time should seek advice of its counsel as to the proper application of this opinion letter at such time. Very truly yours, EX-12 4 COMPUTATIONS EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) ------------------- Nine Months Ended Three Months Ended September 30, 1997 September 30, 1997 ------------------ ------------------ Earnings before income taxes and cumulative effect of accounting changes $ 8,427 $ 2,363 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (147) (42) Dividends from less than 50% owned affiliates 107 25 Fixed charges 1,095 353 Interest capitalized, net of amortization (15) (17) ------- ------- Earnings available for fixed charges $ 9,467 $ 2,682 ======= ======= Fixed charges: Interest incurred: Consumer products $ 936 $ 300 Financial services and real estate 51 17 ------- ------- 987 317 Portion of rent expense deemed to represent interest factor 108 36 ------- ------- Fixed charges $ 1,095 $ 353 ======= ======= Ratio of earnings to fixed charges 8.6 7.6 ======= ======= EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) ------------------- 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-27 5 FINANCIAL DATA SCHEDULE
5 This schedule contains summary information extracted from Pages 3-5 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997 and is qualified in its entirety by reference to such financial statements. 1,000,000 9-MOS DEC-31-1996 SEP-30-1997 779 0 5,211 (161) 8,925 16,151 19,999 8,390 55,043 14,028 13,283 0 0 935 13,706 55,043 54,722 54,722 19,978 32,326 13,154 0 815 8,427 3,412 5,015 0 0 0 5,015 2.07 2.07
EX-99 6 RESOLUTION Exhibit 99 Impact of the Proposed Resolution on the U.S. Cigarette Industry The Conrad Senatorial Task Force has requested the industry to estimate the impact of the proposed resolution on cigarette consumption in the U.S. and its potential effect on individual tobacco company stock prices. This paper attempts to respond to this request despite the significant uncertainties associated with these topics. Cigarette Consumption There has been much speculation on the impact of the proposed resolution on the level and nature of future cigarette consumption in the U.S. Any projection is a perilous exercise, but in this specific instance, it is particularly difficult to predict with any degree of confidence the proposed resolution's effect on cigarette consumption. This inherent uncertainty arises from the unprecedented magnitude and scope of the combined impact of the numerous economic and non-economic measures contained in the proposed resolution. Cigarette consumption in the U.S. is estimated to have reached a level of 482.7 billion units in 1996 reflecting an annual average decline of 1.3 percent since 1990.(1) Cigarette consumption levels are a function of numerous parameters and their interrelationships. These parameters include price, price gaps, the availability of substitute products, demographics, inflation, consumer disposable income, social attitudes towards smoking, smoking restrictions, etc. Many of these parameters are subject to considerable uncertainty and will be significantly impacted by the proposed resolution. Economists measure the impact of real price movements on the purchase of any product through econometric modelling which yields a price elasticity ratio. For example, a price elasticity ratio of -0.5 means that a real price increase of 10 percent generates a reduction in demand of 5 percent. Numerous studies have been conducted that estimate the price elasticity of demand for cigarettes in the U.S. market. The vast majority - ---------- (1) Industry estimates of consumption derived from industry shipments adjusted for trade inventory movements. suggest that elasticity falls between -0.40 and -0.45.(2) These studies rely on historical data to measure elasticity and generally derive estimates based on "short run" or immediate impacts. Some studies have attempted to measure the "long run" elasticity of demand for cigarettes. A study by Economics Nobel Prize laureate, Gary Becker, estimated that the long run response to a permanent change in price falls between -0.73 and -0.79 with an average elasticity factor of -0.75.(3) The Becker study implies that a 10 percent increase in real prices will cause a short run decrease in cigarette sales of approximately 4 percent and a long run decrease in cigarette demand of 7.5 percent. A March 1994 analysis by Gravelle and Zimmerman of the Congressional Research Service(4) also highlights the fact that the expected long run reduction in demand for cigarettes will be much greater than in the short run. The study implies that the long run elasticity could be as high as -1.2. Thus, under this measure, a 10 percent price increase would result in a long run decline in cigarette sales of 12 percent. Price elasticity of demand is not independent of real price movements. When consumer prices reach unprecedented levels, sensitivity to price also rises and thus elasticity ratios become more pronounced. Accordingly, the industry conservatively estimates that as a result of the real retail price increases that will result from the implementation of the proposed resolution, price elasticity is likely to fall between -0.5 and -0.75. U.S. cigarette consumption is estimated to have a negative annual underlying trend, independent of real price movements, of between 1 percent and 2 percent. (5) The proposed resolution incorporates a wide array of measures which will clearly impact this underlying trend in demand. These measures include access restrictions, well funded public education campaigns and billions of dollars earmarked for cessation programs. While it is difficult to predict in an accurate manner the extent to which the underlying negative trend will accelerate, it can safely be assumed that at a very minimum it will increase to a range of between 2 percent and 3 percent. - ---------- (2) 1989 Surgeon General Report, Table 12 on Page 535. (3) Becker et al, Analysis of Cigarette Addiction, the American Economic Review, June 1994, Volume 84, No. 3, Page 407, Table 4. (4) Gravelle and Zimmerman, Cigarette Taxes to Fund Health Care Reform: An Economic Analysis, March 8, 1994, Congressional Research Service, The Library of Congress. (5) Patrick Fleenor, Tax Foundation - The Effect of Excise Tax Differentials on the Interstate Smuggling and Cross-Border Sales of Cig, arettes in the U.S., October 1996, as well as industry estimates. -2- 10/8/97 In recent weeks the public health community and numerous officials have stated that retail prices will increase by 62 cents per pack by the fifth year of implementation of the proposed resolution. This number is grossly underestimated. For example, it totally ignores the multipliers inherent in the retail price structure of cigarettes, e.g., trade margins and state and local general sales taxes. The industry conservatively estimates that retail prices will increase by an absolute minimum of $1.20 per pack by the fifth year and by an absolute minimum of $1.50 per pack by the tenth year of implementation of the proposed resolution.(6) Accordingly, retail prices will rise at least to the levels that are being advocated by the public health community and the President without the imposition of any additional Federal or State excise taxes.(7) The following table highlights cigarette demand levels that are derived from price elasticity factors of -0.5 and -0.75 and a downward underlying trend in demand of 2.5 percent: Table 1 - -------------------------------------------------------------------------------- Projected Cigarette Consumption 1997 - 2007 (Billion Cigarettes) % Variance ----------------------- 2002 vs. 2007 vs. Elasticity 1997 2002 2007 1997 1997 - ---------- ---- ---- ---- ---- ---- -0.50 477.0 337.8 301.1 (29.2)% (36.9)% -0.75 477.0 300.6 269.3 (37.0)% (43.5)% - -------------------------------------------------------------------------------- Over a ten year period it is estimated that cigarette consumption would fall by between 175.9 billion cigarettes and 207.7 billion cigarettes versus 1997 estimated consumption of 477 billion cigarettes. Table 2 highlights the above-mentioned projections versus cigarette consumption levels that would otherwise have materialized as a result of the secular downward trend of approximately 1.5 percent: - ---------- (6) See detailed retail price projections on Table 5, Page 9. (7) Over and above the prevailing average State Excise tax of $0.33/pack and the $0.39/pack Federal Excise tax as of 2002. -3- 10/8/97 Table 2 ---------------------------------------------------------------- Projected Cigarette Consumption 1997 - 2007 (Billion Cigarettes) 1997 2002 2007 ---- ---- ---- Base 477.0 442.3 410.1 Scenario 1 477.0 337.8 301.1 Scenario 2 477.0 300.6 269.3 % Variance Versus Base: Scenario 1 - (23.6)% (26.6)% Scenario 2 - (32.0)% (34.3)% ---------------------------------------------------------------- Such volume declines will have a significant adverse impact on the entire cigarette supply chain. Industry pretax earnings will suffer even if unit margins rise to offset the higher burden of unit fixed costs in the face of declining sales volumes. The Federal Trade Commission has recently issued a report that alleges that the industry could reap substantial benefits from the proposed resolution.(8) Indeed, the FTC report claims that the industry could raise prices with impunity and thereby generate huge windfall profits. The report also claims that the industry would retain two thirds of incremental revenues to the detriment of the public sector. The report's analysis and conclusions are seriously flawed for the following reasons: (i) The report erroneously assumes that increases in the retail price of cigarettes beyond the level required to pass through the settlement payments will accrue solely to the manufacturers. For example, under the FTC report's "200% scenario" which entails a retail price of $3.04/pack, the FTC report assumes that - ---------- (8) Federal Trade Commission, Competition and the Financial Impact of the Proposed Tobacco Industry Settlement, September, 1997. -4- 10/8/97 the manufacturers' price(9) net of taxes and settlement payments will be $1.42/pack. As highlighted on Table 3, had the FTC used more accurate assumptions in its projections, it would have concluded that the manufacturers' price would be significantly lower than its study suggests under its retail price assumptions. Table 3 - -------------------------------------------------------------------------------- 200% Price Increase ($ / pack) 2007 FTC Projection Amended FTC Projection(10) -------------- -------------------------- Retail Price $3.04 $3.04 Federal Excise Tax(a) (0.24) (0.39) State Excise Tax (0.32) (0.33)(b) Settlement Payment(c) (0.62) (0.83) Trade Margin (0.44)(d) (0.58)(e) Sales Tax at 4.7% -- (0.14) ----- ----- Manufacturers' Price $1.42 $0.77 ===== ===== (a) After the publication of the report, the FTC stated that the $0.15/pack excise tax credit ($0.10/pack in 2000 and $0.05/pack in 2002) should not have been factored into its assumptions. (b) The weighted average state excise tax prevailing in July 1997 was $0.3362/pack reflecting increases in New Hampshire, Utah and Rhode Island. (c) The minimum 3 percent per annum escalator is omitted by the FTC. (d) The FTC report does not explicitly divulge the trade margin assumption. The trade margin is derived from the FTC report by deduction and is consistent with the theory expounded in the report that any increase in retail price accrues solely to the manufacturers. (e) This conservatively assumes that the trade will earn a margin of only 12 percent on any increase in retail price beyond the $1.90/pack. - -------------------------------------------------------------------------------- For perspective, it should be highlighted that the average manufacturers' net selling price in 1996 was $0.80/pack. - ---------- (9) Manufacturers' price to wholesalers. (10) It follows from this analysis that the retail price would have to be $3.81/pack to yield a manufacturers' price of $1.42/pack. -5- 10/8/97 (ii) The assumptions pertaining to industry profitability are simplistic at best. The FTC report uses a weighted average operating profit of $0.32/pack. The Brown and Williamson Tobacco Corporation (B&W) which accounted for 17.2 percent of industry sales volume in 1996 is omitted from this calculation. Had the FTC report included B&W's operating profits in the weighting, the average operating profit would decline to $0.30/pack, a difference of $500 million dollars in annual industry pretax earnings. The report fails to specify that a significant proportion of the industry's cost base is composed of fixed costs, i.e., costs that are independent of throughput along the entire supply chain. The report simply assumes that all industry costs are variable. In other words, the FTC assumes that all fixed costs will decline in line with projected volume declines. Under the FTC's premise, a sales volume loss of one billion cigarette packs would erode industry profits by $300 million dollars. In fact the loss would be more than double this level, as fixed costs will remain and the industry would lose the full marginal contribution generated by this volume, i.e., approximately $640 million dollars. The report admits that in order to "simplify the analysis" it ignores the potential impact of a change in mix, i.e., a potential shift in demand from premium priced brands to either discount or generic products. Premium brands currently account for approximately 72 percent of total sales. For purposes of illustration, should this segment decline to a level of 60 percent with a corresponding increase in the discount segment, the net cost to the industry would be in excess of $600 million in operating profits at prevailing unit margin levels.(11) The FTC report estimates potential marketing and legal expenditure savings that ostensibly would be derived from the implementation of the proposed resolution. It is by no means certain that the industry will in fact generate savings in its legal expenditures. The FTC fails to take account of the industry's continued exposure to individual litigation and to its obligations in terms of attorneys' fees. Moreover, the FTC fails to account for any cost increases associated with the proposed resolution. It notably omits from its assumptions: - the interest costs related to the industry up-front payment of $10 billion. - ---------- (11) A shift in consumption to the discount segment will result in a lower average retail price than otherwise would be the case and hence volume would be marginally higher. The resulting higher volume would only partially offset the significant margin erosion resulting from an adverse change in mix. -6- 10/8/97 - the significant expenditures required to fully comply with the broad array of regulatory measures that are contained in the proposed resolution. - the implications of the proposed resolution on the cost of tobacco. Future legislation will in all likelihood contain provisions designed to protect domestic tobacco growers and their communities from the impact of declining volumes. These provisions are likely to increase the direct or indirect cost of tobacco. - any potential surcharge that would be imposed on the industry in the event that underage smoking incidence would fail to meet the reduction targets that are specified in the proposed resolution. (iii) The report chooses to neglect the historical pattern of state excise tax increases which have risen at an annual average rate of approximately 5 percent since 1990. It is simply unrealistic to assume that both the Federal Excise Tax and State Excise Taxes will remain at current levels for the next 25 years if industry profitability should ever reach the unprecedented levels that are suggested by the FTC report. Company Share Prices The inherent uncertainty pertaining to the impact of the proposed resolution on the level and nature of future cigarette consumption and on industry profitability also clearly applies to the reaction of the stock market. It is an indisputable fact that the stock prices of tobacco companies historically have been volatile and that the relative Price/Earnings ratios of these companies have been adversely impacted by the threat of litigation, despite the fact that the industry has consistently prevailed in the courts. There are those on Wall Street who believe that the elimination of substantial event risk provides predictability and thus should be a net positive for the tobacco companies. They claim that these companies are all highly diversified and thus the market discount afforded to these non-tobacco assets would be removed. -7- 10/8/97 Conversely, there are others on Wall Street who believe that the proposed resolution will be a net negative for the tobacco companies. They believe that the terms of the resolution are too onerous and that these companies can sustain their successful track record in the courts. Moreover, they argue that any potential expansion in their respective Price/Earnings ratios would be fully offset by the erosion in profitability that these companies will incur as a result of the resolution. The fact of the matter is that no one is in a position to predict what may happen to individual stock prices. Table 4 highlights the performance of individual stock prices versus the S&P 500 at market close on September 25, 1997: Table 4 - -------------------------------------------------------------------------------- September 25, 1997 Stock Prices ------------------------------- Year-End Year-End P/E 1995 1996 Ratio -------- -------- ----- BAT Industries (7.7)% 8.2% 11 Loews 42.8% 18.8% 14 Philip Morris Companies 38.0% 10.2% 15 RJR Nabisco 8.3% (2.0)% 13 S&P 500 53.4% 21.7% 24 - -------------------------------------------------------------------------------- Table 4 clearly highlights that the stock market's reaction to date to the terms of the proposed resolution has been negative as every single company has trailed the S&P 500 since both year-end 1995 and year-end 1996 despite solid profit growth and attractive dividend yields. Wall Street is oriented towards the short term, and the bulk of the projections emanating from Wall Street focus on a period of only 3 years and, in some rare instances, 5 years. In addition, in a bull market everything is viewed optimistically. The long term impact remains uncertain and will depend on each individual company's ability to generate earnings growth through its other businesses. -8- 10/8/97 Table 5 Minimum Retail Price Projections(13) ($ / pack of 20 Cigarettes)
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- On-going Settlement Payments (a) - 0.360 0.414 0.517 0.647 0.715 0.737 0.759 0.782 0.805 0.829 Industry Price (b) - 0.027 0.054 0.082 0.111 0.141 0.171 0.202 0.234 0.267 0.300 Federal Excise Tax - - - 0.100 0.100 0.150 0.150 0.150 0.150 0.150 0.150 Trade Margin (c) - 0.053 0.064 0.095 0.117 0.137 0.144 0.152 0.159 0.167 0.174 Sales Tax (d) - 0.021 0.025 0.037 0.046 0.054 0.056 0.059 0.062 0.065 0.068 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total Increase - 0.461 0.557 0.831 1.021 1.197 1.258 1.322 1.387 1.454 1.521 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Retail Price 1.82(e) 2.28 2.38 2.65 2.84 3.02 3.08 3.14 3.21 3.27 3.34
(a) Reflects on-going settlement payments adjusted for volume and indexed at minimum annual rate of 3%. (b) Only reflects adjustment for inflation of 2.5%. (c) Assumes a combined 12% rate for both wholesalers and retailers. Current average trade margin, expressed as a percentage of retail price, exceeds 20% and thus this assumption is extremely conservative. (d) Reflects national average tax of 4.7%. (e) Average weighted net price to consumer. 13 These projections exclude any additional federal or state excise taxes and any additional payments that may be required under the terms of the proposed resolution, e.g., surcharges pertaining to the lookback provision. -9- 10/8/97 -----END PRIVACY-ENHANCED MESSAGE-----