-----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, VbukNjxfH4xuN1YdCcFMAElYSdmX3SbtfMESG/N7GNc7tWiOguRPkaDAQxqjGJws GWINk/FcvAj+W8tN5rHggQ== 0001047469-98-031299.txt : 19980817 0001047469-98-031299.hdr.sgml : 19980817 ACCESSION NUMBER: 0001047469-98-031299 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 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: 98687351 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 June 30, 1998 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 July 31, 1998, there were 2,432,090,598 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 June 30, 1998 and December 31, 1997 3 - 4 Condensed Consolidated Statements of Earnings for the Six Months Ended June 30, 1998 and 1997 5 Three Months Ended June 30, 1998 and 1997 6 Condensed Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 1997 and the Six Months Ended June 30, 1998 7 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1998 and 1997 8 - 9 Notes to Condensed Consolidated Financial Statements 10 - 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 23 - 44 PART II - OTHER INFORMATION Item 1. Legal Proceedings. 45 Item 6. Exhibits and Reports on Form 8-K. 45 Signature 46 -2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (in millions of dollars) (Unaudited)
June 30, December 31, 1998 1997 -------- ------------ ASSETS CONSUMER PRODUCTS Cash and cash equivalents $ 4,605 $ 2,282 Receivables, net 5,293 4,294 Inventories: Leaf tobacco 4,166 4,348 Other raw materials 1,910 1,689 Finished product 3,043 3,002 ------- ------- 9,119 9,039 Other current assets 1,840 1,825 ------- ------- Total current assets 20,857 17,440 Property, plant and equipment, at cost 20,595 20,002 Less accumulated depreciation 8,740 8,381 ------- ------- 11,855 11,621 Goodwill and other intangible assets (less accumulated amortization of $5,087 and $4,814) 17,557 17,789 Other assets 3,023 3,211 ------- ------- Total consumer products assets 53,292 50,061 FINANCIAL SERVICES Finance assets, net 5,900 5,712 Other assets 171 174 ------- ------- Total financial services assets 6,071 5,886 ------- ------- TOTAL ASSETS $59,363 $55,947 ======= =======
See notes to condensed consolidated financial statements. Continued -3- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Continued) (in millions of dollars, except per share data) (Unaudited)
June 30, December 31, 1998 1997 -------- ------------ LIABILITIES CONSUMER PRODUCTS Short-term borrowings $ 847 $ 157 Current portion of long-term debt 1,577 1,516 Accounts payable 2,505 3,318 Accrued marketing 2,148 2,149 Accrued taxes, except income taxes 1,667 1,234 Accrued settlement charges 1,790 886 Other accrued liabilities 3,467 3,977 Income taxes 1,000 862 Dividends payable 975 972 ------- ------- Total current liabilities 15,976 15,071 Long-term debt 12,289 11,585 Deferred income taxes 920 889 Accrued postretirement health care costs 2,506 2,432 Other liabilities 6,630 6,218 ------- ------- Total consumer products liabilities 38,321 36,195 FINANCIAL SERVICES Short-term borrowings 103 Long-term debt 838 845 Deferred income taxes 3,933 3,877 Other liabilities 146 110 ------- ------- Total financial services liabilities 5,020 4,832 ------- ------- Total liabilities 43,341 41,027 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 26,111 24,924 Accumulated other comprehensive earnings: Currency translation adjustments (1,330) (1,109) ------- ------- 25,716 24,750 Less cost of repurchased stock (374,902,778 and 380,474,028 shares) 9,694 9,830 ------- ------- Total stockholders' equity 16,022 14,920 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $59,363 $55,947 ======= =======
See notes to condensed consolidated financial statements. -4- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions of dollars, except per share data) (Unaudited)
For the Six Months Ended June 30, ------------------------ 1998 1997 ------- ------- Operating revenues $37,361 $36,630 Cost of sales 13,590 13,407 Excise taxes on products 8,419 8,247 ------- ------- Gross profit 15,352 14,976 Marketing, administration and research costs 8,354 8,050 Settlement charges (Note 3) 1,005 Amortization of goodwill 290 296 ------- ------- Operating income 5,703 6,630 Interest and other debt expense, net 482 566 ------- ------- Earnings before income taxes 5,221 6,064 Provision for income taxes 2,103 2,455 ------- ------- Net earnings $ 3,118 $ 3,609 ======= ======= Per share data: Basic earnings per share $ 1.28 $ 1.49 ======= ======= Diluted earnings per share $ 1.28 $ 1.48 ======= ======= Dividends declared $ 0.80 $ 0.80 ======= =======
See notes to condensed consolidated financial statements. -5- Philip Morris Companies Inc. and Subsidiaries Condensed Consolidated Statements of Earnings (in millions of dollars, except per share data) (Unaudited)
For the Three Months Ended June 30, -------------------------- 1998 1997 ------- ------- Operating revenues $18,978 $18,413 Cost of sales 6,883 6,690 Excise taxes on products 4,192 4,123 ------- ------- Gross profit 7,903 7,600 Marketing, administration and research costs 4,420 4,089 Settlement charges (Note 3) 199 Amortization of goodwill 144 147 ------- ------- Operating income 3,140 3,364 Interest and other debt expense, net 238 279 ------- ------- Earnings before income taxes 2,902 3,085 Provision for income taxes 1,166 1,249 ------- ------- Net earnings $ 1,736 $ 1,836 ======= ======= Per share data: Basic earnings per share $ 0.72 $ 0.76 ======= ======= Diluted earnings per share $ 0.71 $ 0.75 ======= ======= 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, 1997 and the Six Months Ended June 30, 1998 (in millions of dollars, except per share data) (Unaudited)
Earnings Accumulated Total Reinvested Currency Other Cost of Stock- Common in the Translation Comprehensive Repurchased holders' Stock Business Adjustments Earnings Stock Equity ------ ---------- ----------- ------------- ----------- -------- Balances, January 1, 1997 $ 935 $22,480 $ 192 $ 190 $(9,387) $14,218 Comprehensive earnings: Net earnings 6,310 6,310 Other comprehensive earnings, net of income taxes: Currency translation adjustments (1,301) (1,301) (1,301) Net unrealized appreciation on securities 2 2 ------- ------- ------- Total other comprehensive earnings (1,301) (1,299) (1,299) ------- ------- ------- Total comprehensive earnings 5,011 Exercise of stock options and issuance of other stock awards 14 300 314 Cash dividends declared($1.60 per share) (3,880) (3,880) Stock repurchased (743) (743) ----- ------- ------- ------- ------- ------- Balances, December 31, 1997 935 24,924 (1,109) (1,109) (9,830) 14,920 Comprehensive earnings: Net earnings 3,118 3,118 Other comprehensive earnings, net of income taxes: Currency translation adjustments (221) (221) (221) ------- ------- ------- Total other comprehensive earnings (221) (221) (221) ------- ------- ------- Total comprehensive earnings 2,897 Exercise of stock options and issuance of other stock awards 12 136 148 Cash dividends declared($0.80 per share) (1,943) (1,943) ----- ------ ------- ------- ------- ------- Balances, June 30, 1998 $ 935 $26,111 $(1,330) $(1,330) $(9,694) $16,022 ===== ======= ======= ======= ======= =======
Total comprehensive earnings, which primarily represent net earnings partially offset by currency translation adjustments, were $1,696 million and $1,670 million, respectively, for the quarters ended June 30, 1998 and 1997, and $2,761 million for the first six months of 1997. 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 Six Months Ended June 30, ------------------------ 1998 1997 ------- ------- CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net earnings - Consumer products $ 3,059 $ 3,541 - Financial services and real estate 59 68 ------- ------- Net earnings 3,118 3,609 Adjustments to reconcile net earnings to operating cash flows: CONSUMER PRODUCTS Depreciation and amortization 863 855 Deferred income tax provision 121 93 Gain on sale of a business (23) Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net (1,133) (973) Inventories (63) (147) Accounts payable (951) (864) Income taxes 176 201 Other working capital items 778 455 Other 625 151 FINANCIAL SERVICES AND REAL ESTATE Deferred income tax provision 59 48 Other 66 52 ------- ------- Net cash provided by operating activities 3,659 3,457 ------- ------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES CONSUMER PRODUCTS Capital expenditures (806) (745) Purchases of businesses, net of acquired cash (223) Proceeds from sales of businesses 164 Other 22 (5) FINANCIAL SERVICES AND REAL ESTATE Investments in finance assets (263) (328) Proceeds from finance assets 67 181 ------- ------- Net cash used in investing activities (980) (956) ------- -------
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 Six Months Ended June 30, ------------------------ 1998 1997 ------- ------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES CONSUMER PRODUCTS Net issuance(repayment)of short-term borrowings $ 693 $ (149) Long-term debt proceeds 1,985 1,786 Long-term debt repaid (1,205) (1,277) FINANCIAL SERVICES AND REAL ESTATE Net issuance of short-term borrowings 103 252 Long-term debt proceeds 174 Long-term debt repaid (387) Dividends paid (1,942) (1,946) Issuance of shares 98 58 Repurchase of outstanding stock (805) Other (73) (77) ------- ------- Net cash used in financing activities (341) (2,371) ------- ------- Effect of exchange rate changes on cash and cash equivalents (15) (53) ------- ------- Cash and cash equivalents: Increase 2,323 77 Balance at beginning of period 2,282 240 ------- ------- Balance at end of period $ 4,605 $ 317 ======= =======
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, 1997 (the "1997 Form 10-K"). Balance sheet accounts are segregated by two broad types of business. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services assets and liabilities are unclassified, in accordance with respective industry practices. NOTE 2. RECENTLY ADOPTED ACCOUNTING STANDARDS: Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" ("EPS") which establishes standards for computing and presenting EPS and requires the presentation of both basic and diluted EPS. Prior period EPS have been restated to conform with the standards established by SFAS No. 128. Basic and diluted EPS were calculated using the following:
For the Six Months Ended June 30, ------------------------ 1998 1997 ---- ---- (in millions) Net earnings $3,118 $3,609 ====== ====== Weighted average shares for basic EPS 2,427 2,418 Plus incremental shares from conversions: Restricted stock and stock rights 1 1 Stock options 15 21 ----- ----- Weighted average shares for diluted EPS 2,443 2,440 ====== ====== For the Three Months Ended June 30, -------------------------- 1998 1997 ---- ---- (in millions) Net earnings $1,736 $1,836 ====== ====== Weighted average shares for basic EPS 2,428 2,414 Plus incremental shares from conversions: Restricted stock and stock rights 1 1 Stock options 14 21 ----- ----- Weighted average shares for diluted EPS 2,443 2,436 ====== ======
-10- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Options on shares of common stock were excluded from the calculation of weighted average shares for diluted EPS because their effects were antidilutive, as follows: 1998 1997 ---- ---- (in millions) For the three months ended June 30, 39 16 For the six months ended June 30, 20 8 In 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP No. 98-1 requires certain costs incurred in connection with developing or obtaining internal-use software to be capitalized and other costs to be expensed. The Company adopted SOP No. 98-1 effective January 1, 1998, and its application for the three and six month periods ended June 30, 1998 had no material effect on the Company's financial position or results of operations. 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 and affiliates, including Philip Morris Incorporated ("PM Inc."), the Company's domestic tobacco subsidiary, Philip Morris International Inc. ("PMI"), the Company's international tobacco subsidiary, and their respective indemnitees. Various types of claims are raised in these proceedings, including 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 cases brought by state and local governments seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking, as well as similar cases, including class actions, brought by non-governmental plaintiffs such as unions, health maintenance organizations ("HMOs"), federal and state taxpayers, native American tribes and others. Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. In recent years there has been a substantial increase in the number of smoking and health cases being filed in the United States. As of August 1, 1998, there were approximately 400 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 with approximately 375 such cases on December 31, 1997, and 185 such cases on December 31, 1996. Many of the new cases were filed in Florida and New -11- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) York. Twenty-two of the individual cases involve allegations of various personal injuries allegedly related to exposure to environmental tobacco smoke ("ETS"). In addition, as of August 1, 1998, there were approximately 65 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including eight that involve allegations of various personal injuries related to exposure to ETS), compared with approximately 50 such cases on December 31, 1997, and 20 such cases on December 31, 1996. Most of these actions purport to constitute statewide class actions and were filed after May 1996 when 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. The number of health care cost recovery actions in the United States also increased, with approximately 140 such cases pending as of August 1, 1998, compared with approximately 105 such cases on December 31, 1997, and 25 such cases on December 31, 1996. There are also a number of tobacco-related actions pending outside the United States against affiliates and subsidiaries of PMI including, as of August 1, 1998, approximately 20 smoking and health cases initiated by one or more individuals (Argentina (13), Brazil (1), Canada (1), Italy (1), Japan (1), Scotland (1) and Turkey (2)), four smoking and health class actions (Brazil (2), Canada (1) and Nigeria (1)) and one health care cost recovery action (Republic of the Marshall Islands). In addition, the Republic of Guatemala has filed a health care cost recovery action in the United States. LITIGATION SETTLEMENTS During 1997 and 1998, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida, Texas and Minnesota, and an ETS smoking and health class action brought on behalf of airline flight attendants. The Minnesota settlement is discussed in Note 3 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. The other settlements are discussed in Part I, Item 3. Legal Proceedings of the Company's 1997 Form 10-K. Recently, the Mississippi and Texas settlement agreements were amended pursuant to their "most favored nation" clause to reflect the terms of the Minnesota settlement agreement. The amended settlement agreements are discussed below under the heading "Health Care Cost Recovery Litigation - Most Favored Nation Provisions." The Mississippi, Florida, Texas and Minnesota health care cost recovery settlement agreements, the amendments to the Mississippi and Texas settlement agreements and certain ancillary agreements are filed as exhibits to various of the Company's reports filed with the Securities and Exchange Commission. VERDICTS IN INDIVIDUAL CASES During the last two years, juries have returned verdicts for defendants in three smoking and health cases in Florida and in one individual ETS smoking and health case in Indiana. In June 1998, a Florida appeals court reversed a $750,000 jury verdict awarded in August 1996 against another United States cigarette manufacturer. Also in June 1998, a Florida jury awarded the estate of a deceased smoker in a smoking and health case against another United States cigarette manufacturer $500,000 in compensatory damages, $52,000 for medical expenses and $450,000 in punitive damages. In Brazil, a court in 1997 awarded plaintiffs in a -12- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) smoking and health case the Brazilian currency 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. Neither the Company nor its affiliates were parties to that action. Several of the above verdicts and decisions are under appeal. TRIAL DATES Jury selection is currently underway in a smoking and health class action in Florida in which PM Inc. is a defendant (ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL.). The State of Washington's health care cost recovery action is scheduled for trial in September 1998. As set forth in Exhibit 99 hereto, approximately 15 health care cost recovery actions and four smoking and health class actions are scheduled for trial in 1999. During the remainder of 1998, five individual smoking and health cases are scheduled for trial against PM Inc., and approximately 15 such cases, including three in which the Company is a defendant, are scheduled for trial in 1999. Trial dates, however, are subject to change. A description of the smoking and health litigation, health care cost recovery litigation and certain other proceedings pending against the Company and/or its subsidiaries and affiliates follows. SMOKING AND HEALTH LITIGATION Plaintiffs' allegations of liability in smoking and health cases are based on various theories of recovery, including negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, violations of deceptive trade practice laws and consumer protection statutes, and claims under the federal Racketeer Influenced and Corrupt Organization Act ("RICO") and state RICO statutes. In certain of these cases, plaintiffs claim that cigarette smoking exacerbated the injuries caused by their exposure to asbestos. Plaintiffs in the smoking and health actions seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring funds, disgorgement of profits, and injunctive and equitable relief. Defenses raised in these cases include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, statutes of limitations, and preemption by the Federal Cigarette Labeling and Advertising Act (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 further 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 -13- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) preemption defense, proposed in Congress in recent years, were enacted. It is not possible to predict whether any such legislation will be enacted. In May 1996, the Fifth Circuit Court of Appeals held that a purported class consisting of all "addicted" smokers nationwide did not meet the standards and requirements of the federal rules governing class actions (CASTANO, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL.). Since this class decertification, lawyers for plaintiffs have filed numerous smoking and health class action suits in various state and federal courts. In general, these cases purport to be brought on behalf of residents of a particular state or states and raise "addiction" claims similar to those raised in the CASTANO case and, in some cases, claims of physical injury as well. As of August 1, 1998, putative smoking and health class actions were pending in Alabama, Arkansas, California, the District of Columbia, Florida, Georgia, Hawaii, Illinois, Indiana, Iowa, Kansas, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Nevada, New Jersey, New Mexico, New York, Ohio, Oklahoma, Pennsylvania, Puerto Rico, South Carolina, Tennessee, Texas, Utah, West Virginia and Wisconsin, as well as in Canada, Brazil and Nigeria. As of August 1, 1998, class certification had been denied or reversed by courts in six smoking and health class actions involving PM Inc., in Louisiana, the District of Columbia, New York (2), Pennsylvania and Puerto Rico, while classes remained certified in three cases in Florida, Louisiana and Maryland. A number of the foregoing decisions relating to class certification are under appeal. Class certification motions are pending in a number of the other purported smoking and health class actions. One ETS smoking and health class action was settled in 1997 as discussed in the Company's 1997 Form 10-K. ENGLE TRIAL Jury selection began in July 1998. Plaintiffs seek compensatory and punitive damages ranging into the billions of dollars, as well as equitable relief including, but not limited to, a medical fund for future health care costs, attorneys' fees and court costs. The class consists of all Florida residents and citizens, and their survivors, who have suffered, presently suffer or have died from diseases and medical conditions caused by their addiction to cigarettes that contain nicotine. For a discussion of certain recent rulings in this case, see Exhibit 99 hereto. The trial plan currently calls for the case to be tried in three phases. Phase One will involve three stages. Phase One, Stage One will involve evidence concerning common issues of liability and causation for all class members, including scientific and statistical evidence, and common class issues concerning plaintiffs' causes of action. Entitlement to punitive damages will be decided at the end of Phase One, Stage Two. If the jury determines that plaintiffs are entitled to punitive damages, evidence concerning assessment of punitive damages, by way of a ratio to be applied in the class members' subsequent individual trials, will be presented in Phase One, Stage Three. If plaintiffs prevail in Phase One, Phase Two will involve individual determination of specific causation and other individual issues regarding entitlement to compensatory damages for the class representatives. Phase Three of the trial will be held before separate juries to address absent class members' determination of specific causation and other individual issues regarding entitlement to compensatory damages. -14- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) HEALTH CARE COST RECOVERY LITIGATION In certain of the pending proceedings, foreign, state and local government entities, unions, HMOs, 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. Certain of these cases purport to be brought on behalf of a class of plaintiffs, and in some cases, the class has been certified by the court. In one health care cost recovery case, private citizens seek recovery of alleged tobacco-related health care expenditures incurred by the federal Medicare program. In others, Blue Cross subscribers seek 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/multiple damages and other statutory damages and penalties, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti-smoking programs, disclosure of nicotine yields, and payment of attorney and expert witness fees. The claims asserted in these health care cost recovery actions vary. In most 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 include failure to state a valid claim, lack of benefit, adequate remedy at law, "unclean hands" (namely, that plaintiffs cannot obtain equitable relief because they participated in, and benefited from, the sale of cigarettes), lack of antitrust injury, federal preemption, lack of proximate cause, remoteness 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 a number of states seeking to block the state's health care cost recovery action and/or to prevent the state from hiring contingency fee counsel. As discussed in Exhibit 99 hereto, Maryland and Vermont have recently enacted statutes that are intended to facilitate the state's ability to recover Medicaid and/or other health care cost expenditures allegedly caused by cigarette smoking. Other states are considering similar legislation. These statutes and proposed bills vary by jurisdiction, but generally include provisions that purport to -15- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) abrogate certain affirmative defenses, create a direct cause of action for the state (thus avoiding the need to proceed via subrogation) and authorize the use of statistical models to prove damages and/or causation. The legality of the Vermont statute is currently being challenged in court by PM Inc. and other domestic tobacco manufacturers. As of August 1, 1998, there were approximately 140 health care cost recovery cases pending against PM Inc. and, in some cases, the Company. Thirty-seven of these cases were filed by states, through their attorneys general and/or other state agencies, in Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Hawaii, Idaho, Illinois, Indiana (dismissed by trial court), Iowa (dismissal of Medicaid reimbursement claims affirmed by appellate court), Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Utah, Vermont, Washington, West Virginia and Wisconsin, and eight were filed by city and county governments. Approximately 70 of the pending health care cost recovery actions were filed by unions (four of which have been dismissed in their entirety by courts in Florida, Maryland, Pennsylvania and Oregon, but for which appeals are pending or may yet be filed), six by HMOs, five by federal and state taxpayers and five by native American tribes. Health care cost recovery actions have also been brought by the Republic of the Marshall Islands, the Commonwealth of Puerto Rico and the Republic of Guatemala. In July 1998, the press reported that the Clinton Administration is reviewing the possibility of filing a Medicare health care cost recovery action on behalf of the federal government. As discussed above, under the heading "Overview of Tobacco-Related Litigation--Litigation Settlements," four health care cost recovery cases have been settled in 1997 and 1998. WASHINGTON TRIAL Trial in the Washington health care cost recovery action is scheduled to begin in September 1998. Plaintiff seeks damages in unspecified amounts, funding of smoking cessation and public education programs, civil penalties of $2,000 for each violation of the state's unfair business practices statute, civil penalties of $100,000 against each individual defendant and $500,000 against each corporate defendant for each violation of the state's antitrust statute, costs and attorneys' fees, various forms of non-monetary relief and such other relief as the court deems appropriate. For a discussion of certain recent rulings in this case, see Exhibit 99 hereto. MOST FAVORED NATION PROVISIONS Following the settlement of Minnesota's health care cost recovery action in May 1998, the States of Texas, Florida and Mississippi contacted PM Inc. to discuss the issue of what effect, if any, the settlement of the Minnesota action has upon the terms of the prior settlements with those states pursuant to the "most favored nation" ("MFN") provision of those prior state settlements. That provision provides that, in the event the settling defendants enter into a subsequent pre-verdict settlement with a non-federal governmental entity on terms more favorable to such entity than the terms of the prior state settlements (after due consideration of relevant differences in population or other appropriate factors), the terms of the prior state settlements will be revised to provide treatment at least as relatively favorable. The Mississippi and Texas settlement agreements were recently amended pursuant to this provision, as described in detail below. Discussions with the State of Florida have not concluded in an agreement. (Copies -16- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) of the MFN amendments are filed as Exhibits to this Form 10-Q, and the discussion herein is qualified by reference thereto.) The Mississippi and Texas MFN amendments to the settlement agreements call for the industry to make additional payments to Mississippi and Texas over a five- year period aggregating $550 million and $2.275 billion, respectively. These amounts are payable in January of the year indicated and, for payments after 1999, are to be adjusted for inflation, changes in domestic sales volume and, under specified circumstances, increases in net operating profits from domestic sales:
(in millions) 1999 2000 2001 2002 2003 Total ---- ---- ---- ---- ---- ----- Mississippi $ 41.738 $145.173 $145.173 $145.173 $ 72.743 $ 550.000 Texas 156.530 605.090 605.090 605.090 303.200 2,275.000 -------- -------- -------- -------- -------- ---------- $198.268 $750.263 $750.263 $750.263 $375.943 $2,825.000 ======== ======== ======== ======== ======== ==========
These payments will be allocated among the settling defendants in accordance with their relative unit volume of domestic cigarette shipments in the year preceding payment. In the event a settling defendant defaults on its obligation to make timely payment of the above amounts, the remaining settling defendants may, in their absolute discretion, pay the missing payment. If they elect not to make up the missing payment, each settling defendant can be required by the state to pay its share of the remaining payments scheduled above within 30 days of the default, subject to inflation and volume adjustments. The obligations of the settling defendants under the amended settlement agreements are several and not joint; the amended settlement agreements do not obligate any settling defendant to pay the share of another settling defendant. The stated amounts of the ongoing annual payments (the "Ongoing Annual Payments") contemplated by the original Mississippi and Texas settlement agreements are unchanged by the MFN amendments. The MFN amendments modify the provisions of the original settlement agreements that address the impact that enactment of federal tobacco legislation before November 30, 2000, would have on such settlements. Under the MFN amendments, the settling defendants will be entitled to receive a dollar-for-dollar offset against their Ongoing Annual Payments for amounts that Mississippi or Texas, as the case may be, could elect to receive pursuant to any such federal tobacco legislation ("Federal Settlement Funds"), except to the extent that: (i) such Federal Settlement Funds are required to be used for purposes other than health care or tobacco-related purposes; (ii) such federal tobacco legislation does not provide for the abrogation, settlement or relinquishment of state tobacco-related claims; or (iii) state receipt of such Federal Settlement Funds is conditioned upon (A) the relinquishment of rights or benefits under that respective state's settlement (excepting any Ongoing Annual Payment amounts subject to the offset); or (B) actions or expenditures by such state unrelated to health care or tobacco (including but not limited to tobacco education, cessation, control or enforcement). The MFN amendments also supersede the MFN provisions contained in the original settlement agreements. Under the MFN amendments, if the settling defendants enter -17- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) into any future pre-verdict settlement agreement of similar health care cost recovery litigation on terms more favorable to a non-federal governmental plaintiff, the Mississippi and Texas settlements will not otherwise be revised except to the extent such future settlement provides for: (i) joint and several liability for monetary payments, (ii) a parent company guaranty or other credit assurance, (iii) the implementation of different non-economic tobacco-related public health measures, or (iv) monetary offsets in the event of federal tobacco legislation that are more favorable to such plaintiff than those described above. The settling defendants agreed as part of the MFN amendments to disclose specified future payments for lobbying or related purposes in Mississippi and Texas, to support enumerated legislative and regulatory proposals and to not support legislation, rules or policies that would diminish Mississippi's and Texas' rights under the amended settlement agreements. The settling defendants further agreed not to make any payments for tobacco product placement in motion pictures made in the United States. The settling defendants also submitted to a Consent Judgment enjoining the industry from (i) offering or selling non-tobacco services or merchandise (e.g., caps, jackets or bags) in Mississippi and Texas bearing the name or logo of a tobacco brand other than tobacco products or items with the sole function of advertising; (ii) making any material misrepresentation of fact regarding the health consequences of using tobacco products; (iii) entering into any contract, combination or conspiracy to limit health information or research into smoking and health or product development; and (iv) taking any action to target children in Mississippi and Texas in the advertising, promotion or marketing of cigarettes. In connection with the MFN amendments, the parties executed new agreements governing settling defendants' payment of attorneys' fees to counsel for Mississippi and Texas. (Copies of these agreements are filed as Exhibits to this Form 10-Q, and the discussion herein is qualified by reference thereto.) The agreements provide that beginning in November 1998, a three-member arbitration panel will consider and determine the amount of attorneys' fees to be awarded. These awards will be allocated among the settling defendants in accordance with their relative unit volume of domestic cigarette shipments. Under the agreements, there is an annual cap of $500 million on aggregate attorneys' fees to be paid pursuant to arbitration awards, including those to be paid for counsel for Mississippi and Texas. A one-time $250 million payment may be paid for cases that were settled in 1997. This aggregate annual cap includes: (i) all attorneys' fees paid pursuant to an award by the panel in connection with settlements of any smoking and health cases (other than individual cases), (ii) all attorneys' fees paid pursuant to an award by the panel for activities in connection with smoking and health cases resolved by operation of federal legislation provided such legislation imposes an obligation on the settling defendants to pay attorneys' fees, and (iii) all attorneys' and professional fees paid pursuant to an award by the panel for contributions made toward the enactment of federal tobacco legislation. The settling defendants have made payments to counsel for Mississippi and Texas totaling $200 million as advances against awards of attorneys' fees by the arbitration panel, such advances to be credited against the annual cap over several years commencing in 1999. -18- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) The Company has recorded charges of $199 million in the second quarter of 1998 to accrue for PM Inc.'s share of all fixed and determinable portions of the obligations described above. CERTAIN OTHER TOBACCO-RELATED LITIGATION Since September 1997, a number of suits have been filed by former asbestos manufacturers and asbestos manufacturers' personal injury settlement trusts against domestic tobacco manufacturers, including PM Inc., and others (RAYMARK INDUSTRIES, INC. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL.; RAYMARK INDUSTRIES, INC. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL.; FIBREBOARD CORPORATION AND OWENS CORNING V. THE AMERICAN TOBACCO COMPANY, ET AL.; ROBERT A. FALISE, ET AL., TRUSTEES OF THE MANVILLE PERSONAL INJURY SETTLEMENT TRUST V. THE AMERICAN TOBACCO COMPANY, ET AL.; KEENE CREDITORS TRUST V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL.; H.K. PORTER COMPANY, INC. V. B.A.T. INDUSTRIES, PLC, ET al.; RAYMARK INDUSTRIES, INC. V. THE AMERICAN TOBACCO COMPANY, ET AL.; H.K. PORTER COMPANY, INC. V. THE AMERICAN TOBACCO COMPANY, ET AL.). These cases seek, among other things, contribution or reimbursement for amounts expended for the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking. Plaintiffs in most of these cases also seek punitive damages. Since June 1998, three class actions have been filed against PM Inc. and the Company, in Florida, New Jersey and Pennsylvania on behalf of individuals who purchased and consumed MARLBORO LIGHTS (HOGUE, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., CIRCUIT COURT, THIRTEENTH JUDICIAL CIRCUIT HILLSBOROUGH COUNTY, FLORIDA, FILED JUNE 30, 1998; CUMMIS, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., SUPERIOR COURT OF NEW JERSEY, LAW DIVISION, MORRIS COUNTY, FILED JULY 9, 1998; MCNAMARA, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., COURT OF COMMON PLEAS, MONTGOMERY COUNTY, PENNSYLVANIA, FILED JULY 16, 1998). These cases allege in connection with the use of the term "Lights," among other things, deceptive and unfair trade practices, unjust enrichment, and seek injunctive and equitable relief. Similar class actions have been threatened in Massachusetts. Since July 1998, two suits have been filed in California courts alleging that domestic cigarette manufacturers, including PM Inc., and others have violated the California statute known as "Proposition 65" by not informing the public of the alleged risks of ETS to non-smokers. Plaintiffs also allege violations of California's Business and Professions Code regarding unfair and fraudulent business practices. Plaintiffs seek statutory penalties, injunctions barring the sale of cigarettes, restitution, disgorgement of profits and other relief (PEOPLE OF THE STATE OF CALIFORNIA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, LOS ANGELES, CALIFORNIA, FILED JULY 14, 1998; PEOPLE OF THE STATE OF CALIFORNIA, ET AL. V. BROWN & WILLIAMSON, ET AL., SUPERIOR COURT, SAN FRANCISCO, CALIFORNIA, FILED JULY 28, 1998). CERTAIN OTHER ACTIONS In March 1994, the Company and certain officers and directors were named as defendants in a complaint filed as a purported class action in the United States District Court for the Eastern District of New York (LAWRENCE, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL.). Plaintiffs allege that defendants violated the federal securities laws by maintaining artificially high levels of profitability through an inventory management practice pursuant to which PM Inc. allegedly shipped more inventory to customers than was necessary to satisfy market demand. The plaintiff class consists of all persons who purchased common stock of the -19- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Company between July 10, 1991, and April 1, 1993, and who held such stock at the close of business on April 1, 1993. In April 1994, the Company and certain officers and directors were named as defendants in several other purported class actions that were later consolidated in the United States District Court in the Southern District of New York (KURZWEIL, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL.). In those cases, plaintiffs assert that defendants violated the federal securities laws by making allegedly false and misleading statements regarding the allegedly "addictive" qualities of cigarettes. The plaintiff class consists of all persons who purchased common stock of the Company between June 11, 1991, and May 6, 1994. In June 1998, the court gave preliminary approval to an agreement reached by the parties to settle the KURZWEIL case. Pursuant to the agreement, the Company deposited into escrow $105 million to create a fund for the benefit of class members. In July 1998, the court gave preliminary approval to a revision of the June agreement, pursuant to which the Company has deposited an additional $10.5 million into the escrow fund for the benefit of class members. This $115.5 million fund will also cover any attorneys' fees and other expenses ordered by the court if the settlement is finally approved. If so approved, the settlement will also result in a release of all claims in the LAWRENCE action by class members who do not request exclusion from the KURZWEIL class. If the settlement is finally approved, the parties to the LAWRENCE action will seek the dismissal of that action. The settlement is subject to a number of conditions, including final court approval. 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 (STUART, ET AL. V. KRAFT FOODS, INC., ET AL.; SHEEKS, ET AL. V. KRAFT FOODS, INC., ET AL.; SERVAIS, ET AL. V. KRAFT FOODS, INC. AND THE NATIONAL CHEESE EXCHANGE, INC.; DODSON, ET AL. V. KRAFT FOODS, INC., ET AL.; and NOLL, ET AL. V. KRAFT FOODS, INC., ET AL.). Plaintiffs seek injunctive and equitable relief and treble damages. The court has granted the SHEEKS and STUART plaintiffs' motions for voluntary dismissal without prejudice. Plaintiffs in the three remaining cases have filed a consolidated class action complaint in Wisconsin seeking certification of a class consisting of all milk producers in the United States. In June 1998, the court in this consolidated action denied Kraft's motion to dismiss as to the antitrust and tortious interference claims and granted Kraft's motion to dismiss on breach of contract and false advertising claims. In October 1997, a purported class action suit was filed in Illinois against Kraft only (VINCENT, ET AL. V. KRAFT FOODS, INC.), and in April 1998, a purported class action suit was filed in California against Kraft and others (KNEVELBOARD DAIRIES, ET AL. V. KRAFT FOODS, INC., ET AL., SUPERIOR COURT OF CALIFORNIA, LOS ANGELES COUNTY, FILED APRIL 14, 1998). Both of these suits contain allegations similar to those in the consolidated Wisconsin class action, but the VINCENT case seeks a class comprising all of Kraft's milk suppliers, and the KNEVELBOARD case seeks a class comprising all of defendants' milk suppliers in California. In June 1998, the Illinois court in the VINCENT case granted Kraft's motion to dismiss, but has allowed plaintiffs to file an amended complaint. 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 lira equivalent of $2.5 -20- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) billion. In addition, the Italian lira equivalent of $3.5 billion in interest and penalties has been assessed (reduced from $6.0 billion to reflect a change in law). The Company anticipates that value-added and income tax assessments may also be received in respect of 1996 and 1997. In September 1997, the Italian administrative tax court in Milan overturned one of the assessments for value-added taxes, and that decision has been appealed by the tax authorities. In May and June 1998, the Italian administrative tax court in Milan overturned 42 additional assessments for value-added and income taxes. In a separate proceeding in Naples, in October 1997, a court dismissed charges of criminal association against certain present and former officers and directors of affiliates of the Company, but permitted charges of tax evasion to remain pending. In February 1998, the tax evasion charges were dismissed by the criminal court in Naples following a determination that jurisdiction was not proper, and the case file was transmitted to the public prosecutor in Milan, who will determine whether to bring charges, in which case a preliminary investigations judge will make a new finding as to whether there should be a trial on these charges. The Company, its affiliates and the officers and directors who are subject to the proceedings believe they have complied with applicable Italian tax laws and are vigorously contesting the pending tax assessments and pending proceedings. THE JUNE 1997 PROPOSED RESOLUTION AND PROPOSED FEDERAL TOBACCO LEGISLATION In June 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding (the "Resolution") to support the adoption of federal legislation and ancillary undertakings that 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. (The proposed Resolution is discussed in the Company's 1997 Form 10-K, and a copy of the proposed Resolution is filed as Exhibit 10.17 thereto.) Such legislation was never enacted. In April 1998, the Senate Commerce Committee approved a bill that was substantially different and significantly more adverse to the domestic tobacco industry and the Company than the proposed Resolution (the "Commerce Bill"). That Bill, as approved by the Commerce Committee, contemplated industry payments in excess of one-half trillion dollars over the first twenty-five years, provided the United States Food and Drug Administration ("FDA") with broad regulatory control over tobacco products, applied, in certain respects, to international sales of tobacco products, and eliminated virtually all of the provisions of the proposed Resolution that would limit liability of the tobacco industry in civil litigation in the United States. In June 1998, the United States Senate voted to return the Commerce Bill to the Senate Commerce Committee for further consideration. Other federal tobacco bills are also under consideration by Congress. The Company cannot predict whether the Commerce Bill or any other such federal tobacco legislation will be enacted or the form any such enactment might take. ------------------------- 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 or settlement of a pending smoking and health or health care cost recovery case could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco -21- Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) industry that have received widespread media attention. These developments may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. The present legislative and litigation environment is substantially uncertain and it is possible that the Company's business, results of operations, cash flows or financial position could be materially affected by an unfavorable outcome or settlement of certain pending litigation or by the enactment of federal tobacco legislation discussed above. The Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. All such cases are, and will continue to be, vigorously defended. However, the Company and its subsidiaries periodically may enter into discussions in an attempt to settle various cases when they believe it is in the best interests of the Company's stockholders to do so. In that regard, PM Inc. has discussed with certain state attorneys general the possibility of settling the asserted and unasserted health care cost recovery claims of most states. No assurance can be given that any cases will be settled or what the terms of any settlement might be. Reference is made to Exhibit 99 to this Form 10-Q for a list of pending smoking and health class actions and health care cost recovery actions, and for a description of certain developments in such proceedings. NOTE 4. RECENTLY ISSUED ACCOUNTING STANDARDS: During the second quarter of 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which must be adopted by the Company by January 1, 2000, with early adoption permitted. SFAS No. 133 requires that all derivative instruments be recorded on the consolidated balance sheet at their fair value. Changes in the fair value of derivatives will be recorded each period in earnings or other comprehensive earnings, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in other comprehensive earnings will be reclassified as earnings in the periods in which earnings are affected by the hedged item. The Company has not yet determined the timing of adoption or the impact that adoption or subsequent application of SFAS No. 133 will have on its financial position or results of operations. In 1998, AcSEC issued SOP No. 98-5, "Reporting on the Costs of Start-Up Activities." SOP No. 98-5 establishes standards on accounting for start-up and organization costs and in general, requires such costs to be expensed as incurred. This standard is required to be adopted on January 1, 1999. The Company currently estimates that adoption of SOP No. 98-5 will have no material effect on the Company's financial position or results of operations. -22- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONSOLIDATED OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30,
OPERATING REVENUES ------------------------------ (in millions) 1998 1997 ------- ------- Tobacco $21,336 $20,073 Food 13,710 14,164 Beer 2,176 2,193 Financial services and real estate 139 200 ------- ------- Operating revenues $37,361 $36,630 ======= ======= OPERATING INCOME ------------------------------ (in millions) 1998 1997 ------- ------- Tobacco $ 3,731 $4,672 Food 2,193 2,118 Beer 286 285 Financial services and real estate 93 106 ------- ------- Operating companies income 6,303 7,181 Amortization of goodwill (290) (296) General corporate expenses (248) (222) Minority interest in earnings of consolidated subsidiaries (62) (33) ------- ------- Operating income $ 5,703 $ 6,630 ======= ======= FOR THE THREE MONTHS ENDED JUNE 30, OPERATING REVENUES ------------------------------ (in millions) 1998 1997 ------- ------- Tobacco $10,673 $10,153 Food 7,035 6,953 Beer 1,196 1,207 Financial services and real estate 74 100 ------- ------- Operating revenues $18,978 $18,413 ======= ======= OPERATING INCOME ------------------------------ (in millions) 1998 1997 ------- ------- Tobacco $ 2,083 $ 2,318 Food 1,156 1,102 Beer 158 166 Financial services and real estate 51 58 ------- ------- Operating companies income 3,448 3,644 Amortization of goodwill (144) (147) General corporate expenses (133) (113) Minority interest in earnings of consolidated subsidiaries (31) (20) ------- ------- Operating income $ 3,140 $ 3,364 ======= =======
-23- RESULTS OF OPERATIONS Operating revenues for the first six months of 1998 increased 2.0% over the first six months of 1997, and operating revenues for the second quarter of 1998 increased 3.1% over the comparable 1997 period. These increases were primarily due to domestic tobacco, international tobacco and North American food operations. Food segment operating revenues were affected by the 1997 sales of Brazilian ice cream businesses, North American maple-flavored syrup businesses and a Scandinavian sugar confectionery business. Financial services and real estate operating revenues decreased due to the 1997 sale of the real estate business. Excluding the operating revenues of these and other smaller operations divested in 1997, underlying operating revenues for the first six months of 1998 increased $1.1 billion (3.1%) over the first six months of 1997, and underlying operating revenues for the second quarter of 1998 increased $724 million (4.0%) over the comparable 1997 period. Operating income for the first six months and second quarter of 1998 decreased 14.0% and 6.7%, respectively, from the comparable 1997 periods, reflecting charges related to voluntary early retirement and separation programs and the settlement of tobacco litigation. In February 1998, the Company announced voluntary early retirement and separation programs for salaried and hourly employees, primarily at PM Inc. The programs resulted in pre-tax charges of $327 million during the first six months of 1998, of which $232 million was recorded during the second quarter. First-half results also reflect first-quarter pre-tax charges of $806 million related to settling health care cost recovery litigation in Minnesota and second quarter charges of $199 million related to "Most Favored Nation" clauses in previous state settlement agreements with the states of Mississippi and Texas, as previously discussed in Note 3 to the Condensed Consolidated Financial Statements. Excluding the charges for voluntary early retirement and separation programs and for tobacco litigation settlements, as well as results from operations divested since the beginning of 1997, underlying operating income increased $484 million (7.4%) and $238 million (7.1%) over the first six months and second quarter of 1997, respectively, reflecting favorable results in domestic tobacco, international tobacco and North American food operations. Currency movements, primarily the strengthening of the U.S. dollar versus European and Asian currencies, decreased operating revenues by $1.7 billion ($1.0 billion, excluding excise taxes) and operating income by $224 million in the first six months of 1998 versus the comparable 1997 period. During the second quarter, currency movements decreased operating revenues by $645 million ($388 million, excluding excise taxes) and operating income by $91 million versus the comparable 1997 period. Although the Company cannot predict future movements in currency rates or economic developments, it anticipates that the continued strength of the U.S. dollar will have a significant adverse impact on operating revenues and operating income during the remainder of 1998 and 1999 and that economic instability in Asia will continue to slow the Company's businesses in that region. Interest and other debt expense, net, decreased $84 million (14.8%) in the first six months of 1998 and $41 million (14.7%) in the second quarter from the respective comparable 1997 periods. These decreases were due primarily to lower average debt outstanding during 1998 and higher interest income, reflecting increased cash and cash equivalents. Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per Share." SFAS No. 128 establishes standards for computing and presenting EPS and -24- requires the presentation of both basic and diluted EPS. Prior period EPS have been restated to conform with the standards established by SFAS No. 128. Diluted and basic EPS, both of which were $1.28 for the first six months of 1998, decreased by 13.5% and 14.1%, respectively, from the comparable 1997 period due primarily to previously discussed charges for voluntary early retirement and separation programs and tobacco litigation settlements. Excluding the after-tax impact of these charges, first-half underlying net earnings increased 8.9% to $3.9 billion, diluted EPS increased 8.8% to $1.61 and basic EPS increased 8.7% to $1.62. Reported diluted EPS of $0.71 and basic EPS of $0.72 in the second quarter of 1998 each decreased by 5.3% from the comparable 1997 period. Excluding the after-tax impact of charges for voluntary early retirement and separation programs and tobacco litigation settlements, second quarter underlying net earnings increased 8.9% to $2.0 billion, diluted EPS increased 9.3% to $0.82 and basic EPS increased 7.9%, to $0.82. YEAR 2000 As many computer systems and other equipment with embedded chips or processors (collectively, "Business Systems") use only two digits to represent the year, they may be unable to process accurately certain data before, during or after the year 2000. As a result, business and governmental entities are at risk for possible miscalculations or systems failures causing disruptions in their business operations. This is commonly known as the Year 2000 ("Y2K") issue or Century Date Change ("CDC") issue. The CDC issue can arise at any point in the Company's supply, manufacturing, processing, distribution, and financial chains. The Company and each of its operating subsidiaries are in the process of implementing a CDC readiness program with the objective of having all of their significant Business Systems, including those that affect facilities and manufacturing activities, functioning properly with respect to the CDC before January 1, 2000. Each operating subsidiary is in a different stage of CDC readiness. Generally, those subsidiaries with primarily North American operations (Philip Morris USA, Kraft Foods North America, Miller Brewing Company and Philip Morris Capital Corporation) are closer to CDC readiness than those with extensive international operations (Philip Morris International and Kraft Foods International). The first component of the CDC readiness program is to identify the internal Business Systems of the Company and its operating subsidiaries that are susceptible to system failures or processing errors as a result of the CDC issue. This effort is substantially complete with all operating subsidiaries having identified the Business Systems that may require remediation or replacement and established priorities for repair or replacement. Those Business Systems considered most critical to continuing operations are being given the highest priority. The second component of the CDC readiness program involves the actual remediation and replacement of Business Systems. The Company and its operating subsidiaries are using both internal and external resources to complete this process. Business Systems ranked highest in priority have either been remediated or replaced or scheduled for remediation or replacement. Business Systems previously earmarked for retirement and replacement without regard to the CDC issue have been evaluated for early replacement with CDC compliant systems or programs or, in the alternative, remediation. The Company's objective is to complete substantially all remediation and replacement of internal Business Systems by March 1999, and to complete final testing and certification for CDC readiness by September 1999. -25- As part of the CDC readiness program, significant service providers, vendors, suppliers, customers and governmental entities ("Key Business Partners") that are believed to be critical to business operations after January 1, 2000, have been identified and steps are being undertaken in an attempt to reasonably ascertain their stage of CDC readiness through questionnaires, interviews, on-site visits and other available means. In conjunction with this effort, key governmental agencies and utilities upon which the Company and its operating subsidiaries rely are being approached on a worldwide basis to identify their level of CDC preparedness. In many cases, these entities (particularly outside North America) have a lower level of CDC awareness and are less willing to provide information concerning their state of CDC readiness. Because of the vast number of Business Systems used by the Company and its operating subsidiaries, the significant number of Key Business Partners, the extent of the Company's foreign operations, including operations within countries that are not actively promoting remediation of the CDC issue, the Company presently believes that it may experience some disruption in its business due to the CDC issue. More specifically, because of the interdependent nature of Business Systems, the Company and its operating subsidiaries could be materially adversely affected if utilities, private businesses and governmental entities with which they do business or that provide essential services are not CDC ready. The Company currently believes that the greatest risk of disruption in its businesses exists in certain international markets. The possible consequences of the Company or Key Business Partners not being fully CDC compliant by January 1, 2000 include, among other things, temporary plant closings, delays in the delivery of products, delays in the receipt of supplies, invoice and collection errors, and inventory and supply obsolescence. Consequently, the business and results of operations of the Company could be materially adversely affected by a temporary inability of the Company and its operating subsidiaries to conduct their businesses in the ordinary course for a period of time after January 1, 2000. However, the Company believes that its CDC readiness program, including the contingency planning discussed below, should significantly reduce the adverse effect any such disruptions may have. Concurrently with the CDC readiness measures described above, the Company and its operating subsidiaries are developing contingency plans intended to mitigate the possible disruption in business operations that may result from the CDC issue, and are developing cost estimates for such plans. Contingency plans may include stockpiling raw and packaging materials, increasing inventory levels, securing alternate sources of supply, adjusting facility shut-down and start-up schedules and other appropriate measures. Once developed, contingency plans and related cost estimates will be continually refined as additional information becomes available. It is currently estimated that the aggregate cost of the Company's CDC efforts will be approximately $400 million to $500 million, of which approximately $150 million has been spent. These costs are being expensed as they are incurred and are being funded through operating cash flow. These amounts do not include any costs associated with the implementation of contingency plans, which are in the process of being developed. The costs associated with the replacement of computerized systems, hardware or equipment (currently estimated to be approximately $100 million), substantially all of which would be capitalized, are not included in the above estimates. The Company's CDC readiness program is an ongoing process and the estimates of costs and completion dates for various components of the CDC readiness program described above are subject to change. -26- EURO On January 1, 1999, eleven of the fifteen member countries of the European Union are scheduled to establish fixed conversion rates between their existing currencies ("legacy currencies") and one common currency - the euro. The euro will then trade on currency exchanges and may be used in business transactions. Beginning in January 2002, new euro-denominated bills and coins will be issued, and legacy currencies will be withdrawn from circulation. The Company's operating subsidiaries affected by the euro conversion have established plans to address the systems and business issues raised by the euro currency conversion. These issues include, among others, (1) the need to adapt computer and other business systems and equipment to accommodate euro-denominated transactions; and (2) the competitive impact of cross-border price transparency, which may make it more difficult for businesses to charge different prices for the same products on a country-by-country basis particularly once the euro currency is issued in 2002. The Company anticipates that the euro conversion will not have a material adverse impact on its financial condition or results of operations. OPERATING RESULTS BY BUSINESS SEGMENT TOBACCO BUSINESS ENVIRONMENT The tobacco industry, both in the United States and abroad, has faced, and continues to face, a number of issues that may adversely affect the business, volume, operating revenues, cash flows, operating income and financial position of PM Inc., PMI and the Company. In the United States, these issues include actual and proposed excise tax increases; proposed federal regulatory controls (including, as discussed below, the issuance of final regulations by the FDA that regulate cigarettes as "drugs" or "medical devices"); actual and proposed requirements regarding disclosure of cigarette ingredients and other proprietary information; actual and proposed requirements regarding disclosure of the yields of "tar", nicotine and other constituents found in cigarette smoke; 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; actual and proposed federal, state and local governmental and private bans and restrictions on smoking (including in workplaces and in buildings permitting public access); actual and proposed restrictions on tobacco manufacturing, marketing, advertising (including decisions by certain companies to limit or not accept tobacco advertising) and sales; actual 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; proposed legislation to require the establishment of ignition propensity performance standards for cigarettes; increased assertions of adverse health effects associated with both smoking and exposure to 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; and federal tobacco legislation under consideration by Congress. 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 -27- 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 and other cigarette-related taxes levied by federal, state and local governments have been increasing. These taxes vary considerably and, when combined with sales taxes and the current federal excise tax, may be as high as $1.50 per pack in a given locality. Congress has been considering a number of bills that provide for significant increases in the federal excise tax or other payments from tobacco manufacturers. Increases in other cigarette-related taxes have been proposed at the state and local level. 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, cash flows and operating income of PM Inc. and the Company. PM Inc. and others challenged in the courts the FDA's authority to regulate cigarettes. 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 regulate cigarettes if the facts asserted in support of the 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 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. In March 1998, a member of the Fourth Circuit panel that was considering the appeals died and as a result the appeals were reargued in June 1998. The outcome of this litigation cannot be predicted. In August 1996, the Commonwealth of Massachusetts enacted legislation to 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 ingredient disclosure provisions of the statute 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. -28- In December 1997, the court granted a preliminary injunction to the tobacco company plaintiffs and enjoined the Commonwealth from enforcing the ingredient disclosure provisions of the legislation until further order of the court. In July 1998, the Commonwealth's appeal of this ruling was argued before the First Circuit Court of Appeals. In addition, both parties' cross-motions for summary judgment were argued before the district court earlier this year. The ultimate outcome of this lawsuit cannot be predicted. The enactment of this legislation has encouraged efforts to enact, and the enactment of, ingredient disclosure legislation in other states, such as Texas and Minnesota. In December 1997, PM Inc. disclosed to the DPH "nicotine-yield ratings" for its products sold in the Commonwealth based on standards established by the DPH for determining "nicotine delivery under average smoking conditions." The "nicotine-yield ratings" produced using the DPH standards are higher than the yields produced using the standards established by a 1970 voluntary agreement between the Federal Trade Commission ("FTC") and domestic cigarette manufacturers, including PM Inc., and which are required to be included in all cigarette advertising. In September 1997, the FTC issued a request for public comments on its proposed revision of the "tar" and nicotine testing and reporting standards established by the 1970 voluntary agreement. In February 1998, PM Inc. and three other domestic cigarette manufacturers filed comments on the proposed revisions in which they stressed the value of historical continuity with respect to "tar" and nicotine testing and disclosure; expressed the opinion that the proposed revisions are unnecessary; but, agreed to assist the FTC in its efforts to improve consumer understanding of the meaning of routine testing results. In June 1995, PM Inc. announced that it had voluntarily undertaken a program to limit minors' access to cigarettes. Elements of the program include discontinuing free cigarette sampling to consumers in the United States, discontinuing the distribution of cigarettes by mail to consumers in the United States, placing a notice on cigarette cartons and packs for sale in the United States stating "Underage Sale Prohibited," working with others in support of state legislation to prevent youth access to tobacco products, taking measures to encourage retailer compliance with minimum-age laws, and independent auditing of the program. In October 1997, at the request of the United States Senate Judiciary Committee, PM Inc. provided the Committee with a document setting forth the Company's position on a number of issues. On the issues of the causal role played by cigarette smoking in the development of lung cancer and other diseases in smokers, and whether nicotine, as found in cigarette smoke, is "addictive", the Company stated that despite the differences that may exist between its views and those of the public health community, it would, in order to ensure that there will be a single, consistent public health message on these issues, refrain from debating the issues other than as necessary to defend itself and its opinions in the courts and other forums in which it is required to do so. The Company also stated that in relation to these issues, and the alleged health effects of exposure to ETS, the Company is prepared to defer to the judgment of public health authorities as to what health warning messages will best serve the public interest. In 1993, the U.S. Environmental Protection Agency ("EPA") issued a report relating to certain alleged health effects of ETS. The report included, among other things, a risk assessment relating to the alleged association between ETS and lung cancer in nonsmokers, and a determination by EPA to classify ETS as a "Group A" carcinogen. The risk assessment and classification has been one of the primary sources cited in support of smoking restrictions in workplaces and public places around the world. PM Inc. and others challenged the risk assessment and classification on several grounds in a U.S. district court. In July 1998, the court vacated those sections of the EPA report relating to lung cancer, finding, -29- among other things, that, although the agency has been authorized by Congress to conduct a risk assessment and classification of ETS, EPA may have reached different conclusions had it complied with certain relevant statutory requirements. The federal government has announced that it intends to appeal the court's ruling. It is not possible to predict what impact, if any, the ruling will have on existing or proposed regulations banning or restricting smoking in workplaces and public places. In late January 1998, the chief executive officers of the four leading domestic tobacco companies or their parent corporations, including the Company, pledged to Congress to publicly release millions of pages of industry documents placed into the document depository established in connection with Minnesota's health care cost recovery action. The documents comprise a wide range of smoking and health issues covered in scientific and marketing research reports, memoranda, executive correspondence, handwritten notes and other materials. They do not include highly sensitive trade secret information, certain third-party and personnel information, or documents for which attorney client privilege or work product doctrine claims have been asserted. Several installments of these documents have been made available via the Internet. The remaining installments are expected to be posted on the Internet before year end. Many foreign countries, as well as the European Union, have also taken a number of different steps to regulate the manufacture and/or marketing of cigarettes. Most prominently, these steps include: restricting or prohibiting cigarette advertising and promotion, banning or severely restricting smoking in workplaces and public places or otherwise discouraging cigarette smoking and increasing taxes on cigarettes. Some countries have taken further steps, including requiring ingredient disclosure, imposing maximum constituent levels, controlling prices, and restricting imports. 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. In June 1998, a European Communities Directive, effective July 6, 1998, was published in the Official Journal of the European Communities. The directive bans virtually all forms of tobacco advertising and sponsorship in the European Union. Member States must enact implementing legislation by July 2001. However, Member States may delay full implementation of the ban for additional periods (one year for print advertising, two years for sponsorships generally, and until October 1, 2006 for sponsorship of events such as Formula One racing). The directive does not apply to a few limited types of advertising such as point of sale displays which may be regulated by Member States as they see fit. In March 1998, pursuant to a regulation in Thailand that requires manufacturers and importers of tobacco products to disclose to the Ministry of Public Health ("MPH") the ingredients of their products to be sold in Thailand on a by-brand basis, a subsidiary of PMI disclosed to the MPH by-brand ingredient lists for its products imported into Thailand for sale in that country. The disclosure was accompanied by a claim of confidentiality under applicable Thai and international law. Although this Thai regulation does not require the MPH to make public the submitted ingredient lists, there are no assurances that the confidentiality of the lists submitted will be maintained. 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 include an investigation by the United States -30- 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. While the outcomes of these investigations cannot be predicted, PM Inc. believes it has acted lawfully. As further discussed above in Note 3 to the Condensed Consolidated Financial Statements, there is litigation pending in various U.S. and foreign 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 cases brought by state and local governments seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking, as well as similar cases, including class actions, brought by non-governmental plaintiffs such as unions, HMOs, federal and state taxpayers, native American tribes and others. Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. In recent years there has been a substantial increase in the number of smoking and health cases being filed in the United States. As of August 1, 1998, there were approximately 400 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 with approximately 375 such cases on December 31, 1997, and 185 such cases on December 31, 1996. Many of the new cases were filed in Florida and New York. Twenty-two of the individual cases involve allegations of various personal injuries allegedly related to exposure to ETS. In addition, as of August 1, 1998, there were approximately 65 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including eight that involve allegations of various personal injuries related to exposure to ETS), compared with approximately 50 such cases on December 31, 1997, and 20 such cases on December 31, 1996. Most of these actions purport to constitute statewide class actions and were filed after May 1996 when 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. The number of health care cost recovery actions in the United States also increased, with approximately 140 such cases pending as of August 1, 1998, compared with approximately 105 such cases on December 31, 1997, and 25 such cases on December 31, 1996. There are also a number of tobacco-related actions pending outside the United States against affiliates and subsidiaries of PMI including, as of August 1, 1998, approximately 20 smoking and health cases initiated by one or more individuals (Argentina (13), Brazil (1), Canada (1), Italy (1), Japan (1), Scotland (1) and Turkey (2)), four smoking and health class actions (Brazil (2), Canada (1) and Nigeria (1)) and one health care cost recovery action (Republic of the Marshall Islands). In addition, the Republic of Guatemala has filed a health care cost recovery action in the United States. -31- During 1997 and the first half of 1998, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida, Texas and Minnesota and an ETS smoking and health class action brought on behalf of airline flight attendants. As discussed above in Note 3, the Mississippi and Texas settlement agreements were amended recently pursuant to their "most favored nation" clause to reflect the terms of the Minnesota settlement. THE JUNE 1997 PROPOSED RESOLUTION AND PROPOSED FEDERAL TOBACCO LEGISLATION In June 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding (the "Resolution") to support the adoption of federal legislation and ancillary undertakings that 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. (The proposed Resolution is discussed in the Company's 1997 Form 10-K and a copy of the proposed Resolution is filed as Exhibit 10.17 thereto.) Such legislation was never enacted. In April 1998, the Senate Commerce Committee approved a bill that was substantially different and significantly more adverse to the domestic tobacco industry and the Company than the proposed Resolution (the "Commerce Bill"). That Bill, as approved by the Commerce Committee, contemplated industry payments in excess of one-half trillion dollars over the first twenty-five years, provided the FDA with broad regulatory control over tobacco products, applied, in certain respects, to international sales of tobacco products, and eliminated virtually all of the provisions of the proposed Resolution that would limit liability of the tobacco industry in civil litigation in the United States. In June 1998, the United States Senate voted to return the Commerce Bill to the Senate Commerce Committee for further consideration. Other federal tobacco bills are also under consideration by Congress. The Company cannot predict whether the Commerce Bill or any other such federal tobacco legislation will be enacted or the form any such enactment might take. ------------------------- 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 or settlement of a pending smoking and health or health care cost recovery case could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention. These developments may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. The present legislative and litigation environment is substantially uncertain and it is possible that the Company's business, results of operations, cash flows or financial position could be materially affected by an unfavorable outcome or settlement of certain pending litigation or by the enactment of federal tobacco legislation discussed above. The Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. All such cases are, and will continue to be, vigorously defended. However, -32- the Company and its subsidiaries periodically may enter into discussions in an attempt to settle various cases when they believe it is in the best interests of the Company's stockholders to do so. In that regard, PM Inc. has discussed with certain state attorneys general the possibility of settling the asserted and unasserted health care cost recovery claims of most states. No assurance can be given that any cases will be settled or what the terms of any settlement might be. OPERATING RESULTS
FOR THE SIX MONTHS ENDED JUNE 30, ------------------------------------------------------ OPERATING REVENUES OPERATING INCOME ------------------------------------------------------ (in millions) 1998 1997 1998 1997 ------ ------- ------ ----- Domestic tobacco $ 7,011 $ 6,369 $1,049 $2,259 International tobacco 14,325 13,704 2,682 2,413 ------- ------- ------ ------ Total $21,336 $20,073 $3,731 $4,672 ======= ======= ====== ======
DOMESTIC TOBACCO. During the first six months of 1998, PM Inc.'s operating revenues increased 10.1% over the comparable 1997 period, due to pricing ($765 million) and improved product mix ($27 million), partially offset by lower volume ($150 million). During the first six months of 1998, PM Inc. recorded pre-tax charges of $1,005 million related to tobacco litigation settlements, as discussed in Note 3 to the Condensed Consolidated Financial Statements. In addition, PM Inc. recorded pre-tax charges of $309 million related to voluntary early retirement and separation programs for salaried and hourly employees. Operating income for the first six months of 1998 decreased 53.6% from the comparable 1997 period, due primarily to tobacco litigation settlement charges ($1,005 million), higher marketing, administration and research costs ($327 million), charges for the voluntary early retirement and separation programs ($309 million) and lower volume ($99 million), partially offset by price increases, net of cost increases (aggregating to $514 million) and improved product mix ($17 million). Excluding the impact of the voluntary early retirement and separation programs and the tobacco litigation settlement charges, PM Inc.'s underlying operating income for the first six months of 1998 increased 4.6% over the comparable 1997 period. Domestic tobacco industry shipment volume during the first six months of 1998 declined 3.2% from the first six months of 1997. PM Inc. estimates that second-quarter, and to a lesser extent, year-to-date industry shipments were affected by a second-quarter reduction in trade inventories, which wholesalers had increased in late 1997 in anticipation of price increases. PM Inc. further estimates that its second-quarter, and to a lesser extent, its year-to-date shipments and resultant shipment market shares were adversely affected by the timing of its consumer promotions and a disproportionate reduction in its trade inventories. While PM Inc. cannot predict future rates of change in industry shipments, it believes that, over the long term, industry shipments should continue to decline in line with historical trends, subject to the effects of price increases related to tobacco litigation settlements or the possible enactment of federal tobacco legislation discussed under "Tobacco--Business Environment" above. -33- PM Inc.'s shipment volume for the first six months of 1998 was 111.8 billion units, a decrease of 2.1% from the first six months of 1997. However, PM Inc. estimates that, excluding the factors mentioned above, its volume would have decreased by less than 0.5%. MARLBORO shipment volume for the first six months of 1998 increased 0.3 billion units (0.4%) over the comparable 1997 period to 79.6 billion units for a 35.2% share of the total industry, an increase of 1.3 share points over 1997. For the first six months of 1998, PM Inc.'s shipment market share was 49.4%, an increase of 0.5 share points over the comparable period of 1997. However, PM Inc. estimates that, excluding the factors mentioned above, its shipment share grew by more than 1.0 point to approximately 49.7%. This increase is consistent with consumer purchases as measured by retail data from an independent market research company. Based on shipments, the premium segment accounted for approximately 72.9% of the domestic cigarette industry volume in the first six months of 1998, an increase of 0.9 share points over the comparable period of 1997. This reflects a continued shift toward higher-margin premium cigarettes and away from the discount segment, a trend which began in the second half of 1993. In the premium segment, PM Inc.'s volume decreased 0.8% in the first half of 1998, compared with a 2.0% decrease for the industry, resulting in a premium segment share of 58.5%, an increase of 0.7 share points over the comparable period of 1997. In the discount segment, PM Inc.'s shipments decreased 9.7% to 15.2 billion units in the first six months of 1998, compared with an industry decline of 6.3%, resulting in a discount segment share of 24.8%, a decrease of 0.9 share points from the comparable period of 1997. BASIC shipment volume for the first six months of 1998 was flat at 11.5 billion units, for an 18.7% share of the discount segment, an increase of 1.1 share points over the comparable 1997 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 PM Inc.'s shipments would be materially adversely affected by price increases related to tobacco litigation settlements or the possible enactment of federal tobacco legislation discussed under "Tobacco--Business Environment" above. Subsequent to the end of the second quarter, PM Inc. announced a price increase of $3.00 per thousand cigarettes on its premium and discount brands in August 1998. This increase follows similar announcements of price increases of $2.50 per thousand cigarettes in May 1998, $2.50 per thousand cigarettes in April 1998, $1.25 per thousand cigarettes in January 1998, $3.50 per thousand cigarettes in September 1997 and $2.50 per thousand cigarettes in March 1997. Each $1.00 per thousand increase by PM Inc. equates to a $.02 increase to the wholesale price of each pack of twenty cigarettes. INTERNATIONAL TOBACCO. During the first six months of 1998, international tobacco operating revenues of PMI increased 4.5% over 1997, including excise taxes. Excluding excise taxes, operating revenues increased 5.8%, due primarily to price increases ($331 million), favorable volume/mix ($254 million) and the consolidation of previously unconsolidated subsidiaries ($273 million), partially offset by unfavorable currency movements ($584 million). Operating income for the first six months of 1998 increased 11.1% over the comparable 1997 period, due primarily to price increases, net of cost increases ($285 million), favorable volume/mix ($117 million), the consolidation of previously unconsolidated subsidiaries ($53 million) and lower marketing, administration and research costs, partially offset by unfavorable currency movements ($192 million). -34- PMI's volume in the first six months of 1998 grew 16.1 billion units (4.4%) over the comparable 1997 period to 384.1 billion units. PMI's volume growth was impeded by weaker business conditions in Asia, particularly in Korea, Indonesia and the Philippines. Volume advanced strongly in a number of important markets, including Germany, Italy, France, the Benelux countries, Spain, Greece, Austria, Poland, Hungary, Turkey, Eastern Europe, Japan, Mexico and Argentina. However, volume growth in the Eastern Europe region slowed during the second quarter as a result of adverse economic developments in Russia. PMI recorded market share gains in virtually all major markets. Overall volume growth was driven by aggregate gains for PMI's portfolio of major international brands, including MARLBORO, which grew strongly over the first half of 1997.
FOR THE THREE MONTHS ENDED JUNE 30, ----------------------------------------------------------- OPERATING REVENUES OPERATING INCOME ------------------------- ----------------------- (in millions) 1998 1997 1998 1997 ------- ------- ------ ------ Domestic tobacco $ 3,700 $ 3,457 $ 825 $1,185 International tobacco 6,973 6,696 1,258 1,133 ------- ------- ------ ------ Total $10,673 $10,153 $2,083 $2,318 ======= ======= ====== ======
DOMESTIC TOBACCO. During the second quarter of 1998, PM Inc.'s operating revenues increased 7.0% over the comparable 1997 period, due to pricing ($437 million) and improved product mix ($9 million), partially offset by lower volume ($203 million). Operating income for the second quarter of 1998 decreased 30.4% from the comparable 1997 period, due to charges for voluntary early retirement and separation programs ($214 million), tobacco litigation settlement charges ($199 million), higher marketing, administration and research costs ($127 million), lower volume ($133 million), partially offset by price increases, net of cost increases (aggregating to $299 million), lower fixed manufacturing costs ($9 million) and improved product mix ($5 million). Excluding the impact of charges for the voluntary early retirement and separation programs and tobacco litigation settlements, PM Inc.'s underlying operating income for the second quarter of 1998 increased 4.5% over the comparable 1997 period. Domestic tobacco industry shipment volume during the second quarter declined 4.4% from the comparable 1997 period. However, PM Inc. estimates that industry shipments during the quarter were significantly affected by a reduction in trade inventories, which wholesalers had increased in late 1997 in anticipation of price increases. PM Inc. also estimates that its shipments and resultant shipment market share were adversely affected by the timing of consumer promotions and a disproportionate impact of the reduction in trade inventories. While PM Inc. cannot predict future rates of change in industry shipments, it believes that, over the long term, industry shipments should continue to decline in line with historical trends, subject to the effects of price increases related to tobacco litigation settlements or the possible enactment of federal tobacco legislation discussed under "Tobacco--Business Environment" above. PM Inc.'s shipment volume for the second quarter of 1998 was 57.3 billion units, a decrease of 5.8% from the second quarter of 1997, reflecting the factors mentioned above. Second-quarter MARLBORO shipment volume decreased 1.8 billion units (4.1%) to 40.8 billion units for a 34.5% share of the total industry, an -35- increase of 0.1 share points over the second quarter of 1997. PM Inc.'s second quarter 1998 shipment market share was 48.5%, a decrease of 0.7 share points from the comparable period of 1997. PM Inc. estimates that, excluding the factors mentioned above, its shipment share grew by approximately 1.2 share points to 50%. This increase is consistent with the trend of consumer purchases as measured by retail data from an independent market research company. Based on shipments, the premium segment accounted for approximately 73.1% of domestic cigarette industry volume in the second quarter of 1998, an increase of 0.7 share points over the comparable 1997 period. This reflects a continued shift toward higher-margin premium cigarettes and away from the discount segment, a trend which began in the second half of 1993. In the premium segment, PM Inc.'s second-quarter volume decreased 4.4%, compared with a 3.4% decrease for the industry, resulting in a premium segment share of 57.6%, a decrease of 0.6 share points from the second quarter of 1997. In the discount segment, PM Inc.'s second quarter shipments decreased 14.2% to 7.4 billion units in 1998, compared with an industry decline of 6.9%, resulting in a discount segment share of 23.4%, a decrease of 2.0 share points from the comparable period of 1997. BASIC second quarter shipment volume decreased 528 million units to 5.5 billion units, for a 17.2% share of the discount segment, a decrease of 0.4 share points from the comparable 1997 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 PM Inc.'s shipments would be materially adversely affected by price increases related to tobacco litigation settlements or the possible enactment of federal tobacco legislation discussed under "Tobacco--Business Environment" above. INTERNATIONAL TOBACCO. During the second quarter of 1998, international tobacco operating revenues of PMI increased 4.1% over 1997, including excise taxes. Excluding excise taxes, operating revenues increased 4.8%, due primarily to price increases ($122 million), favorable volume/mix ($109 million) and the consolidation of previously unconsolidated subsidiaries ($61 million), partially offset by unfavorable currency movements ($228 million). Operating income for the second quarter of 1998 increased 11.0% over the comparable 1997 period, due primarily to price increases ($122 million), favorable volume/mix ($78 million) and the consolidation of previously unconsolidated subsidiaries ($25 million), partially offset by unfavorable currency movements ($81 million). PMI's volume in the second quarter of 1998 grew 7.1 billion units (4.0%) over the comparable 1997 period to 184.2 billion units. PMI's volume growth was impeded by weaker business conditions in Asia, particularly in Korea, Indonesia and the Philippines. Volume advanced strongly in a number of important markets, including Germany, Italy, France, the Benelux countries, Spain, Greece, Austria, Poland, Hungary, Turkey, Eastern Europe, Japan, Mexico and Argentina. However, volume growth in the Eastern Europe region has slowed during the quarter as a result of adverse economic developments in Russia. In Japan, volume growth reflects, in part, a favorable comparison to the second quarter of 1997, when volume declined following first-quarter trade purchases in advance of an April 1, 1997 tax-driven retail price increase. PMI recorded market share gains in virtually all major markets. Overall volume growth was driven by aggregate gains for PMI's portfolio of major international brands, including MARLBORO, which grew strongly over the second quarter of 1997. -36- 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, currency movements 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. To confront these challenges, Kraft, KFI and PMI continue to take steps to build the value of premium brands, with new product and marketing initiatives, to improve their food business portfolios and to reduce costs. Increases in commodity costs can cause retail price volatility and influence consumer and trade buying patterns, leading to price competition in some markets. The North American and international food businesses are subject to fluctuating commodity costs, particularly coffee bean and cocoa prices. Coffee bean prices reached a twenty-year high in May 1997, leading to price increases by Kraft, KFI and their competitors. In 1998, coffee bean prices have declined from their 1997 levels. During 1997, PMI sold its Brazilian ice cream businesses in the fourth quarter, Kraft sold North American maple-flavored syrup businesses in the third quarter and KFI sold a Scandinavian sugar confectionery business in the first quarter. Kraft and KFI also sold several smaller non-strategic businesses in 1997. The operating results of businesses divested in 1997 were not material to operating results in any of the periods presented. In the fourth quarter of 1997, KFI and the food operations of PMI recorded realignment charges related primarily to the downsizing or closure of manufacturing and other facilities, as well as the discontinuance of certain low-margin product lines. Included in the charges were provisions for incremental postemployment benefits, primarily related to severance. OPERATING RESULTS
FOR THE SIX MONTHS ENDED JUNE 30, ------------------------------------------------------ OPERATING REVENUES OPERATING INCOME ----------------------- ---------------------- (in millions) 1998 1997 1998 1997 ------- ------- ------ ------ North American food $ 8,905 $ 8,731 $1,686 $1,558 International food 4,805 5,433 507 560 ------- ------- ------ ------ Total $13,710 $14,164 $2,193 $2,118 ======= ======= ====== ======
NORTH AMERICAN FOOD. During the first six months of 1998, operating revenues increased 2.0% over the first six months of 1997, due primarily to favorable volume ($293 million) and pricing ($92 million), partially offset by unfavorable product mix ($77 million), the impact of divestitures ($90 million) and unfavorable currency movements ($44 million). Operating income for the first six -37- months of 1998 increased 8.2% over the first six months of 1997, due primarily to volume increases in ongoing operations ($167 million) and pricing ($92 million), partially offset by unfavorable product mix ($76 million), higher marketing, administration and research costs ($31 million) and the impact of divestitures ($22 million). Excluding operating results of the divested North American food businesses discussed above, underlying operating revenues and underlying operating income increased 3.1% and 9.8%, respectively, in the first six months of 1998 versus the comparable 1997 period. Strong underlying volume gains were achieved by frozen pizza, resulting from the continued success of rising crust pizza; meals, due to the growth of Taco Bell grocery products as well as strength in macaroni and cheese dinners; beverages, from the strength of ready-to-drink products and new product introductions, partially offset by declines in higher-margin powdered soft drinks; and cereals, aided by new products. Volume also grew in cheese, across all major product lines; processed meats, due to the strength lunch combinations, which reflected the continued success of new product introductions, and to increases in hot dogs and bacon; and desserts and snacks on the strength of refrigerated ready-to-eat desserts and shelf-stable puddings and new product introductions. Enhancers volume grew slightly, reflecting strong growth in spoonable dressings, partially offset by lower barbecue sauce shipments. Coffee volume in the first half of 1998 declined from the comparable 1997 period due largely to market contraction resulting from higher retail prices in the first quarter of 1998. In Canada, volume was essentially flat, reflecting the solid performance in retail branded products, offset by the planned reduction of low margin products. INTERNATIONAL FOOD. Operating revenues for the first six months of 1998 decreased 11.6% from the first six months of 1997, due to unfavorable currency movements ($407 million), lower volume/mix ($142 million) and the impact of divestitures ($230 million), partially offset by pricing ($117 million) and the consolidation of a previously unconsolidated subsidiary ($34 million). Operating income for the first six months of 1998 decreased 9.5% from the first six months of 1997, due primarily to cost increases net of price increases (netting to $57 million, primarily related to higher coffee costs), lower volume/mix ($22 million), the impact of divestitures ($29 million) and unfavorable currency movements ($26 million), partially offset by lower marketing, administration and research costs ($75 million) and the consolidation of a previously unconsolidated subsidiary. Excluding the operating results of the divested international food businesses discussed above, underlying operating revenues decreased 7.6% and underlying operating income decreased 4.5% in the first six months of 1998 from the first six months of 1997. KFI's coffee volume continued to be adversely affected by soft consumption and trade de-stocking in anticipation of price declines in certain markets, as well as a difficult comparison against the prior year, when shipments were heavy in advance of rising prices. Confectionery volume increased on the strength of continued growth and new product introductions in Central and Eastern Europe. These increases more than offset volume declines due to the contraction of several key European chocolate markets, as well as higher prices in Germany. Volume also increased in KFI's cheese and grocery business as a result of higher shipments of cheese in the United Kingdom, snacks in Scandinavia, powdered soft drinks in the Middle East and China and processed cheese slices and peanut butter in Australia. Cheese and grocery volume in Germany was down due primarily to the impact of retail price increases. Cheese and grocery volume was also down in -38- Southeast Asia, reflecting the current economic instability of the region. In Latin America, volume grew solidly due primarily to powdered soft drinks in Brazil and ready-to-drink beverages in Puerto Rico.
FOR THE THREE MONTHS ENDED JUNE 30, ------------------------------------------------------- OPERATING REVENUES OPERATING INCOME ---------------------- ---------------------- (in millions) 1998 1997 1998 1997 ------ ------ ------ ------ North American food $4,540 $4,331 $ 884 $ 815 International food 2,495 2,622 272 287 ------ ------ ------ ------ Total $7,035 $6,953 $1,156 $1,102 ====== ====== ====== ======
NORTH AMERICAN FOOD. During the second quarter of 1998, operating revenues increased 4.8% over the second quarter of 1997, due primarily to favorable volume ($299 million), partially offset by the impact of divestitures ($40 million), unfavorable product mix ($27 million) and unfavorable currency movements ($21 million). Operating income for the second quarter of 1998 increased 8.5% over the second quarter of 1997, due primarily to volume increases in ongoing operations ($155 million) and cost decreases, net of price decreases (aggregating to $8 million), partially offset by higher marketing, administration and research costs ($60 million), unfavorable product mix ($26 million) and the impact of divestitures ($11 million). Excluding operating results of the divested North American food businesses discussed above, underlying operating revenues and underlying operating income increased 5.8% and 10.0%, respectively, in the second quarter of 1998 versus the comparable 1997 period. Coffee volume in the second quarter of 1998 increased strongly over the comparable 1997 period when coffee shipments were unusually low following accelerated purchases in the first quarter of 1997 in advance of commodity-driven price increases. Strong coffee volume in the second quarter of 1998 also reflects the favorable impact of reductions in retail prices as green coffee bean costs declined. Strong underlying volume gains were also achieved by frozen pizza, resulting from the continued success of rising crust pizza; meals, due to the growth of Taco Bell grocery products, as well as strength in macaroni and cheese dinners; and processed meats, due to the strength of lunch combinations, which reflected the continued success of new product introductions, and to increases in hot dogs, cold cuts and bacon; cheese due to strength across all major product categories; and enhancers due to growth in spoonable and pourable salad dressings, reflecting new advertising and a new line of pourable salad dressings. Cheese and enhancers volumes were also favorably affected by the timing of the Easter holiday. Volume also grew in desserts and snacks on the strength of refrigerated ready-to-eat desserts and shelf-stable puddings, as well as new products; cereals, aided by new products; and beverages, from the strength of ready-to-drink products and new product introductions, partially offset by lower shipments of higher-margin powdered soft drinks. In Canada, volume decreased slightly due to the planned reduction of low margin products. INTERNATIONAL FOOD. Operating revenues for the second quarter of 1998 decreased 4.8% from the second quarter of 1997, due to unfavorable currency movements ($139 million) and the impact of divestitures ($85 million), partially offset by higher ongoing volume/mix ($64 million), pricing ($19 million) and the consolidation of -39- a previously unconsolidated subsidiary ($14 million). Operating income for the second quarter of 1998 decreased 5.2% from the second quarter of 1997, due primarily to cost increases net of price increases (aggregating to $26 million, primarily related to higher coffee costs), higher marketing, administration and research costs ($13 million), and unfavorable currency movements ($7 million), partially offset by higher volume/mix from ongoing operations ($29 million). Excluding the operating results of the divested international food businesses discussed above, underlying operating revenues decreased 1.7% and underlying operating income decreased 5.9% in the second quarter of 1998 from the second quarter of 1997. KFI's coffee volume continued to be adversely affected by soft consumption and trade de-stocking in anticipation of price declines in certain markets. Confectionery volume increased on the strength of successful promotions in Germany, continued growth and new product introductions in Central and Eastern Europe and the timing of Easter shipments. Volume also grew in KFI's cheese and grocery business as a result of higher shipments of cheese in the United Kingdom; snacks in Scandinavia; cheese, cream cheese and meats in Italy; powdered soft drinks in the Middle East and China; and processed cheese slices and peanut butter in Australia. Cheese and grocery volume was down in Southeast Asia, reflecting the current economic instability of the region. In Latin America, volume increased strongly due primarily to powdered soft drinks in Brazil and Mexico, as well as higher shipments of ready-to-drink beverages in Puerto Rico. BEER SIX MONTHS ENDED JUNE 30 Operating revenues of the Miller Brewing Company ("Miller") for the first six months of 1998 decreased $17 million (0.8%) from the first six months of 1997, due primarily to lower volume ($15 million) and unfavorable price/mix ($2 million). Operating income for the first six months of 1998 increased $1 million (0.4%) over the first six months of 1997, due primarily to lower marketing, administration and research costs ($20 million, primarily lower marketing), partially offset by lower volume ($8 million), unfavorable price/mix ($6 million) and higher fixed manufacturing costs ($5 million). Excluding the 1997 results of then 20%-owned Molson Breweries of Canada, underlying operating income increased 1.1%. Miller's domestic shipment volume of 21.9 million barrels for the first six months of 1998 increased 0.1% from the comparable 1997 period, reflecting increases in near-premium brands and steady performance in premium and budget brands. Export volume decreased 28.2%, as volume shifted to sales under international licensing agreements. Domestic shipments of premium products were even with 1997 as higher shipments of MILLER LITE and double-digit gains in ICEHOUSE and FOSTER'S were offset by lower shipments of MILLER beer and MILLER GENUINE DRAFT. Domestic shipments of near-premium products increased slightly on the performance of RED DOG. Domestic shipments of budget brands were even with 1997, despite volume growth in the MILWAUKEE'S BEST FAMILY OF BEERS. Wholesalers' sales to retailers in the first six months of 1998 decreased slightly from the comparable 1997 period, reflecting lower sales of MILLER LITE, MILLER GENUINE DRAFT and MILLER beer, partially offset by double-digit increases for ICEHOUSE and FOSTER'S, as well as solid increases for the MILWAUKEE'S BEST FAMILY OF BEERS. -40- THREE MONTHS ENDED JUNE 30 Miller's operating revenues for the second quarter of 1998 decreased $11 million (0.9%) from the second quarter of 1997, due primarily to lower volume ($14 million), partially offset by favorable price/mix ($3 million). Operating income for the second quarter of 1998 decreased $8 million (4.8%) from the second quarter of 1997, due primarily to the impact of a divested equity investment ($9 million), lower volume ($7 million), unfavorable price/mix ($2 million) and higher fixed manufacturing costs ($3 million), partially offset by lower marketing, administration and research costs ($13 million). Excluding the 1997 results of then 20%-owned Molson Breweries of Canada, underlying operating income increased 0.6%. Miller's domestic shipment volume of 12.0 million barrels for the second quarter of 1998 decreased 0.3% from the comparable 1997 period, reflecting slight decreases in near-premium and budget brands. Domestic shipments of premium brands were essentially even with the comparable 1997 period, as higher MILLER LITE shipments, coupled with double-digit increases for ICEHOUSE and FOSTER'S, were offset by lower domestic shipments of MILLER beer and MILLER GENUINE DRAFT, which continues to be adversely affected by intense competition in the key markets of California and Texas. Domestic shipments of near-premium products decreased slightly on lower shipments of RED DOG. Domestic budget brand volume decreased slightly, despite increases for the MILWAUKEE'S BEST FAMILY OF BEERS. Wholesalers' sales to retailers in the second quarter of 1998 decreased slightly from the comparable 1997 period, reflecting lower sales of MILLER LITE, MILLER GENUINE DRAFT and MILLER beer, partially offset by double-digit increases for ICEHOUSE and Foster's, as well as higher sales of the MILWAUKEE'S BEST FAMILY OF BEERS. During the second quarter of 1998, Miller announced an agreement with S&P Company to contract manufacture certain Pabst brands, as well as the brands of other S&P subsidiaries, in several states. The five-year contract, which is renewable in its fourth year, will result in manufacturing fee income for Miller, which is not expected to materially affect Miller's operating income in 1998. Miller's shipments of Pabst brands are expected to begin in the third quarter of 1998. FINANCIAL SERVICES AND REAL ESTATE Philip Morris Capital Corporation's ("PMCC") financial services and real estate operating revenues and operating income declined in the first six months and the second quarter of 1998 from the comparable 1997 periods, reflecting the sale of its real estate subsidiary, Mission Viejo Company, in the third quarter of 1997. Operating revenues and operating income from PMCC's financial services business increased in the first six months and second quarter of 1998 over the comparable 1997 periods due to increased leasing and structured finance investments and the continued profitability of PMCC's existing portfolio of finance assets. FINANCIAL REVIEW NET CASH PROVIDED BY OPERATING ACTIVITIES During the first six months of 1998, net cash provided by operating activities was $3.7 billion compared with $3.5 billion in the comparable 1997 period. The increase primarily reflects higher underlying net earnings, partially offset by the payment of tobacco litigation settlements charged to earnings in the second half of 1997. Included in net earnings for the first six months of 1998 were previously discussed charges for voluntary early retirement programs and the -41- settlement of tobacco litigation (aggregating to $814 million on an after-tax basis), payments for the majority of which will be made in future periods. NET CASH USED IN INVESTING ACTIVITIES During the first six months of 1998, net cash used in investing activities was $980 million, substantially unchanged from $956 million used during the comparable 1997 period. During the first six months of 1997, cash used by PMI for the purchase of a controlling interest in a cigarette manufacturer in Portugal more than offset cash provided by KFI from the sale of a Scandinavian sugar confectionery business. NET CASH USED IN FINANCING ACTIVITIES During the first six months of 1998, net cash of $341 million was used in financing activities, as compared with $2.4 billion used in financing activities during the comparable 1997 period. This difference was primarily due to higher net issuance of debt in 1998 and to stock repurchases during the first half of 1997. DEBT The Company's total debt (consumer products and financial services) was $15.7 billion and $14.1 billion at June 30, 1998 and December 31, 1997, respectively. Total consumer products debt was $14.7 billion and $13.3 billion at June 30, 1998 and December 31, 1997, respectively. At June 30, 1998 and December 31, 1997, the Company's ratio of consumer products debt to total equity was 0.92 and 0.89, respectively. The ratio of total debt to total equity was 0.98 and 0.95 at June 30, 1998 and December 31, 1997, respectively. The Company and its subsidiaries maintain credit facilities with a number of lending institutions, amounting to approximately $12.0 billion at June 30, 1998. These include revolving bank credit agreements totaling $10.0 billion, which may be used to support any commercial paper borrowings by the Company and which are available for acquisitions and other corporate purposes. An agreement that enables the Company to borrow $2.0 billion for short-term purposes expires in October 1998. The Company intends to negotiate a new short-term agreement to replace the current agreement. An agreement for $8.0 billion expires in 2002, enabling the Company to refinance short-term debt on a long-term basis. The Company expects 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. 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 a portion of its exposure to currency movements. The U.S. dollar value of aggregate notional principal amounts for these agreements outstanding was equivalent to $2.5 billion and $1.4 billion, respectively, at June 30, 1998 and December 31, 1997. Of these amounts, $1.8 billion and $736 million related to consumer products debt at June 30, 1998 and December 31, 1997, respectively. In addition, during the first half of 1998, the Company entered into a swap agreement that effectively converts $800 million of fixed rate debt to variable rate debt. -42- 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 June 30, 1998 and December 31, 1997, the Company had entered into contracts, with maturities of less than one year and U.S. dollar equivalents of $2.4 billion (including $873 million in option contracts) and $2.5 billion (including $1.1 billion in option contracts), respectively. Use of the above-mentioned derivative financial instruments has not had a material impact on the Company's financial position at June 30, 1998 or results of operations for the three or six months then ended. The Company's credit ratings by Moody's at June 30, 1998 and December 31, 1997 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 June 30, 1998 and December 31, 1997 were "A-1" in the commercial paper market and "A" for long-term debt obligations. The debt ratings of the Company remain on S&P's CreditWatch list, as S&P monitors tobacco litigation and legislation developments. As discussed above under "Tobacco--Business Environment," the present legislative and litigation environment is substantially uncertain and could result in material adverse consequences for the business, financial condition, cash flows or results of operations of the Company, PM Inc. and PMI. EQUITY AND DIVIDENDS During the first quarter of 1997, the Board of Directors announced an $8.0 billion share repurchase program. The Company repurchased common stock at an aggregate cost of $51 million under this program prior to its suspension in April 1997. Dividends paid in the first six months of 1998 were substantially unchanged from the comparable 1997 period. The current quarterly dividend rate of $0.40 per share was established by the Company's Board of Directors in the third quarter of 1996, resulting in an annualized dividend rate of $1.60 per share. During the first six months of 1998, currency translation adjustments reduced stockholders' equity by $221 million due to the strengthening of the U.S. dollar versus European currencies, primarily the Swiss franc, Swedish krona, German mark, Norwegian krone and Netherlands guilder. CASH AND CASH EQUIVALENTS Cash and cash equivalents were $4.6 billion at June 30, 1998 and $2.3 billion at December 31, 1997, the increase being largely attributable to the 1997 suspension of the Company's share repurchase program and 1998 debt issuances discussed above. NEW ACCOUNTING STANDARDS During the second quarter of 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities", which must be adopted by the Company by January 1, 2000, with early adoption permitted. SFAS No. 133 requires that all derivative instruments be recorded on the consolidated balance sheet at their fair value. Changes in the -43- fair value of derivatives will be recorded each period in earnings or other comprehensive earnings, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in other comprehensive earnings will be reclassified as earnings in the periods in which earnings are affected by the hedged item. The Company has not yet determined the timing of adoption or the impact that adoption or subsequent application of SFAS No. 133 will have on its financial position or results of operations. In 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP No. 98-1 requires certain costs incurred in connection with developing or obtaining internal-use software to be capitalized and other costs to be expensed. The Company adopted SOP No. 98-1 effective January 1, 1998, and its application for the three and six month periods ended June 30, 1998 had no material effect on the Company's financial position or results of operations. In 1998, AcSEC issued SOP No. 98-5, "Reporting on the Costs of Start-Up Activities." SOP No. 98-5 establishes standards on accounting for start-up and organization costs and in general, requires such costs to be expensed as incurred. This standard is required to be adopted on January 1, 1999. The Company currently estimates that adoption of SOP No. 98-5 will have no material effect on the Company's financial position or results of operations. CONTINGENCIES See Note 3 to the Condensed Consolidated Financial Statements for a discussion of contingencies. FORWARD-LOOKING AND CAUTIONARY STATEMENTS The Company and its representatives may from time to time make written or oral forward-looking statements, including statements contained in the Company's filings with the Securities and Exchange Commission and in its reports to stockholders. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby identifying 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; any such statement is qualified by reference to the following cautionary statements. The tobacco industry continues to be subject to health concerns relating to the use of tobacco products and exposure to ETS, legislation, including tax increases, governmental regulation, privately imposed smoking restrictions, governmental and grand jury investigations, litigation, and the effects of price increases related to tobacco litigation settlements and, if implemented, federal tobacco legislation discussed above. Each of the Company's operating subsidiaries is subject to intense competition, changes in consumer preferences, the effects of changing prices for its raw materials, local economic conditions and the potential impact of the CDC issue. The performance of each of PMI and KFI is affected by foreign economies and currency movements. Developments in any of these areas, which are more fully described above and which descriptions are incorporated into this section by reference, could cause the Company's results to differ materially from results that have been or may be projected by or on behalf of the Company. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company. -44- 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 10.1 Stipulation of Amendment to Settlement Agreement and For Entry of Agreed Order, dated July 2, 1998, regarding the settlement of the Mississippi health care cost recovery action. 10.2 Mississippi Fee Payment Agreement, dated July 2, 1998, regarding the payment of attorneys' fees. 10.3 Mississippi MFN Escrow Agreement, dated July 2, 1998. 10.4 Stipulation of Amendment to Settlement Agreement and For Entry of Consent Decree, dated July 24, 1998, regarding the settlement of the Texas health care recovery action. 10.5 Texas Fee Payment Agreement, dated July 24, 1998, regarding the payment of attorneys' fees. 12 Statement regarding computation of ratios of earnings to fixed charges. 27 Financial Data Schedule. 99 Certain Pending Litigation Matters and Recent Developments. (b) Reports on Form 8-K. During the quarter for which this report is filed, the Registrant filed a Current Report on Form 8-K, dated April 20, 1998, containing a letter to stockholders describing the Company's view of a federal tobacco bill sponsored by Senator John McCain. -45- 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 August 14, 1998 -46- EX-10.1 2 STIPULATION OF AMDT. TO SETTLEMENT AGREEMENT AND Exhibit 10.1 IN THE CHANCERY COURT OF JACKSON COUNTY, STATE OF MISSISSIPPI ) IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429 STATE OF MISSISSIPPI TOBACCO LITIGATION ) ) STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF AGREED ORDER THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF AGREED ORDER (the "Stipulation of Amendment") is made as of the date hereof, by and among the parties hereto, as indicated by their signatures below, to amend the Comprehensive Settlement Agreement and Release entered into by the parties hereto with respect to this Action on October 17, 1997 (the "Settlement Agreement"). WHEREAS, on July 2, 1997, the State of Mississippi and certain defendants (the "Settling Defendants") entered into a Memorandum of Understanding (the "MOU"), setting forth the terms of an agreement in principle to settle all present and future claims relating to the subject matter of this Action, which MOU contemplated that the parties would draft and execute a comprehensive settlement agreement incorporating the terms of the MOU as well as other customary terms and conditions, including releases; WHEREAS, on October 17, 1997, the State of Mississippi and Settling Defendants entered into the Settlement Agreement to settle and resolve with finality all present and future civil claims against all parties to this litigation relating to the subject matter of this litigation which have been or could have been asserted by any of the parties hereto; WHEREAS, the Settlement Agreement was approved and adopted as an enforceable order of the Court pursuant to Court Order dated December 29, 1997; WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of this Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement shall be revised so that the State of Mississippi will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on May 8, 1998, Settling Defendants entered into a pre-verdict settlement agreement with the State of Minnesota to settle the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994) (the "Minnesota Settlement"); 2 WHEREAS, the State of Mississippi and Settling Defendants agree that, pursuant to the Most Favored Nation clause of the Settlement Agreement, the Settlement Agreement is to be revised in light of the Minnesota Settlement; WHEREAS, the State of Mississippi and Settling Defendants have agreed on the terms of revisions to the Settlement Agreement in light of the Minnesota Settlement, as set forth in this Stipulation of Amendment and the Agreed Order attached as Exhibit 1 hereto; and WHEREAS, the parties hereto have further agreed jointly to petition the Court for approval of the Agreed Order: NOW, THEREFORE, BE IT KNOWN THAT, pursuant to the Most Favored Nation clause of the Settlement Agreement and in consideration of their mutual agreement to the terms of this Stipulation of Amendment (including, inter alia, waiver of any further claim to revise the Settlement Agreement pursuant to the Most Favored Nation clause, except as expressly provided herein), and such other consideration as described herein, the sufficiency of which is hereby acknowledged, the parties hereto, acting by and through their authorized agents, memorialize and agree as follows: 1. Amendment of Settlement Agreement. The provisions of this Stipulation of Amendment supplement the terms of the Settlement Agreement, 3 which shall remain in full force and effect except insofar as they are expressly revised by the provisions of this Stipulation of Amendment. 2. Voluntary Agreement of the Parties. The Court may, upon the State's application, enter the Agreed Order attached hereto as Exhibit A. The State and Settling Defendants understand that Congress may enact legislation dealing with some of the issues addressed in the Settlement Agreement, this Stipulation of Amendment or the Agreed Order. Settling Defendants and their assigns, affiliates, agents and successors hereby voluntarily waive any right to challenge the Settlement Agreement, this Stipulation of Amendment or the Agreed Order, directly or through third parties, on the ground that any term thereof or hereof is unconstitutional, outside the power or jurisdiction of the Court or preempted by or in conflict with any current or future federal legislation (except insofar as any terms of the Settlement Agreement (as revised hereby) or the Agreed Order that relate to matters other than payments are irreconcilable with any such future federal legislation). 3. Definitions. For the purposes of the Settlement Agreement, this Stipulation of Amendment and the Agreed Order, the following terms shall have the meanings set forth below: (a) "Consumer Price Index" means the Consumer Price Index for All Urban Consumers for the most recent twelve-month period for which 4 such percentage information is available, as published by the Bureau of Labor Statistics of the U.S. Department of Labor; (b) "Market Share" means a Settling Defendant's respective share of sales of cigarettes, by number of individual cigarettes shipped for consumption in the United States, during (i) with respect to payments made pursuant to paragraph 7 of this Stipulation of Amendment, the calendar year ending on the date on which the payment at issue is due, regardless of when such payment is made, and (ii) with respect to all other payments made pursuant to this Stipulation of Amendment and the Settlement Agreement, the calendar year immediately preceding the year in which the payment at issue is due, regardless of when such payment is made; (c) "Cigarettes" means any product which contains nicotine, is intended to be burned or heated under ordinary conditions of use, and consists of or contains (i) any roll of tobacco wrapped in paper or in any substance not containing tobacco; or (ii) tobacco, in any form, that is functional in the product, which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette; or (iii) any roll of tobacco wrapped in any substance containing tobacco which, because of its appearance, the type of tobacco used in the filler, or its packaging and 5 labeling, is likely to be offered to, or purchased by, consumers as a cigarette described in subparagraph (i) of this paragraph; (d) "Smokeless Tobacco" means any powder that consists of cut, ground, powdered or leaf tobacco that contains nicotine and that is intended to be placed in the oral cavity; (e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and (f) "Children" means persons under the age of 18; The above definitions supplement the definitions provided in the Settlement Agreement and, insofar as they differ, supersede them. 4. Settlement Receipts. The payments to be made by Settling Defendants under the Settlement Agreement and this Stipulation of Amendment constitute reimbursement for public health expenditures of the State of Mississippi and the political subdivisions and agencies of the State of Mississippi, including but not limited to the Mississippi State Employees Health Insurance Plan, University Medical Center and charity hospitals, as well as for Medicaid expenditures of the State of Mississippi. Any payments made by Settling Defendants in a given year are in settlement of claims for damages by the State in the year of payment or earlier years related to the subject matter of this Action, including, without limitation, claims for equitable and injunctive relief, claims for health care 6 expenditures and claims for punitive damages, except that no part of any payment under the Settlement Agreement or this Stipulation of Amendment is made in settlement of an actual or potential liability for a fine, penalty (civil or criminal) or enhanced damages or as the cost of a tangible or intangible asset or other future benefit. In consonance with the relief sought by this Action and the Proposed Resolution, the parties hereto anticipate that the funds provided hereunder and under the Settlement Agreement, other than funds provided pursuant to the Settlement Agreement that are dedicated for the Mississippi Pilot Program and legal expense reimbursement, will be used for health-related expenditures of the State of Mississippi. This paragraph 4 supersedes paragraph 11 of the Settlement Agreement, which is hereby rendered null, void and of no further effect. 5. Supplemental Initial Payment. Each Settling Defendant severally shall cause to be paid, pro rata in proportion to its Market Share and in accordance with and subject to paragraph 17 of this Stipulation of Amendment, to an account designated in writing by the State of Mississippi, its share of $41,738,000, to be paid on or before January 4, 1999; its share of $145,173,000, to be paid on or before January 3, 2000; its share of $145,173,000, to be paid on or before January 2, 2001; its share of $145,173,000, to be paid on or before January 2, 2002; and its share of $72,743,000, to be paid on or before January 2, 2003. The payments made by Settling Defendants pursuant to this paragraph shall be adjusted upward 7 by the greater of 3% or the actual total percent change in the Consumer Price Index applied each year on the previous year, beginning with the payment due to be made on or before January 3, 2000. The payments due to be made by Settling Defendants pursuant to this paragraph on or before January 3, 2000, on or before January 2, 2001, on or before January 2, 2002, and on or before January 2, 2003, will also be decreased or increased, as the case may be, in accordance with the formula for adjustment of payments set forth in Appendix A hereto. The payment due to be made by Settling Defendants pursuant to this paragraph 5 on or before January 4, 1999, shall not be subject to adjustment for inflation or in accordance with the formula for adjustment of payments set forth in Appendix A hereto. 6. Acceleration of Supplemental Initial Payment. In the event that any Settling Defendant fails to make any payment required of it pursuant to paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of Mississippi shall provide notice to each of the Settling Defendants of such non-payment. The Defaulting Defendant shall have 15 days after receipt of such notice to pay the Missed Payment, together with interest accrued from the original applicable due date at the prime rate as published in the Wall Street Journal on the latest publication date on or before the date of default plus 3%. If the Defaulting Defendant does not make such payment within such 15-day period, the State of 8 Mississippi shall have the option of providing notice to each of the Settling Defendants of such continued non-payment. In the event that the State of Mississippi elects to provide such notice, any or all of the Settling Defendants (other than the Defaulting Defendant) shall have 15 days after receipt of such notice to elect (in such Settling Defendant's or such Settling Defendants' sole and absolute discretion) to pay the Missed Payment, together with interest accrued from the original applicable due date at the prime rate as published in the Wall Street Journal on the latest publication date on or before the date of default plus 3%. In the event that the State of Mississippi does not receive the Missed Payment, together with such accrued interest, within such additional 15-day period, all payments required to be made by each of the respective Settling Defendants pursuant to paragraph 5 of this Stipulation of Amendment that have yet to come due prior to the conclusion of such additional 15-day period shall be accelerated and immediately become due and owing to the State of Mississippi from each Settling Defendant, pro rata in proportion to its Market Share; provided, however, that such accelerated payments (a) shall all be adjusted upward by the greater of (i) the rate of 3% per annum or (ii) the actual total percent change in the Consumer Price Index, in either instance for the period between January 1 of the year in which the acceleration of payments pursuant to this paragraph occurs and the date on which such accelerated payments are made pursuant to this paragraph 6, and (b) 9 shall all immediately be adjusted in accordance with the formula for adjustment of payments set forth in Appendix A hereto. Nothing in this paragraph 6 shall be deemed under any circumstance to create any obligation on the part of any Settling Defendant to pay any amount owed or payable to the State of Mississippi by any other Settling Defendant. All obligations of the Settling Defendants pursuant to this paragraph 6 are intended to be and shall remain several, and not joint. 7. Annual Payments. Each of the Settling Defendants agrees that, beginning on December 31, 1998 (subject to adjustment for appropriate allocation among Settling Defendants by January 30, 1999), and annually thereafter on December 31st of each year after 1998 (subject to final adjustment within 30 days), it shall severally cause to be paid to an account designated in writing by the State of Mississippi, in accordance with and subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion to its respective Market Share, its share of 1.7% of the following amounts (in billions): Year 1998 1999 2000 2001 2002 2003 thereafter 1 2 3 4 5 6 Amount $4B $4.5B $5B $6.5B $6.5B $8B $8B The payments made by Settling Defendants pursuant to this paragraph 7 shall be adjusted upward by the greater of 3% or the actual total percent change in the Consumer Price Index applied each year on the previous year, beginning with the 10 annual payment due on December 31, 1999. Such payments will also be decreased or increased, as the case may be, beginning with the annual payment due on December 31, 1999, in accordance with the formula for adjustments of payments set forth in Appendix A. This paragraph 7 supersedes paragraph 9 of the Settlement Agreement (and, insofar as not already superseded thereby, paragraph 3 of the MOU), which is hereby rendered null, void and of no further effect. 8. Determination of Market Share. In the event of a disagreement between or among any Settling Defendants as to their respective shares of any payment due to be paid on a Market Share basis pursuant to the Settlement Agreement and this Stipulation of Amendment, each Settling Defendant shall pay its undisputed share of such payment promptly on or before the date on which such payment is due, and shall, within 21 days of such date, submit copies of its federal excise tax reports for the year in question to a third party to be selected by agreement of Settling Defendants (the "Third Party"), who shall determine the Market Share of each Settling Defendant within 3 business days of receipt of such federal excise tax reports. The decision of the Third Party shall be final and non-appealable, and shall be communicated by facsimile to each person designated to receive notice under paragraph 23 of the Settlement Agreement. Each Settling Defendant shall, within two business days of receipt of the Third Party's decision, pay the State or such other Settling Defendant, as appropriate, the difference, if any, between (1) 11 the amount that such Settling Defendant has already paid with respect to the payment in question and (2) the amount of the payment in question that corresponds to such Settling Defendant's Market Share as determined by the Third Party, together with interest accrued from the original date on which the payment in question was due, at the prime rate as published in the Wall Street Journal on the latest publication date on or before the original date on which the payment in question was due, plus 3%. 9. Adjustments in Event of Federal Legislation. In the event that federal tobacco legislation is enacted before November 30, 2000 that provides for payments by tobacco companies (whether in the form of settlement payment, tax or otherwise) ("Tobacco Legislation"): (a) Settling Defendants shall be entitled to receive a dollar for dollar offset against the annual payments required under paragraph 7 of this Stipulation of Amendment of any amounts that the State of Mississippi could elect to receive pursuant to such Tobacco Legislation ("Federal Settlement Funds"), up to the full amount of such annual payments, except to the extent that: (i) such Federal Settlement Funds are required to be used for purposes other than health care or tobacco-related purposes; 12 (ii) such Tobacco Legislation does not provide for the abrogation, settlement or relinquishment of state tobacco-related claims; or (iii) state receipt of such Federal Settlement Funds is conditioned upon (A) the relinquishment of rights or benefits under the Settlement Agreement (including this Stipulation of Amendment and the Agreed Order) (excepting any annual payment amounts subject to the offset); or (B) actions or expenditures by the state unrelated to health care or tobacco (including but not limited to tobacco education, cessation, control or enforcement). (b) Nothing in this paragraph 9 shall reduce (i) the payments made to the State of Mississippi pursuant to paragraphs 7 and 8 of the Settlement Agreement and paragraphs 5 and 6 of this Stipulation of Amendment (by offset, credit, recoupment, refund or otherwise); or (ii) the percentage figure (1.7%) used to determine the State of Mississippi's annual payments pursuant to paragraph 7 of this Stipulation of Amendment. Nothing in this paragraph 9 is intended to or shall reduce the total amounts payable by Settling Defendants to the State of Mississippi under the Settlement Agreement (as revised hereby) by an amount greater than the amount of 13 Federal Settlement Funds that the State of Mississippi could elect to receive. This paragraph 9 supersedes paragraph 10 of the Settlement Agreement (and, insofar as not already superseded thereby, paragraph 5 of the MOU), which is hereby rendered null, void and of no further effect. 10. Clarification of Scope of State's Release. The release of claims provided in paragraph 13 of the Settlement Agreement shall, with respect to the Claims identified in subparagraph (2) thereof, apply only to monetary Claims and, further, shall not operate as a release of any person, party or entity (whether or not a signatory to the Settlement Agreement or this Stipulation of Amendment) as to any of the obligations undertaken in the Settlement Agreement (as revised hereby) in connection with a monetary breach or default thereof. This paragraph 10 does not supersede but rather supplements and clarifies the scope of the release provided in paragraph 13 of the Settlement Agreement. 11. Limited Most-Favored Nation Provision. In partial consideration for the monetary payments to be made by Settling Defendants pursuant to this Stipulation of Amendment, the State of Mississippi agrees that, if Settling Defendants enter into any future pre-verdict settlement agreement of other similar litigation brought by a non-federal governmental plaintiff, or any amendment to any such existing settlement agreement, on terms more favorable to such non- 15 federal governmental plaintiff than the terms of the Settlement Agreement (including this Stipulation of Amendment and the Agreed Order) (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement (including this Stipulation of Amendment and the Agreed Order) shall not be revised except as follows: to the extent, if any, such other pre-verdict settlement agreement includes terms that provide: (a) for joint and several liability among Settling Defendants with respect to monetary payments to be made pursuant to such agreement; (b) a guarantee by the parent company of any of Settling Defendants or other assurances of payment or creditors' remedies with respect to monetary payments to be made pursuant to such agreement; (c) for the implementation of non-economic tobacco-related public health measures different from those contained in the Settlement Agreement (including this Stipulation of Amendment and the Agreed Order); (d) for no offset of Federal Settlement Funds against annual settlement payments pursuant to such settlement agreement; or (e) for an offset term more favorable to the plaintiff than the offset provisions of paragraph 9 of this Stipulation of Amendment, 14 then the Settlement Agreement shall, at the option of the Office of the Attorney General of the State of Mississippi, be revised to include terms comparable to such terms. This paragraph 11 supersedes paragraph 15 of the Settlement Agreement (and, insofar as not already superseded thereby, paragraph 7 of the MOU), which is hereby rendered null, void and of no further effect. The State of Mississippi hereby acknowledges that, pursuant to the terms of this paragraph 11, it has irrevocably waived any future claim to revise the terms of the Settlement Agreement or this Stipulation of Amendment pursuant to paragraph 15 of the Settlement Agreement (or paragraph 7 of the MOU) (except as provided in paragraph 23 of this Stipulation of Amendment), and it hereby further covenants and agrees that, in consideration for Settling Defendants' agreement to the terms of this Stipulation of Amendment, it shall not hereafter seek to revise the Settlement Agreement or this Stipulation of Amendment, except as expressly provided in this paragraph 11 (or pursuant to mutually agreeable amendment by the parties hereto as provided in paragraph 22 of the Settlement Agreement and paragraph 19 hereof). 12. Settling Defendants' Assurances. Settling Defendants agree: 16 (a) to support the legislative initiatives to enact new laws and administrative initiatives to promulgate new rules described in paragraph 6 of the Settlement Agreement; and (b) not to support in Congress or any other forum legislation, rules or policies which would preempt, override, abrogate or diminish the State's rights or recoveries under the Settlement Agreement (as amended hereby). Except as specifically provided in the foregoing sentence, nothing in this Settlement Agreement (including this Stipulation of Amendment and the Agreed Order) shall be deemed to restrain the parties from advocating terms of any national settlement or taking any other positions on issues relating to tobacco. 13. Disclosure of Payments. Each Settling Defendant shall disclose to the Office of the Attorney General and the Office of the Governor, at the times and in the manner provided below, information about the following payments: (a) Any payment to a "lobbyist" within the meaning of Miss. Code Ann. ss.ss. 5-8-3, 5-8-7 (Supp. 1997)), if the Settling Defendant knows or has reason to know that the payment will be used, directly or indirectly, to influence legislative or administrative action or the official action of state or local government in Mississippi in any way relating to Tobacco Products or their use; 17 (b) Any payment to a third party, if the Settling Defendant knows the payment is partly in consideration for the third party attending, offering testimony at, or participating before a state or local government hearing in Mississippi in any way relating to Tobacco Products or their use; and (c) Any payment (other than a "campaign contribution" under Miss. Code Ann. ss.ss. 23-15-801 et. seq. (1972 & Supp. 1997) to, or for the benefit of, a state or local official in Mississippi, whether made directly by the Settling Defendant or indirectly through an employee of the Settling Defendant acting within the scope of his employment, or through an affiliate, lobbyist or other agent acting under the substantial control of the Settling Defendant. Disclosures required under this paragraph 13 shall be filed with the Office of the Attorney General and the Office of the Governor on the first day of February, May, August and November of each year for any and all payments made through the first day of the previous month, and shall be transmitted in electronic format or such format as the Attorney General may require, with the following information: o The name, address, telephone number and e-mail address of the recipient; o The amount of each payment described in this paragraph 13; and o The aggregate amount of all payments described in this paragraph 13 to the recipient in the calendar year. 18 Information disclosed pursuant to this paragraph 13 is a "public record" within the meaning of the Mississippi Public Records Act of 1983, Miss. Code Ann. ss.ss. 25-61-1 et seq. (1972 & Supp. 1997). 14. Prohibition of Certain Payments for Product Placement. Settling Defendants shall not make or cause to be made, in connection with any motion picture made in the United States, any payment, direct or indirect, to any person to use, display, make reference to or use as a prop any cigarette, cigarette package, advertisement for cigarettes, or any other item bearing the brand name, logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia of product identification identical or similar to, or identifiable with, those used for any brand of domestic Tobacco Products. 15. Prohibition on Promotional Merchandise. On and after December 31, 1998, Settling Defendants shall permanently cease marketing, licensing, distributing, selling or offering, directly or indirectly, including by catalogue or direct mail, in the State of Mississippi, any service or item (other than Tobacco Products or any item of which the sole function is to advertise Tobacco Products) which bears the brand name (alone or in conjunction with any other word), logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia of product identification identical or similar to, or identifiable with, those used for any brand of domestic Tobacco Products. 19 16. Document Production. Settling Defendants shall provide to the State of Mississippi a copy of any CD-ROMs of documents that Settling Defendants have agreed to produce, pursuant to the Minnesota Settlement, to the document depository established in connection with the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994), with a copy of the accompanying transmittal letter provided to each person designated to receive notice under paragraph 23 of the Settlement Agreement. 17. Court Approval. The parties hereto agree to submit this Stipulation of Amendment promptly to the Court for its review and approval. If the Court refuses to approve this Stipulation of Amendment or any material provision hereof, or if such approval is modified in any material respect or set aside on appeal, then this Stipulation of Amendment shall be canceled and terminated and it and all orders issued pursuant hereto (including the Agreed Order) shall become null and void and of no further effect. Any such cancellation or termination of this Stipulation of Amendment shall not result in the cancellation or termination of the Settlement Agreement as approved by the Court on December 29, 1997. All payments described in this Stipulation of Amendment shall be paid into a special escrow account, pursuant to the terms of a mutually acceptable escrow agreement (the "MFN Escrow Agreement"), and if so paid shall remain in said escrow account, until such time as (1) the time for appeal or to seek review of the Court's order 20 approving this Stipulation of Amendment has expired without the filing of any notice of appeal or petition for review; or (2) in the event of any such appeal or petition, the appeal or the petition has been dismissed or the Court's order has been affirmed in all material respects by the court of last resort to which such appeal or petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review. Any payments made into escrow shall be disbursed from escrow only in strict accordance with the terms of the MFN Escrow Agreement. 18. Obligations Several, Not Joint. All obligations of the Settling Defendants pursuant to the Settlement Agreement and this Stipulation of Amendment are intended to be and shall remain several, and not joint. 19. Applicable Provisions of Settlement Agreement. The provisions of paragraphs 17 (Representations of Parties); 19 (Headings), 20 (No Determination or Admission), 21 (Non-Admissibility), 22 (Amendment), 23 (Notices), 24 (Cooperation), 26 (Construction), 27 (Severability), 28 (Intended Beneficiaries) and 29 (Counterparts) of the Settlement Agreement shall be equally applicable to this Stipulation of Amendment as though fully set forth herein, and all references to the Settlement Agreement in the paragraphs thereof specifically listed in this paragraph 19 shall be construed to include this Stipulation of Amendment. 21 20. Release of Right to Additional Compensation. In consideration for the terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the State of Mississippi hereby irrevocably releases Settling Defendants from any claim for additional compensation pursuant to paragraph 16 of the Settlement Agreement (and, insofar as not already superseded thereby, paragraph 8 of the MOU), the provisions of which regarding the State's rights to additional compensation are hereby rendered null, void and of no further effect. 21. Governing Law. The Settlement Agreement (including this Stipulation of Amendment and the Agreed Order) shall be governed by the laws of the State of Mississippi without regard to the conflict of law rules of such State. This paragraph supersedes paragraph 25 of the Settlement Agreement, which is hereby rendered null, void and of no further effect. 22. Attorneys' Fees. The parties hereto acknowledge that the entire obligation of Settling Defendants regarding payment of private counsel's fees pursuant to paragraph 16 of the Settlement Agreement (and, insofar as not already superseded thereby, paragraph 8 of the MOU) is set forth in the Mississippi Fee Payment Agreement dated July 2, 1998. The Attorney General represents that all of the State's outside counsel that have represented the State in connection with this action are, by and through their authorized representatives, signatories to the Mississippi Fee Payment Agreement. Under no circumstances shall Settling 22 Defendants' entry into this Stipulation of Amendment or the Mississippi Fee Payment Agreement be construed as, or deemed to be, evidence of or an admission or concession that the Settlement Agreement can be revised pursuant to the Most Favored Nations clause without incorporation of all terms of any settlement agreement that provides the occasion for any such revision, including all terms with respect to attorneys' fees. 23. Conditioned on Minnesota Settlement. In the event that a court order or other judicial determination is issued on or before January 2, 2003 that overturns, voids or invalidates the Minnesota Settlement or otherwise declares it to be unenforceable (such that Settling Defendants are relieved from making payments required under the Minnesota Settlement) (the "Minnesota Order"), Settling Defendants shall have the option to elect not to make any payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due on or after the date of such Minnesota Order. In the event that Settling Defendants make such an election: (a) Settling Defendants shall not be obligated to make any payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due on or after the date of the Minnesota Order; provided, however, that if the Minnesota Order is reversed on appeal or otherwise set aside, Settling Defendants shall be obligated to make any payments 23 pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were not made when initially due as result of the Minnesota Order; (b) the provisions of paragraph 11 of this Stipulation of Amendment shall not apply to preclude the application of paragraph 15 of the Settlement Agreement with respect to any pre-verdict settlement agreement described therein entered into after the date of the Minnesota Order; and (c) Settling Defendants shall be entitled to a credit, in the amount of any payments made pursuant to paragraphs 5 and 6 of this Stipulation of Amendment, against any payments due to the State of Mississippi as a result of application of paragraph 15 of the Settlement Agreement in connection with any pre-verdict settlement agreement entered into after the date of the Minnesota Order, pursuant to subparagraph (b) of this paragraph 23. No other provision of the Settlement Agreement, this Stipulation of Amendment or the Consent Decree shall be affected by the Minnesota Order. Settling Defendants will provide the State of Mississippi with notice of any filing seeking to obtain a Minnesota Order. 24. Entire Agreement of Parties. The Settlement Agreement (including for purposes of this paragraph 24 this Stipulation of Amendment, the Mississippi Fee Payment Agreement and the Agreed Order) contains an entire, complete and 24 integrated statement of each and every term and provision agreed to by and among the parties hereto relating in any way to the settlement of the tobacco litigation brought by the State of Mississippi, and is not subject to any condition not provided for herein. IN WITNESS WHEREOF, the parties hereto, through their fully authorized representatives, have agreed to this Stipulation of Amendment as of this 2nd day of July, 1998. STATE OF MISSISSIPPI, acting by and through Michael C. Moore, its duly elected and authorized Attorney General By: /s/ Michael C. Moore ------------------------------- Michael C. Moore Attorney General 25 PHILIP MORRIS INCORPORATED By: /s/ Meyer G. Koplow -------------------------------- Meyer G. Koplow Counsel By: /s/ Martin J. Barrington by MGK -------------------------------- Martin J. Barrington General Counsel R.J. REYNOLDS TOBACCO COMPANY By: /s/ Arthur F. Golden -------------------------------- Arthur F. Golden Counsel By: /s/ Charles A. Blixt by AFG -------------------------------- Charles A. Blixt General Counsel 26 BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton ------------------------------------ Stephen R. Patton Counsel By: /s/ F. Anthony Burke ------------------------------------ F. Anthony Burke Vice President & General Counsel LORILLARD TOBACCO COMPANY By: Arthur J. Stevens by MGK ------------------------------------ Arthur J. Stevens Senior Vice President and General Counsel 27 APPENDIX A FORMULA FOR CALCULATING VOLUME ADJUSTMENTS Any payment that by the terms of the Stipulation of Amendment is to be adjusted pursuant to this Appendix (the "Applicable Base Payment") shall be adjusted pursuant to this Appendix in the following manner: (A) in the event the aggregate number of cigarettes shipped for domestic consumption by Settling Defendants in the Applicable Year (as defined hereinbelow) (the "Actual Volume") is greater than the aggregate number of cigarettes shipped for domestic consumption by Settling Defendants in 1997 (the "Base Volume"), the Applicable Base Payment shall be multiplied by the ratio of the Actual Volume to the Base Volume; (B) in the event the Actual Volume is less than the Base Volume, (i) the Applicable Base Payment shall be multiplied by the ratio of the Actual Volume to the Base Volume, and the resulting product shall be divided by 0.98; and (ii) if a reduction of the Applicable Base Payment results from the application of subparagraph (B)(i) of this Appendix, but the Settling Defendants' aggregate net operating profits from domestic sales of cigarettes for the Applicable Year (the "Actual Net Operating Profit") is greater than the Settling Defendants' aggregate net operating profits from domestic sales of cigarettes in 1997 (the "Base Net Operating Profit") (such Base Net Operating Profit being adjusted upward by the greater of the rate of 3% per annum or the actual total percent change in the Consumer Price Index, in either instance for the period between January 1, 1998 and the date on which the payment at issue is made), then the amount by which the Applicable Base Payment is reduced by the application of subparagraph (B)(i) shall be reduced (but not below zero) by 1.7% of 25% of such increase in such profits. For purposes of this Appendix, "net operating profits from domestic sales of cigarettes" shall mean net operating profits from domestic sales of cigarettes as reported to the United States Securities and Exchange Commission ("SEC") for the Applicable Year or, in the case of a Settling Defendant that does not report profits to the SEC, as reported in financial statements prepared in accordance with generally accepted accounting principles and audited by a nationally recognized accounting firm. The determination of Settling Defendants' aggregate net operating profits from domestic sales of cigarettes shall be derived using the same methodology as was employed in deriving such Settling Defendants' aggregate net operating profits from domestic sales of cigarettes in 1997. Any increase in an Applicable Base Payment pursuant to this subparagraph B(ii) shall be payable within 120 days after the date that the payment at issue was required to be made. (C) "Applicable Year" means (i) with respect to the payments made pursuant to paragraph 7 of the Stipulation of Amendment, the calendar year ending on the date on which the payment at issue is due, regardless of when such payment is made; and (ii) with respect to all other payments made pursuant to the Stipulation of Amendment, the calendar year immediately preceding the year in which the payment at issue is due, regardless of when such payment is made. 2 EXHIBIT 1 IN THE CHANCERY COURT OF JACKSON COUNTY, STATE OF MISSISSIPPI ) IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429 STATE OF MISSISSIPPI TOBACCO LITIGATION ) ) AGREED ORDER APPROVING STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT PURSUANT TO COURT ORDER OF DECEMBER 29, 1997 WHEREAS, on October 17, 1997, the State of Mississippi and certain Defendants entered into a Comprehensive Settlement Agreement and Release (the "Settlement Agreement") to settle and resolve with finality all present and future claims against all parties to this litigation relating to the subject matter of this litigation which have been or could have been asserted by any of the parties hereto; WHEREAS, the Settlement Agreement was approved and adopted as an enforceable order of the Court pursuant to Court Order dated December 29, 1997; WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of the Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement 3 EXHIBIT 1 Agreement shall be revised so that the State of Mississippi will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on May 8, 1998, Settling Defendants entered into a pre-verdict settlement agreement with the State of Minnesota to settle the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994) (the "Minnesota Settlement"); WHEREAS, the State of Mississippi and Settling Defendants agree that, pursuant to the Most Favored Nations clause of the Settlement Agreement, the Settlement Agreement is to be revised in light of the Minnesota Settlement; WHEREAS, the State of Mississippi and Settling Defendants have agreed on the terms of the revisions to the Settlement Agreement as set forth in a Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order executed on July 2, 1998 (the "Stipulation of Amendment"); WHEREAS, the Stipulation of Amendment provides for entry of this Agreed Order and, further, provides that the Settling Defendants have waived as specified therein their right to challenge the terms of this Agreed Order as being superseded or preempted by future congressional enactments; and WHEREAS, the Attorney General believes the entry of this Agreed Order is appropriate and in the public interest; 4 EXHIBIT 1 NOW, THEREFORE, the State of Mississippi and Settling Defendants having come before the Court on their joint motion Ore Tenus for approval of a Stipulation of Amendment to the Settlement Agreement pursuant to the Most Favored Nations clause of the Settlement Agreement and this Court's December 29, 1997 Judgment of Dismissal and Order Approving Settlement Agreement (the "December 29, 1997 Order"), and the Court having reviewed and considered the Stipulation of Amendment and otherwise being fully advised in the premises, it is hereby ORDERED, ADJUDGED and DECREED as follows: 1. Approval. Pursuant to the Settlement Agreement and this Court's December 29, 1997 Order, this Court has continuing jurisdiction to enforce and implement the terms of the Settlement Agreement, including the Most Favored Nations clause of the Settlement Agreement. The Court finds that the terms of the Stipulation of Amendment are just and in the best interests of the State of Mississippi and Settling Defendants, and the same is hereby approved. The parties are directed to comply with the terms of the Stipulation of Amendment. 2. Jurisdiction and Venue. In keeping with the Settlement Agreement and this Court's December 29, 1997 Order, the Court retains jurisdiction for the purpose of enforcement of the Settlement Agreement (as amended by the Stipulation of Amendment) and this Agreed Order. Any party to this Agreed Order may apply to this Court at any time for such further orders and directions as 5 EXHIBIT 1 may be necessary or appropriate for the construction and enforcement of the Settlement Agreement, the Stipulation of Amendment and this Agreed Order. 3. Definitions. The definitions set forth in the Settlement Agreement (as supplemented or superseded by the Stipulation of Amendment) are incorporated by reference herein. 4. Applicability. This Agreed Order applies only to Settling Defendants in their corporate capacity acting through their respective successors and assigns, directors, officers, employees, agents, subsidiaries, divisions or other internal organizational units of any kind or any other entity acting in concert or participating with them. The remedies and penalties for a violation of this Agreed Order shall apply only to Settling Defendants, and shall not be imposed or assessed against any employee, officer or director of Settling Defendants or other person or entity as a consequence of such a violation, and there shall be no jurisdiction under this Agreed Order to impose or assess a penalty against any employee, officer or director of Settling Defendants or other person or entity as a consequence of a violation of this Agreed Order. 5. Effect on Third Parties. This Agreed Order is not intended to and does not vest standing in any third party with respect to the terms hereof, or create for any person other than the parties hereto a right to enforce the terms hereof. 6. Injunctive Relief. Settling Defendants are permanently enjoined from: 6 EXHIBIT 1 (a) On and after December 31, 1998, marketing, licensing, distributing, selling or offering, directly or indirectly, including by catalogue or direct mail, in the State of Mississippi, any service or item (other than Tobacco Products or any item the sole function of which is to advertise Tobacco Products) which bears the brand name (alone or in conjunction with any other word), logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia or product identification identical or similar to, or identifiable with, those used for any domestic brand of Tobacco Products. (b) Making any material misrepresentation of fact regarding the health consequence of using any Tobacco Product, including any tobacco additives, filters, paper or other ingredients; provided, however, that nothing in this paragraph shall limit the exercise of any First Amendment right or any defense or position which persons bound by this Agreed Order may assert in any judicial, legislative or regulatory forum. (c) Entering into any contract, combination or conspiracy between or among themselves which has the purpose or effect of: (1) limiting competition in the production or distribution of information about the health hazards or other consequences of the use of Tobacco Products; 7 EXHIBIT 1 (2) limiting or suppressing research into smoking and health; or (3) limiting or suppressing research into, marketing, or development of new products. (d) Taking any action, directly or indirectly, to target children in Mississippi in the advertising, promotion, or marketing of cigarettes, or taking any action the primary purpose of which is to initiate, maintain or increase the incidence of underage smoking in Mississippi. 7. No Determination or Admission. The Settlement Agreement having been executed prior to the taking of any testimony, no final determination of any violation of any provision of law has been made in this Action. This Agreed Order is not intended to be and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of any liability or any wrongdoing whatsoever on the part of any person covered by the releases provided in paragraphs 12, 13 and 14 of the Settlement Agreement; nor shall this Agreed Order be construed as, or deemed to be, an admission or concession or evidence of personal jurisdiction by any person not a party to this Agreed Order. Defendants specifically disclaim any liability or wrongdoing whatsoever with respect to the claims and allegations asserted against them in this Action and Settling Defendants have entered into the Settlement Agreement and the Stipulation of Amendment, and have stipulated to entry of this Agreed Order, solely to avoid the further expense, inconvenience, burden and risk of litigation. 8 EXHIBIT 1 8. Modification. This Agreed Order shall not be modified unless the party seeking modification demonstrates, by clear and convincing evidence, that it will suffer irreparable harm from new and unforeseen conditions; provided, however, that the provisions of paragraph 4 of this Agreed Order shall in no event be subject to modification. Changes in the economic conditions of the parties shall not be grounds for modification. It is intended that Settling Defendants will comply with this Agreed Order as originally entered, even if Settling Defendants' obligations hereunder are greater than those imposed under current or future law. Therefore, a change in law that results, directly or indirectly, in more favorable or beneficial treatment of any one or more of the Settling Defendants shall not support modification of this Agreed Order. The provisions of this paragraph shall not be construed to limit or affect any future modification of the Settlement Agreement (as amended by the Stipulation of Amendment) in the manner provided in paragraphs 11 and 23 of the Stipulation of Amendment. 9. Enforcement and Attorneys' Fees. In any proceeding which results in a finding that a Settling Defendant violated this Agreed Order, the responsible Settling Defendant or Settling Defendants shall pay the State's costs and attorneys' fees incurred in such proceeding. 10. Non-Exclusivity of Remedy. The remedies in this Agreed Order are cumulative and in addition to any other remedies the State may have at law or 9 EXHIBIT 1 equity. Nothing herein shall be construed to prevent the State from bringing any action simply because the conduct that is the basis for such action may also violate this Agreed Order. SO ORDERED AND ADJUDGED, this the 11th day of July, 1998. /s/ William H. Myers ----------------------------- WILLIAM H. MYERS, CHANCELLOR APPROVED: /s/ Michael C. Moore - ------------------------------------ MICHAEL C. MOORE, Attorney General, for the State of Mississippi /s/ Joe R. Colingo - ------------------------------------ JOE R. COLINGO, for Settling Defendants 10 EX-10.2 3 MISSISSIPPI FEE PAYMENT Exhibit 10.2 MISSISSIPPI FEE PAYMENT AGREEMENT This Mississippi Fee Payment Agreement (the "Agreement") is entered into as of July 2, 1998, by and among Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company (collectively and severally "Settling Defendants" and each individually a "Settling Defendant"), the State of Mississippi and private counsel retained by the State of Mississippi in connection with the lawsuit In re Mike Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429 (Miss. Ch. Ct., Jackson County) (the "Action"). WITNESSETH: WHEREAS, on October 17, 1997, the State of Mississippi and Settling Defendants entered into a comprehensive settlement agreement to settle and resolve with finality all present and future civil claims relating to the subject matter of the Action (the "Settlement Agreement"), which Settlement Agreement was approved by the Chancery Court for the Jackson County (the "Court") and adopted as an enforceable order of the Court pursuant to Court Order dated December 29, 1997; WHEREAS, paragraph 16 of the Settlement Agreement provides that Settling Defendants shall pay reasonable attorneys' fees to private counsel for the State of Mississippi, in an amount set by arbitration, subject to an appropriate annual cap on all such payments of attorneys' fees by Settling Defendants, as well as other conditions; WHEREAS, paragraph 16 of the Settlement Agreement did not and was not intended to reflect the entire agreement of Settling Defendants and the State of Mississippi as to the procedures and conditions that would govern Settling Defendants' payment of fees to private counsel retained by the State of Mississippi in connection with the Action ("Mississippi Counsel"), including an agreed specific annual aggregate national cap on all payments of attorneys' fees and certain other professional fees by Settling Defendants, as well as other essential terms; WHEREAS, Settling Defendants and Mississippi Counsel have entered into a letter agreement dated October 10, 1997 (the "October 10th Letter") which describes the essential terms of Settling Defendants' agreement to pay fees to Mississippi Counsel pursuant to paragraph 16 of the Settlement Agreement; WHEREAS, paragraph 15 of the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of the Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement shall be revised so that the State of Mississippi will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on January 16, 1998, Settling Defendants entered into a pre-verdict settlement agreement with the State of Texas, which sets forth the terms of Settling Defendants' agreement to pay attorneys' fees to private counsel for the State of Texas and includes provisions for advances on such attorneys' fees by Settling Defendants and the State of Texas; WHEREAS, on May 8, 1998, certain Settling Defendants entered into a pre-verdict settlement agreement with the State of Minnesota (the "Minnesota Settlement"), which includes provisions for payment of attorneys' fees to private counsel for the State of Minnesota; WHEREAS, on July 2, 1998, Settling Defendants and the State of Mississippi entered into a Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order (the "Stipulation of Amendment") to resolve any disputes with respect to the Most Favored Nation clause of the Settlement Agreement, including any disputes regarding payment of attorneys' fees, in light of the Texas and Minnesota Settlements; and WHEREAS, Settling Defendants, the State of Mississippi and Mississippi Counsel, in order to resolve any disputes with respect to paragraphs 15 and 16 of the Settlement Agreement, and to describe more fully the procedures that will govern Settling Defendants' payment of fees to Mississippi Counsel, have agreed to the terms of this Agreement: NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual agreement to the terms of this Agreement, the State of Mississippi's and Settling Defendants' mutual agreement to the terms of the Stipulation of 2 Amendment, and such other consideration described herein, including the release of certain claims against Settling Defendants, the sufficiency of which is hereby acknowledged, the parties hereto, acting by and through their authorized agents, memorialize and agree as follows: SECTION 1. Agreement to Pay Fees. Settling Defendants will pay reasonable attorneys' fees to Mississippi Counsel for their representation of the State of Mississippi in connection with the Action. The amount of such fees will be set by a panel of three independent arbitrators (the "Panel") whose decision as to the amount of fees for Mississippi Counsel arbitrated in connection with this Agreement (the "Mississippi Fee Award") shall be final and not appealable. The procedures governing Settling Defendants' obligation to pay the Mississippi Fee Award, including the procedures for making, and the timing of payments in satisfaction of, the Mississippi Fee Award, shall be as provided herein. SECTION 2. Aggregate National Caps on Payment of Certain Fees. Settling Defendants' payment of the Mississippi Fee Award pursuant to this Agreement shall be subject to the payment schedule and the annual and quarterly aggregate national caps specified in sections 11, 12, 13, 14 and 15 hereof, which shall apply to: (a) all payments of attorneys' fees pursuant to an award arbitrated by the Panel ("Fee Award") in connection with the settlement of any tobacco and health cases (other than non-class action personal injury cases brought directly by or on behalf of a single natural person or the survivor of such person or for wrongful death, or any non-class action consolidation of two or more such cases) ("Tobacco Cases") on terms that provide for payment by Settling Defendants or other defendants acting in agreement with Settling Defendants (collectively, "Participating Defendants") of fees with respect to private counsel retained by the plaintiff in connection with any such case ("Private Counsel"), subject to an annual cap on payment of all such fees; (b) all payments of attorneys' fees (other than fees for attorneys of Participating Defendants) pursuant to a Fee Award for activities in connection with Tobacco Cases resolved by operation of federal legislation that either (i) implements the terms of the June 20, 1997 Proposed Resolution (or a substantially equivalent federal program) (the "Proposed Resolution") or (ii) imposes an 3 enforceable obligation on Participating Defendants to pay attorneys' fees with respect to Private Counsel (any such legislation hereinafter referred to as "Federal Legislation"); and (c) all payments of attorneys' fees and certain other professional fees (other than fees for attorneys or agents of Participating Defendants) pursuant to a Fee Award for contributions made toward enacted Federal Legislation. In the event that Federal Legislation is enacted, the terms "Private Counsel" and "Eligible Counsel" shall apply not only to persons otherwise falling within the definitions of such terms herein but also to all persons granted Fee Awards for such contributions (such persons being Eligible Counsel with respect to each month beginning with the month the Federal Legislation was enacted). Nothing in this Agreement shall be construed to require any Settling Defendant to pay Fee Awards in connection with any litigation other than the Action. SECTION 3. Exclusive Obligation of Settling Defendants; Release. The provisions set forth herein constitute the entire obligation of Settling Defendants with respect to payment of attorneys' fees in connection with the Action and the exclusive means by which Mississippi Counsel may seek payment of fees by Settling Defendants in connection with the Action. The parties hereto acknowledge that the provisions for payment set forth herein are the entirety of Settling Defendants' obligations with respect to payment of attorneys' fees pursuant to paragraph 16 of the Settlement Agreement and the October 10th Letter. The State of Mississippi agrees that Settling Defendants shall have no other obligation to pay fees or otherwise compensate Mississippi Counsel, any other counsel or representative of the State of Mississippi or the State of Mississippi itself with respect to attorneys' fees in connection with the Action. Each Mississippi Counsel hereby irrevocably releases Settling Defendants and their respective present and former parents, subsidiaries, divisions, affiliates, officers, directors, employees, representatives, insurers, agents and attorneys (as well as the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing) from any and all claims that such counsel ever had, now has or hereafter can, shall or may have in any way related to the Action (including but not limited to any negotiations related to the settlement of the Action). The foregoing shall not be construed as a release of any person or entity as to any of the obligations undertaken in this Agreement in connection with a breach thereof. 4 SECTION 4. Composition of the Panel. (a) The first and the second members of the Panel shall both be permanent members of the Panel and, as such, will participate in the determination of all Fee Awards. The third Panel member shall not be a permanent Panel member, but instead shall be a state-specific member selected to determine Fee Awards on behalf of Private Counsel retained in connection with litigation within a single state. Accordingly, the third, state-specific member of the Panel for purposes of determining Fee Awards with respect to litigation in the State of Mississippi shall not participate in any determination as to any Fee Award with respect to litigation in any other state (unless selected to participate in such determinations by such persons as may be authorized to make such selections under other agreements). (b) The members of the Panel shall be selected as follows: (i) The first member shall be a natural person selected by Participating Defendants, who shall advise Mississippi Counsel of the name of the person selected by October 8, 1998. (ii) The second member shall be a natural person selected by agreement of Participating Defendants and a majority of the members of a committee composed of the following members: Joseph F. Rice, Richard F. Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the Castano Plaintiffs' Legal Committee and, at the option of Participating Defendants, one additional representative to serve on behalf of counsel for any one or more states that, subsequent to the date hereof, enter into settlement agreements with Participating Defendants that provide for payment of such states' Private Counsel pursuant to an arbitrated award of fees; such second member shall be selected by October 1, 1998. (iii) The third, state-specific member for purposes of determining Fee Awards with respect to litigation in the State of Mississippi shall be a natural person selected by Mississippi Counsel, who shall notify Settling Defendants of the name of the person selected by October 15, 1998. SECTION 5. Commencement of Panel Proceedings. No application for a Fee Award shall be presented to the Panel or any Panel member until November 3, 1998. The Panel shall consider and render 5 decisions on applications for Fee Awards in the order in which they are submitted or pursuant to notice by counsel having priority that they have ceded their place to others. In the event that more than one application for a Fee Award is submitted on the same date, the Panel shall consider and render decisions on such applications in the order in which their respective cases were settled. Counsel may seek permission from the Panel to make combined presentations of aspects of their respective applications. Settling Defendants shall not oppose any request to combine presentations of applications for Fee Awards in connection with the Action, the lawsuit State of Florida v. American Tobacco Co., No. 95-1466AH (15th Jud. Circuit, Palm Beach County), or the lawsuit State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996). SECTION 6. Costs of Arbitration. All costs and expenses of the arbitration proceedings held by the Panel, including compensation of Panel members (but not including any costs, expenses or compensation of counsel making applications to the Panel), shall be borne by Settling Defendants in proportion to their respective Market Shares. SECTION 7. Panel Procedures Regarding Application of Mississippi Counsel. Mississippi Counsel shall make a collective written application to the Panel for a Fee Award on behalf of all Mississippi Counsel not later than November 3, 1998. All interested persons, including persons not parties hereto, may submit to the Panel any information that they wish; but interested persons not parties hereto may submit only written materials. The Panel shall consider all such submissions by any party hereto and may consider any such materials submitted by other interested persons. All written submissions relating to applications for a Fee Award in connection with the Action shall be served on all parties hereto by November 13, 1998. Presentations to the Panel shall, to the extent possible, be based on affidavit rather than live testimony. The Panel shall preserve the confidentiality of any attorney work-product materials or other similar confidential information that may be submitted. Settling Defendants will not take any position adverse to the amount of the Fee Award requested by Mississippi Counsel, nor will they or their representatives express any opinion (even upon request) as to the appropriateness or inappropriateness of the amount of any proposed Mississippi Fee Award. The undersigned outside counsel for Settling Defendants Philip Morris Incorporated and R.J. Reynolds Tobacco Company will appear, if requested, to provide information as to the nature and efficacy of the 6 work of Mississippi Counsel and to advise the Panel that they support a Mississippi Fee Award of full reasonable compensation under the circumstances. SECTION 8. Award of Fees to Mississippi Counsel. The members of the Panel will consider all relevant information submitted to them in reaching a decision as to a Fee Award that fairly provides for full reasonable compensation of Mississippi Counsel for their representation of the State of Mississippi in connection with the Action. The Panel shall determine the amount of fees for all Mississippi Counsel collectively no later than December 10, 1998. Given the significance and uniqueness of the Action, the Panel shall not be limited to an hourly-rate or lodestar analysis in determining the amount of the Mississippi Fee Award, but shall take into account the totality of the circumstances. In considering the amount of the Mississippi Fee Award, the Panel shall not consider Fee Awards that already have been or yet may be awarded to others. The Panel's decisions as to Fee Awards shall be in writing and shall report the amount of the fee awarded (with or without explanation or opinion, at the Panel's discretion). SECTION 9. Allocation of Payments among Mississippi Counsel. All payments (including advances) made by Settling Defendants in satisfaction of the Mississippi Fee Award pursuant to this Agreement shall be paid in the first instance to an account designated in writing by Joseph F. Rice, Esq. Each Mississippi Counsel shall be entitled to receive a percentage of each such payment equal to the percentage such counsel would receive of any fee recovery in the Action, under the terms of the fee-sharing agreement among Mississippi Counsel (such percentage being such counsel's "Fee Percentage" of the payment in question). SECTION 10. Advances on Payment of Fees. Settling Defendants shall severally make two payments as an advance against later payments of the Mississippi Fee Award pursuant to this Agreement, to be credited as provided in section 15 hereof, as follows: (a) On or before July 6, 1998, each Settling Defendant shall pay to Mississippi Counsel, pro rata in proportion to its Market Share indicated on Schedule A hereto, its respective share of $50 million. 7 (b) On or before July 31, 1998, each Settling Defendant shall pay to Mississippi Counsel, pro rata in proportion to its Market Share indicated on Schedule A hereto, its respective share of $50 million. SECTION 11. Annual Amount for 1997; Allocation. (a) For 1997, Settling Defendants shall pay, in the manner described in section 13 hereof, the unsatisfied amount of the Fee Award (the "Unpaid Fees") of Mississippi Counsel, and those Participating Defendants so obligated shall make payments with respect to the Unpaid Fees of Private Counsel retained in connection with the lawsuits State of Florida v. American Tobacco Co., No. 95-1466 AH (15th Jud. Circuit, Palm Beach County), and Mangini v. R.J. Reynolds Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County), in an amount not to exceed $250 million for all payments described in this subsection. (b) In the event that the sum of the Unpaid Fees of those Private Counsel identified in subsection (a) of this section exceeds $250 million, such amount shall be allocated among the payments to be made with respect to such Private Counsel in proportion to the amount of their respective Unpaid Fees (the amount so allocated with respect to the Unpaid Fees of each such Private Counsel being such counsel's "Allocable Share" for 1997). SECTION 12. Annual Amount for 1998; Allocation. (a) For 1998, Settling Defendants shall pay, in the manner described in section 13 hereof, the Unpaid Fees of Mississippi Counsel, and those Participating Defendants so obligated shall make payments with respect to the Unpaid Fees of all other Private Counsel, in an amount not to exceed $500 million for all such payments described in this subsection. (b) The amount payable to Mississippi Counsel by Settling Defendants for 1998 shall be determined as follows: The $500 million annual cap for 1998 shall be allocated equally among each month of the year. Except as provided in section 13(b) hereof, each monthly amount shall be allocated to those Private Counsel retained in connection with Tobacco Cases settled by Participating Defendants or resolved by Federal Legislation before or during such month, up to the amounts of their respective Unpaid Fees (such counsel being "Eligible Counsel" with respect to such monthly amount). In the event that the monthly amount is less than the sum of Eligible Counsel's Unpaid Fees, the monthly amount shall be allocated to Eligible Counsel in proportion to the amounts of their 8 respective Unpaid Fees (the amount so allocated to each Eligible Counsel for a given month being such counsel's Allocable Share for such month, and the sum of each Private Counsel's Allocable Shares for each month being such counsel's Allocable Share for 1998). (c) Settling Defendants represent that, as of the date of this Agreement, the only Tobacco Cases (other than the Action) that have been settled by Participating Defendants on terms that allow for Private Counsel retained in connection with such cases to seek a Fee Award from the Panel are State of Florida v. American Tobacco Co., No. 95-1466AH (15th Jud. Circuit, Palm Beach County), State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex.), and Mangini v. R.J. Reynolds Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County). SECTION 13. Payments with Respect to Annual Amounts for 1997 and 1998. (a) On the earlier of December 15, 1998 or 15 days after the date of the Panel's decision with respect to the Mississippi Fee Award (the "Initial Mississippi Fee Payment Date"), each Settling Defendant shall severally pay, pro rata in proportion to its Market Share, its share of an initial fee payment with respect to the Mississippi Fee Award (the "Initial Mississippi Fee Payment"), which shall include: (i) Mississippi Counsel's Allocable Share for 1997 as provided in section 11 hereof or, in the event that the Panel has not rendered Fee Awards with respect to all Private Counsel described in section 11(a) hereof as of five business days prior to the Initial Mississippi Fee Payment Date, Settling Defendants' reasonable estimation of Mississippi Counsel's Allocable Share for 1997; and (ii) Mississippi Counsel's Allocable Share for 1998 as provided in section 12 hereof for each month of 1998 except those with respect to which Mississippi Counsel's Allocable Share could not be determined as of five days prior to the Initial Mississippi Fee Payment Date, as a result of there being other Eligible Counsel that, as of such date, had not yet been granted or denied a Fee Award by the Panel (either because such counsel's application for a Fee Award was still under consideration by the Panel or for any other reason). 9 (b) On January 15, 1999, each Settling Defendant shall severally pay, pro rata in proportion to its Market Share, its share of Mississippi Counsel's Allocable Share for those months of 1998 not included in the Initial Mississippi Fee Payment. Mississippi Counsel's Allocable Share for any such month shall be based on an allocation of the monthly amount among Eligible Counsel having Fee Awards as of December 31, 1998, without regard to whether there may be other Eligible Counsel that have not been granted or denied a Fee Award by the Panel as of such date. (c) In the event that Settling Defendants pay an estimation of Mississippi Counsel's Allocable Share for 1997, as provided in subsection (a)(i) of this section, subsequent payments pursuant to this Agreement shall be adjusted to ensure that Mississippi Counsel receive their actual Allocable Share for 1997. (d) Notwithstanding any provision of this Agreement, Mississippi Counsel agree to defer payment of $62 million of the payment due from Settling Defendant R.J. Reynolds Tobacco Company ("Reynolds") on the Initial Mississippi Fee Payment Date. In the event that (i) Reynolds' share of the Initial Mississippi Fee Payment is less than $62 million or (ii) the Mississippi Fee Award has not been determined as of the date of any other payment by Reynolds in 1998 with respect to Fee Awards, individual Mississippi Counsel Scruggs, Millette, Bozeman & Dent, P.A. ("Scruggs, Millette") and Ness, Motley, Loadholt, Richardson & Poole ("Ness, Motley") shall also defer the amounts of their respective Fee Percentages of such other 1998 payments, until the sum of all deferred amounts equals $62 million. Under no circumstances shall this subsection require any increase in any payment to be made by any other Settling Defendant. On January 5, 1999, Reynolds shall pay to the appropriate persons the amounts of its 1998 payments deferred pursuant to this section. SECTION 14. Quarterly Amounts for 1999 and Subsequent Years; Allocation. Within 10 business days after the end of each calendar quarter beginning with the first calendar quarter of 1999, Settling Defendants shall pay, in the manner provided in subsection (d) of this section, the Unpaid Fees of Mississippi Counsel, and those Participating Defendants so obligated shall make payments with respect to the Unpaid Fees of all other Private Counsel, in an amount not to exceed $125 million for all such payments, as follows: 10 (a) In the event that Federal Legislation has been enacted by the end of the calendar quarter with respect to which such quarterly payment is being made (the "Applicable Quarter"): (i) the quarterly amount shall be allocated among Private Counsel, up to the amount of their respective Unpaid Fees. Each Private Counsel shall be allocated an amount of each quarterly payment for the calendar year up to (or, in the event that the sum of such Private Counsel's Unpaid Fees exceeds the quarterly amount, in proportion to) the amount of such Private Counsel's Unpaid Fees. Each quarterly payment shall be allocated among Private Counsel having Unpaid Fees, without regard to whether there are other Private Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter. Subsequent quarterly payments shall be adjusted, if necessary, to account for Private Counsel that are granted Fee Awards in a subsequent quarter of the calendar year, as provided in paragraph (ii)(B) of this subsection. (ii) In the event that a quarterly payment for the calendar year is less than the sum of all Private Counsel's Unpaid Fees: (A) in the case of the first such quarterly payment, the quarterly amount shall be allocated among Private Counsel in proportion to the amounts of their respective Unpaid Fees. (B) in the case of a quarterly payment after the first quarterly payment that is less than the sum of all such Unpaid Fees, the quarterly amount shall be allocated only to those Private Counsel, if any, that were not paid a proportionate share of all prior quarterly payments for the calendar year (either because such Private Counsel's applications for Fee Awards were still under consideration as of the end of the calendar quarters with respect to which such quarterly payments were made or for any other reason), until each such Private Counsel has been allocated a proportionate share of all prior quarterly payments. In the event that the sum of all such shares exceeds the amount of the quarterly payment, such payment shall be allocated among such Private Counsel in proportion to the amounts of their respective Unpaid Fees (without regard to whether there are other Private Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter). 11 (b) In the event that Federal Legislation has not been enacted by the end of the Applicable Quarter: (i) the quarterly amount shall be allocated equally among each of the three months of the calendar quarter. The amount for each such month shall be allocated among those Private Counsel retained in connection with Tobacco Cases settled before or during such month (such Private Counsel being "Eligible Counsel" with respect to such monthly amount), each of whom shall be allocated a portion of each such monthly amount up to (or, in the event that the sum of Eligible Counsel's respective Unpaid Fees exceeds such monthly amount, in proportion to) the amount of such Eligible Counsel's Unpaid Fees. The monthly amount for each month of the calendar quarter shall be allocated among Eligible Counsel having Unpaid Fees, without regard to whether there may be Eligible Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter. Subsequent quarterly payments shall be adjusted, as necessary, to account for Eligible Counsel that are granted Fee Awards in a subsequent quarter of the calendar year, as provided in paragraph (ii)(B) of this subsection. (ii) In the event that the amount for a given month is less than the sum of all Eligible Counsel's Unpaid Fees: (A) in the case of a first quarterly payment, such monthly amount shall be allocated among Eligible Counsel for such month in proportion to the amount of their respective Unpaid Fees. (B) in the case of a quarterly payment after the first quarterly payment, the quarterly amount shall be allocated among only those Private Counsel, if any, that were Eligible Counsel with respect to any monthly amount paid in a prior quarter of the calendar year but were not allocated a proportionate share of such monthly amount (either because such counsel's applications for Fee Awards were still under consideration as of the end of the calendar quarter containing the month in question or for any other reason), until each such Eligible Counsel has been allocated a proportionate share of all such prior monthly payments for the calendar year. In the event that the sum of all such shares exceeds the amount of the quarterly payment, the quarterly payment shall 12 be allocated among Eligible Counsel in proportion to the amounts of their respective Unpaid Fees (without regard to whether there may be other Eligible Counsel with respect to such prior monthly amounts that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter). (c) Adjustments pursuant to paragraphs (a)(ii)(B) and (b)(ii)(B) of this section shall be made separately for each calendar year. No amounts paid in any calendar year shall be subject to refund, nor shall any payment in any given calendar year affect the allocation of payments to be made in any subsequent calendar year. (d) Each Settling Defendant shall severally pay, pro rata in proportion to its respective Market Share, its share of the amounts, if any, allocated to Mississippi Counsel pursuant to this section. SECTION 15. Credits and Limitations. Notwithstanding any other provision of this Agreement, all payments by Settling Defendants with respect to Fee Awards shall be subject to the following: (a) Notwithstanding any other provision of this Agreement, the advances against future payments to Mississippi Counsel made pursuant to section 10 hereof shall be credited against and shall reduce the payments due to Mississippi Counsel hereunder, beginning with the first quarterly payment for 1999 pursuant to section 14 hereof, in an amount equal to 50% of the payment in question, until the advances paid by Settling Defendants are fully credited; provided, however, that the sum of all such credits applied in any calendar year with respect to the advances made to Mississippi Counsel pursuant to section 10 hereof shall not exceed $50 million. The amount of any credit made against any such payment to Mississippi Counsel shall be counted in computing the annual and quarterly aggregate national caps on all payments made with respect to Private Counsel, in the amount of the credit applied to any such payment to Mississippi Counsel in any quarterly or annual period. (b) Under no circumstances shall Settling Defendants be required to make payments that would result in aggregate national payments by Participating Defendants with respect to Fee Awards: (i) for 1997, totaling more than $250 million; 13 (ii) during 1998, totaling more than $500 million, except insofar as payments under the separate $250 million cap for 1997 are made in 1998 pursuant to section 13 hereof, and except insofar as advances are made in 1998 against payments due in years after 1998; (iii) during any year beginning with 1999, totaling more than $500 million, excluding payments with respect to any Private Counsel's Allocable Shares for 1998 that are paid in 1999; and (iv) during any calendar quarter beginning with the first calendar quarter of 1999, totaling more than $125 million, excluding payments with respect to any Private Counsel's Allocable Shares for 1998 that are paid in 1999 and except to the extent that payments with respect to any prior quarter of the calendar year did not total $125 million. SECTION 16. Contribution to National Legislation. If Federal Legislation is enacted that implements the Proposed Resolution, a three-member national panel including the two permanent members of the Panel shall consider any application for Fee Awards on behalf of Private Counsel for contributions made toward the enactment of such Federal Legislation, along with all applications for Fee Awards for professional fees by any other persons who claim to have made similar contributions (other than attorneys or agents of Participating Defendants). No person shall make more than one application for a Fee Award in connection with any such contributions toward enactment of such Federal Legislation. All payments with respect to such Fee Awards, if any, shall be paid on the payment schedule and subject to, and counted in computing, the annual and quarterly national caps described in sections 12, 13, 14 and 15 hereof. SECTION 17. Payments on Market Share Basis. All payments to Mississippi Counsel pursuant to this Agreement shall be paid by Settling Defendants pro rata in proportion to their respective Market Shares. Each Settling Defendant shall be severally liable for its share of all such payments. Under no circumstances shall any such payment or portion thereof become the joint obligation of Settling Defendants or the obligation of any party other than the Settling Defendant from which such payment is originally due, nor shall any Settling Defendant be required to pay a portion of any such payment greater than its respective Market Share. With respect to payment of the advances 14 described in section 10 hereof and the payment for 1997 described in section 11 hereof, the Market Share of each Settling Defendant shall be as provided in Schedule A hereto. With respect to the payment for 1998 described in section 12 hereof, the Market Share of each Settling Defendant shall be its respective share of sales of cigarettes, by number of individual cigarettes shipped for consumption in the United States, for 1998. With respect to all other payments pursuant to this Agreement, each Settling Defendant's Market Share shall be its respective share of sales of cigarettes, by number of individual cigarettes shipped for consumption in the United States, for the 12 month period preceding the end of the calendar quarter with respect to which such payment is made. SECTION 18. Determination of Market Share. In the event of a disagreement between or among any Settling Defendants as to their respective shares of any payment pursuant to this Agreement (except payments for which each Settling Defendant's Market Share is expressly provided herein), each Settling Defendant shall pay its undisputed share of such payment promptly, on or before the date on which such payment is due, and shall within 21 days submit copies of its federal excise tax reports for the period in question to a third party to be selected by agreement of Settling Defendants (the "Third Party"), who shall within three days determine the Market Share of each Settling Defendant. The decision of the Third Party shall be final and non-appealable, and shall be communicated by facsimile to each party hereto. Each Settling Defendant shall, within two business days of receipt of the Third Party's decision, pay Mississippi Counsel or such other Settling Defendant, as appropriate, the difference, if any, between (1) the amount that such Settling Defendant has already paid with respect to the payment in question and (2) the amount of the payment in question that corresponds to such Settling Defendant's Market Share as determined by the Third Party, together with interest accrued from the original date on which the payment in question was due, at the prime rate, as published in the Wall Street Journal on the latest publication date on or before the original date on which the payment in question was due, plus 3%. SECTION 19. Limited Waiver as to Other Terms. In consideration of Settling Defendants' agreement to the terms hereof, each Mississippi Counsel hereby covenants and agrees that it will not argue in any forum (other than in proceedings before the Panel relating to Mississippi Counsel's application) that the arrangements made in connection with the Texas Settlement or the Minnesota Settlement for payment of fees to private counsel for 15 the States of Texas or Minnesota give rise to any claim or entitlement on the part of Mississippi Counsel (or any other person) in connection with this Action. SECTION 20. State's Identification of Mississippi Counsel. The Attorney General represents and warrants that Schedule B hereto contains the names of all Mississippi Counsel. SECTION 21. Intended Beneficiaries. No part of this Agreement creates any rights on the part of, or is enforceable by, any person or entity that is not a party hereto or a person covered by the release described in section 3 hereof. Nor shall any part of this Agreement bind any non-party or determine, limit or prejudice the rights of any such person or entity. SECTION 22. Definitions. Terms used herein that are defined in the Settlement Agreement or the Stipulation of Amendment are, unless otherwise defined herein, used in this Agreement as defined in the Settlement Agreement or the Stipulation of Amendment, as applicable. SECTION 23. Representations of Parties. The parties hereto hereby represent that this Agreement has been duly authorized and, upon execution, will constitute a valid and binding contractual obligation, enforceable in accordance with its terms, of each of the parties hereto. SECTION 24. No Admission. This Agreement is not intended to be and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of any liability or wrongdoing whatsoever on the part of any party hereto or any person covered by the release provided under section 3 hereof. Settling Defendants specifically disclaim and deny any liability or wrongdoing whatsoever with respect to the claims released under section 3 hereof and enter into this Agreement for the sole purposes of memorializing Settling Defendants' rights and obligations with respect to payment of attorneys' fees pursuant to the Settlement Agreement 16 and avoiding the further expense, inconvenience, burden and uncertainty of potential litigation. SECTION 25. Non-admissibility. This Agreement having been undertaken by the parties hereto in good faith and for settlement purposes only, neither this Agreement nor any evidence of negotiations relating hereto shall be offered or received in evidence in any action or proceeding other than an action or proceeding arising under this Agreement. SECTION 26. Amendment and Waiver. This Agreement may be amended only by a written instrument executed by the Attorney General, Mississippi Counsel and Settling Defendants. The waiver of any rights conferred hereunder shall be effective only if made by written instrument executed by the waiving party. The waiver by any party of any breach of this Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this Agreement. SECTION 27. Notices. All notices or other communications to any party hereto shall be in writing (including but not limited to telex, telecopy or similar writing) and shall be given to the respective parties listed on Schedule C hereto at the addresses therein indicated. Any party hereto may change the name and address of the person designated to receive notice on behalf of such party by notice given as provided in this section including an updated list conformed to Schedule C hereto. SECTION 28. Governing Law. This Settlement Agreement shall be governed by the laws of the State of Mississippi, without regard to the conflict of law rules of such State. SECTION 29. Construction. None of the parties hereto shall be considered to be the drafter of this Agreement or any provision hereof for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter hereof. 17 SECTION 30. Captions. The captions of the sections of this Agreement are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. SECTION 31. Counterparts. This Agreement may be executed in counterparts. Facsimile or photocopied signatures shall be considered as valid signatures as of the date hereof, although the original signature pages shall thereafter be appended to this Settlement Agreement. SECTION 32. Entire Agreement of Parties. This Agreement contains an entire, complete and integrated statement of each and every term and provision agreed to by and among the parties hereto with respect to payment of attorneys' fees by Settling Defendants in connection with the Action and is not subject to any condition not provided for herein. IN WITNESS WHEREOF, the parties hereto, through their fully authorized representatives, have agreed to this Mississippi Fee Payment Agreement as of this 2nd day of July, 1998. STATE OF MISSISSIPPI acting by and through Michael C. Moore, its duly elected and authorized Attorney General By: /s/ Michael C. Moore --------------------------------- Michael C. Moore Attorney General 18 PHILIP MORRIS INCORPORATED By: /s/ Meyer G. Koplow ------------------------------------ Meyer G. Koplow Counsel By: /s/ Martin J. Barrington by MGK ------------------------------------ Martin J. Barrington General Counsel R.J. REYNOLDS TOBACCO COMPANY By: /s/ Arthur F. Golden ------------------------------------ Arthur F. Golden Counsel By: /s/ Charles A. Blixt by A.F.G. ------------------------------------ Charles A. Blixt General Counsel 19 BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton ------------------------------------ Stephen R. Patton Counsel By: /s/ F. Anthony Burke ------------------------------------ F. Anthony Burke Vice President & General Counsel LORILLARD TOBACCO COMPANY By: /s/ Arthur J. Stevens by MGK ------------------------------------ Arthur J. Stevens Senior Vice President & General Counsel MISSISSIPPI COUNSEL By: /s/ Joseph F. Rice ------------------------------------ Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 20 By: /s/ Richard F. Scruggs by W.S. Bozeman -------------------------------------- Richard F. Scruggs Scruggs, Millette, Bozeman & Dent, P.A By: /s/ Don Barrett -------------------------------------- Don Barrett Barrett Law Offices By: /s/ Paul T. Benton -------------------------------------- Paul T. Benton By: /s/ Frederick B. Clark -------------------------------------- Frederick B. Clark By: /s/ Michael T. Lewis -------------------------------------- Michael T. Lewis Lewis & Lewis 21 By: /s/ David O. McCormick ------------------------------------ David O. McCormick By: /s/ Charles Victor McTeer ------------------------------------ Charles Victor McTeer McTeer & Associates By: /s/ Robert H. Oswald ------------------------------------ Robert H. Oswald Oswald & Reed By: /s/ Crymes G. Pittman ------------------------------------ Crymes G. Pittman Pittman, Germany, Roberts & Welsh By: /s/ Thomas H. Rhoden ------------------------------------ Thomas H. Rhoden Rhoden, Lacy, Downey & Colbert 22 By: /s/ Paul S. Minor ------------------------------------ Paul S. Minor 23 SCHEDULE A MARKET SHARE PERCENTAGES Settling Defendant Percentage - ------------------ ---------- Philip Morris Incorporated ............................................ 49.9 R.J. Reynolds Tobacco Company.......................................... 24.8 Brown & Williamson Tobacco Corp........................................ 16.4 Lorillard Tobacco Company.............................................. 8.9 ---------- TOTAL 100 SCHEDULE B DESIGNATION of MISSISSIPPI COUNSEL by the Attorney General Ness, Motley, Loadholt, Richardson & Poole (Ronald L. Motley, Joseph F. Rice, Charles W. Patrick, Jr., Edward J. Westbrook, Ann K. Ritter, J. Anderson Berly, III, John J. McConnell, Jr., Susan Nial, Robert J. McConnell, Richard L. Akel, Nancy Worth Davis, Alexandra M. Wagner, Kimberly S. Vroon, Jodi W. Flowers, Frederick C. Baker, R. Brian Johnson, Cindi Anne Solomon, Jerry Hudson Evans, Gregory S. Lofstead, William Michael Gruenloh) Scruggs, Millette, Bozeman & Dent, P.A. (Richard F. Scruggs, W. Steve Bozeman, Charles J. Mikhail, Lee E. Young, Jennifer A. Coley, Ashley Hutchings Hendren) Barrett Law Offices (Don Barrett) Paul T. Benton Frederick B. Clark Lewis & Lewis (Michael T. Lewis, Pauline Shular Lewis) David O. McCormick McTeer & Associates (Charles Victor McTeer) Oswald & Reed (Robert H. Oswald, William T. Reed) Pittman, Germany, Roberts & Welsh (Crymes G. Pittman, Robert G. Germany, Joseph E. Roberts, Jr., C. Victor Welsh) Rhoden, Lacy, Downey & Colbert (Thomas H. Rhoden) Paul S. Minor 2 SCHEDULE C NOTICES State of Mississippi Hon. Michael C. Moore Attorney General's Office 450 High Street Post Office Box 220 Jackson, MS 39205 Fax: (601) 359-3441 With copies to: Richard F. Scruggs Scruggs, Millette, Bozeman & Dent, P.A. 743 Delmas Avenue Pascagoula, MS 39568-1425 Fax: (228) 762-1207 and: Joseph F. Rice, Esq. Ness, Motley, Loadholt, Richardson & Poole 151 Meeting Street, Suite 600 Charleston, SC 29402 Fax: (843) 720-9290 and: David O. McCormick 707 Watts Avenue P.O. Box 865 Pascagoula, MS 39568-0865 Fax: (228) 762-4864 (continued) Settling Defendants Philip Morris Incorporated: R.J. Reynolds Tobacco Company: Martin J. Barrington, Esq. Charles A. Blixt, Esq. Philip Morris Incorporated R.J. Reynolds Tobacco Company 120 Park Avenue 401 North Main Street New York, NY 10017-5592 Winston-Salem, NC 27102 Fax: (212) 907-5399 Fax: (336) 741-2998 With a copy to: With a copy to: Meyer G. Koplow, Esq. Arthur F. Golden, Esq. Wachtell, Lipton, Rosen & Katz Davis Polk & Wardwell 51 West 52nd Street 450 Lexington Avenue New York, NY 10019 New York, NY 10017 Fax: (212) 403-2000 Fax: (212) 450-4800 Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company: F. Anthony Burke, Esq. Arthur J. Stevens, Esq. Brown & Williamson Tobacco Corp. Lorillard Tobacco Company 200 Brown & Williamson Tower 714 Green Valley Road 401 South Fourth Avenue Greensboro, NC 27408 Louisville, KY 40202 Fax: (336) 335-7707 Fax: (502) 568-7297 With a copy to: Stephen R. Patton, Esq. Kirkland & Ellis 200 East Randolph Dr. Chicago, IL 60601 Fax: (312) 861-2200 (continued) 2 Mississippi Counsel Joseph F. Rice, Esq. Richard F. Scruggs Ness, Motley, Loadholt, Scruggs, Millette, Bozeman & Dent, P.A. Richardson & Poole 743 Delmas Avenue 151 Meeting Street, Suite 600 Pascagoula, MS 39568-1425 Charleston, SC 29402 Fax: (228) 762-1207 Fax: (843) 720-9290 Don Barrett, Esq. Paul T. Benton, Esq. Barrett Law Offices Attorney At Law P.O. Box 987 P.O. Box 1341 Lexington, Mississippi 39095 Biloxi, MS 39533-1341 Fax 1: (850) 654-4072 Fax: (228) 432-0336 Fax 2: (601) 948-6187 Frederick B. Clark, Esq. Michael T. Lewis Attorney At Law Lewis & Lewis P.O. Box 1806 P.O. Box 1600 Greenwood, MS 38930 Clarksdale, MS 38614 Fax: (601) 455-1282 Fax: (601) 627-2267 David O. McCormick, Esq. Charles Victor McTeer, Esq. 707 Watts Avenue McTeer & Associates P.O. Box 865 P.O. Box 1835 Pascagoula, MS 39568-0865 Greenville, MS 38702 Fax: (228) 762-4864 Fax: (601) 334-6847 Robert H. Oswald, Esq. Crymes Pittman, Esq. Oswald & Reed Pittman, Germany, Roberts & Welsh 3106 Canty Street 401 S. President Street Pascagoula, MS 39567 Jackson, MS 39201 Fax: (228) 769-9019 Fax: (601) 948-6187 (continued) 3 Thomas H. Rhoden, Esq. Paul S. Minor, Esq. Rhoden, Lacy, Downey & Colbert Minor & Associates 111 Park Circle Drive 400 Main Street Flowood, MS 39208 Biloxi, MS 39530 Fax: (601) 936-2515 Fax: (228) 374-6630 4 EX-10.3 4 MFN ESCROW AGREEMENT Exhibit 10.3 MFN ESCROW AGREEMENT This escrow agreement (the "MFN Escrow Agreement") is entered into as of July 2, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company (collectively and severally, "Settling Defendants" and each individually a "Settling Defendant"), the State of Mississippi and SouthTrust Bank, N.A., as escrow agent (the "MFN Escrow Agent"). WITNESSETH: WHEREAS, the State of Mississippi and Settling Defendants entered into a comprehensive settlement agreement and release as of October 17, 1997 (the "Settlement Agreement"), setting forth the terms and conditions of an agreement to settle and resolve with finality all present and future claims relating to the subject matter of the litigation entitled In re Mike Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., Cause No. 94-1429 (Miss. Ch. Ct., Jackson County) (the "Action"), in the Chancery Court of Jackson County, Mississippi (the "Court"); WHEREAS, the State of Mississippi and Settling Defendants entered into a Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order (the "Stipulation of Amendment") on July 2, 1998, paragraph 17 of which provides for Court approval of the Stipulation of Amendment; WHEREAS, paragraph 5 of the Stipulation of Amendment provides that, on the dates specified therein, each Settling Defendant shall severally pay to the State of Mississippi, pro rata in proportion to its Market Share, its respective share of the amounts indicated for each date; WHEREAS, paragraph 17 of the Stipulation of Amendment further provides that all payments described in the Stipulation of Amendment shall be paid into a special escrow account (and if so paid shall remain in said escrow account) until such time as (1) the time for appeal or to seek review of the Court's order approving this Stipulation of Amendment has expired without the filing of any notice of appeal or petition for review; or (2) in the event of any such appeal or petition, the appeal or the petition has been dismissed or the Court's order has been affirmed in all material respects by the court of last resort to which such appeal or petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review (the "Availability Date"); and WHEREAS, the parties hereto believe that at least one of the payments described in the preceding paragraphs may be made prior to the Availability Date: NOW, THEREFORE, the parties hereto agree as follows: SECTION 1. Appointment of MFN Escrow Agent. Settling Defendants and the State of Mississippi hereby appoint the MFN Escrow Agent to act as escrow agent on the terms and conditions set forth herein, and the MFN Escrow Agent hereby accepts such appointment on such terms and conditions. SECTION 2. Deposit. In the event that any payment pursuant to paragraph 5 of the Stipulation of Amendment becomes due on a date prior to the Availability Date, each Settling Defendant shall severally deliver to the MFN Escrow Agent in immediately available funds such Settling Defendant's respective share of the payment in question (the sum of such shares being the "Initial Deposit"). Upon receipt, the MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow account established for such purpose and governed by the terms of this MFN Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to the Stipulation of Amendment that becomes due prior to the Availability Date shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the Initial Deposit and any subsequent payments deposited into the MFN Escrow Account, including any payments of interest or other income on investment of the MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and shall be governed by the terms of this MFN Escrow Agreement. All such deliveries of funds are subject to the right of Settling Defendants to obtain, pursuant to section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN Escrow Amount (less appropriate deductions for administrative fees and expenses, including taxes and other related costs) in the event that the Stipulation of Amendment is cancelled and terminated pursuant to paragraph 17 of the Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested and disbursed by the MFN Escrow Agent strictly in accordance with this MFN Escrow Agreement. SECTION 3. Investment of MFN Escrow Amount. The MFN Escrow Agent shall invest and reinvest the MFN Escrow Amount in either (i) direct obligations of, or obligations the principal and interest on which are unconditionally guaranteed by, the United States of America (including government-sponsored agencies) or the State of Mississippi; (ii) 2 repurchase agreements fully collateralized by securities of the kind specified in clause (i) above; (iii) money market accounts maturing within 30 days of the acquisition thereof and issued by a bank or trust company organized under the laws of the United States of America or a State thereof (a "United States Bank") and having a combined capital surplus in excess of $250,000,000; or (iv) demand deposits with any United States Bank or any federal savings and loan institution having a combined capital surplus in excess of $250,000,000. Any loss on any such investment, including, without limitation, any penalty for any liquidation required to fund a disbursement, shall be borne pro rata by the parties in proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN Escrow Agent's fees and all expenses, including taxes and other related costs, shall, to the extent possible, be paid out of income earned. Whenever the MFN Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as provided herein, the MFN Escrow Agent shall also pay to such party all interest and profits earned to the date of payment on such amount, less deductions for fees and all expenses, including taxes and other related fees. SECTION 4. Release of the MFN Escrow Amount. After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as set forth below: (a) Following receipt of written notice signed by counsel for the Settling Defendants certifying that such notice has been delivered by counsel for the Settling Defendants to all parties hereto and stating that the Stipulation of Amendment has not received court approval or has been canceled, terminated or has otherwise become null and void for any reason, the MFN Escrow Agent shall upon the expiration of ten (10) business days following the MFN Escrow Agent's receipt of notice, and without an order of the Court, disburse the entire MFN Escrow Amount (including any interest thereon, as provided in Section 3) to the Settling Defendants on the same pro rata basis as such funds were contributed to the MFN Escrow Account. (b) Upon receipt of written notice signed by counsel for the Settling Defendants and counsel for the State of Mississippi stating that the Availability Date has occurred, the MFN Escrow Agent shall proceed to distribute the MFN Escrow Amount. (c) For its services, the MFN Escrow Agent shall receive fees in accordance with the MFN Escrow Agent's customary fees in similar matters. All such fees shall constitute a direct charge against the MFN Escrow Amount, but the MFN Escrow Agent shall not debit the MFN 3 Escrow Amount for any such charge until it shall have presented its statement to and received approval by counsel for the Settling Defendants and counsel for the State of Mississippi, which approval shall not be unreasonably withheld. Such approval shall be deemed given if the MFN Escrow Agent has not received written objections from either counsel for Settling Defendants or counsel for the State of Mississippi within 14 days after presentment of its statement. Such fees and all expenses charged against the MFN Escrow Amount shall, to the extent possible, be paid out of interest earned. In the event that counsel for the Settling Defendants or counsel for the State of Mississippi objects in writing to such fees, the MFN Escrow Agent shall not debit the MFN Escrow Amount except upon a court order approving such fees. SECTION 5. Substitute Form W-9; Qualified Settlement Fund. Each of the signatories to this MFN Escrow Agreement shall provide the MFN Escrow Agent with a correct taxpayer identification number on a substitute Form W-9 within 90 days of the date hereof and indicate thereon that it is not subject to backup withholding. It is anticipated that the MFN Escrow Account established pursuant to this MFN Escrow Agreement shall be treated as a Qualified Settlement Fund for federal tax purposes pursuant to Treas. Reg. ss. 1.468B-1. SECTION 6. Termination of MFN Escrow Account. This MFN Escrow Agreement (other than the MFN Escrow Agent's right to indemnification set forth in Section 7) shall terminate when the MFN Escrow Agent shall have released from the MFN Escrow Account all amounts pursuant to Section 4 hereof. SECTION 7. MFN Escrow Agent. (a) The MFN Escrow Agent shall have no duty or obligation hereunder other than to take such specific actions as are required of it from time to time under the provisions hereof, and it shall incur no liability hereunder or in connection herewith for anything whatsoever other than as a result of its own negligence or willful misconduct. The MFN Escrow Agent shall be fully protected if it acts in accordance with the written advice of its counsel. In the event the MFN Escrow Agent fails to receive the instructions contemplated by Section 4 hereof or receives conflicting instructions, the MFN Escrow Agent shall be fully protected in refraining from acting until such instructions are received or such conflict is resolved by written agreement or court order. 4 (b) Settling Defendants, on the same pro rata basis as the funds constituting the MFN Escrow Amount were contributed to the MFN Escrow Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent from and against any and all losses, claims, liabilities and reasonable expenses, including the reasonable fees of its counsel, which it may suffer or incur hereunder or in connection herewith prior to the Availability Date, except such as shall result solely and directly from its own negligence or willful misconduct. The MFN Escrow Agent shall not be bound in any way by any agreement or contract between Settling Defendants and the State of Mississippi (whether or not the MFN Escrow Agent has knowledge thereof) and the only duties and responsibilities of the MFN Escrow Agent shall be to hold and invest the MFN Escrow Amount received hereunder and to release such MFN Escrow Amount in accordance with the terms of this MFN Escrow Agreement. (c) The MFN Escrow Agent may resign at any time by giving written notice thereof to the other parties hereto, but such resignation shall not become effective until a successor MFN Escrow Agent, selected by the Settling Defendants and agreeable to the State of Mississippi, shall have been appointed and shall have accepted such appointment in writing. If an instrument of acceptance by a successor MFN Escrow Agent shall not have been delivered to the MFN Escrow Agent within 30 days after the giving of such notice of resignation, the resigning MFN Escrow Agent may, at the expense of the Settling Defendants and the State of Mississippi (to be shared equally between the State of Mississippi and the Settling Defendants), petition the Court for the appointment of a successor MFN Escrow Agent. (d) Upon the Availability Date having occurred, provided that Settling Defendants have performed all of their obligations required to be performed prior to the Availability Date, all duties and obligations of Settling Defendants hereunder shall cease, with the exception of any indemnification obligation of Settling Defendants incurred prior to the Availability Date. SECTION 8. Miscellaneous. (a) Notices. All notices or other communications to any party or other person hereunder shall be in writing (which shall include telex, telecopy or similar writing) and shall be given to the respective parties or persons at the following addresses. Any party or person may change the name and address of the person designated to receive notice on behalf of such party or person by notice given as provided in this paragraph. 5 State of Mississippi: Hon. Michael C. Moore Attorney General's Office 450 High Street Post Office Box 220 Jackson, MS 39205 Fax: (601) 359-3441 With copies to: Richard F. Scruggs Scruggs, Millette, Bozeman & Dent, P.A. P.O. Drawer 1425 743 Delmas Avenue Pascagoula, MS 39568-1425 Fax: (228) 762-1207 and: Joseph F. Rice, Esq. Ness, Motley, Loadholt, Richardson & Poole 151 Meeting Street, Suite 600 Charleston, SC 29402 Fax: (843) 720-9290 and: David O. McCormick 707 Watts Avenue P.O. Box 865 Pascagoula, MS 39568-0865 Fax: (228) 762-4864 Settling Defendants: For Philip Morris Incorporated: Martin J. Barrington Philip Morris Incorporated 120 Park Avenue New York, NY 10017-5592 Fax: (212) 907-5399 6 With a copy to: Meyer G. Koplow Wachtell, Lipton, Rosen & Katz 51 West 52nd Street New York, NY 10019 Fax: (212) 403-2000 For R.J. Reynolds Tobacco Company: Charles A. Blixt R.J. Reynolds Tobacco Company 401 North Main Street Winston-Salem, NC 27102 Fax: (336) 741-2998 With a copy to: Arthur F. Golden Davis Polk & Wardwell 450 Lexington Avenue New York, NY 10017 Fax: (212) 450-4800 For Brown & Williamson Tobacco Corporation: Michael Walter Brown & Williamson Tobacco Corporation 200 Brown & Williamson Tower 401 South Fourth Avenue Louisville, KY 40202 Fax: (502) 568-7187 With a copy to: F. Anthony Burke Brown & Williamson Tobacco Corporation 200 Brown & Williamson Tower 401 South Fourth Avenue Louisville, KY 40202 Fax: (502) 568-7297 7 For Lorillard Tobacco Company: Arthur J. Stevens Lorillard Tobacco Company 714 Green Valley Road Greensboro, NC 27408 Fax: (336) 335-7707 MFN Escrow Agent: SouthTrust Bank, N.A. 854 Howard Avenue Post Office Box 1419 Biloxi, MS 39530 Phone: (228) 436-8656 Fax: (228) 436-8689 Wire Transfer Instructions: ABA #: 062000080 Account #: 62-780173 Account Name: Mississippi MFN Escrow Account (b) Successors and Assigns. The provisions of this MFN Escrow Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. (c) Governing Law. This MFN Escrow Agreement shall be construed in accordance with and governed by the laws of the State of Mississippi, without regard to the conflicts of law rules of such state. (d) Jurisdiction and Venue. The parties hereto irrevocably and unconditionally submit to the jurisdiction of the Court for purposes of any suit, action or proceeding seeking to enforce any provision of, or based on any right arising out of, this MFN Escrow Agreement, and the parties hereto agree not to commence any such suit, action or proceeding except in such Court. The parties hereto hereby irrevocably and unconditionally waive any objection to the laying of venue of any such suit, action or proceeding in the Court and hereby further irrevocably waive and agree not to plead or claim in such Court that any such suit, action or proceeding has been brought in an inconvenient forum. (e) Definitions. Terms used herein that are defined in the Settlement Agreement or the Stipulation of Amendment are, unless otherwise defined herein, used in this MFN Escrow Agreement as defined 8 in the Settlement Agreement or the Stipulation of Amendment, as appropriate. (f) Amendments. This MFN Escrow Agreement may be amended only by written instrument executed by all parties hereto. The waiver of any rights conferred hereunder shall be effective only if made by written instrument executed by the waiving party. The waiver by any party of any breach of this MFN Escrow Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this MFN Escrow Agreement. (g) Counterparts; Effectiveness. This MFN Escrow Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This MFN Escrow Agreement shall become effective when each party hereto shall have signed a counterpart hereof. Delivery by facsimile of a signed agreement shall be deemed delivery for purposes of acknowledging acceptance hereof; however, an original executed signature page must promptly thereafter be appended to this MFN Escrow Agreement, and an original executed agreement shall promptly thereafter be delivered to each party hereto. (h) Captions. The captions herein are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as of the day and year first hereinabove written. STATE OF MISSISSIPPI By: /s/ Michael C. Moore ------------------------------- Michael C. Moore Attorney General 9 PHILIP MORRIS INCORPORATED By: /s/ Meyer G. Koplow --------------------------------------- Meyer G. Koplow Counsel R.J. REYNOLDS TOBACCO COMPANY By: /s/ Arthur F. Golden --------------------------------------- Arthur F. Golden Counsel BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton --------------------------------------- Stephen R. Patton Counsel LORILLARD TOBACCO COMPANY By: /s/ Arthur J. Stevens by MGK --------------------------------------- Arthur J. Stevens Senior Vice President & General Counsel 10 SOUTHTRUST BANK, N.A. as MFN Escrow Agent By: /s/ Walter H. Stuart, III ------------------------------- Name: Walter H. Stuart, III Title: President & CEO 11 EX-10.4 5 STIPULATION OF AMDT. TO SETTLEMENT AGREEMENT AND Exhibit 10.4 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TEXAS TEXARKANA DIVISION ____________________________________ ) STATE OF TEXAS, ) ) Plaintiff, ) ) vs. ) No. 5-96CV-91 ) AMERICAN TOBACCO ) COMPANY, et al., ) ) Defendants. ) ____________________________________) STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF CONSENT DECREE THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF CONSENT DECREE (the "Stipulation of Amendment") is made as of the date hereof, by and among the parties hereto, as indicated by their signatures below, to amend the Comprehensive Settlement Agreement and Release entered into by the parties hereto with respect to this Action on January 16, 1998 (the "Settlement Agreement"). WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants entered into the Settlement Agreement to settle and resolve with finality all present and future civil claims against all parties to this litigation relating to the subject matter of this litigation which have been or could have been asserted by any of the parties hereto; WHEREAS, the Settlement Agreement was approved and adopted as an enforceable order of the Court pursuant to Court Order dated January 22, 1998. WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of the Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement shall be revised so that the State of Texas will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on May 8, 1998, Settling Defendants Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company (the "MFN Settling Defendants") entered into a pre-verdict settlement agreement with the State of Minnesota (the "Minnesota Settlement") to resolve the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994); 2 WHEREAS, the State of Texas and MFN Settling Defendants agree that, pursuant to the Most Favored Nation clause of the Settlement Agreement, the Settlement Agreement is to be revised in light of the Minnesota Settlement; WHEREAS, the State of Texas and Settling Defendants have agreed on the terms of revisions to the Settlement Agreement, including revisions in light of the Minnesota Settlement, as set forth in this Stipulation of Amendment and the attached Consent Decree; and WHEREAS, the parties hereto have further agreed jointly to petition the Court for approval of the Consent Decree: NOW, THEREFORE, BE IT KNOWN THAT, pursuant to the Most Favored Nation clause of the Settlement Agreement and in consideration of their mutual agreement to the terms of this Stipulation of Amendment (including, inter alia, waiver of any further claim to revise the Settlement Agreement pursuant to the Most Favored Nation clause, except as expressly provided herein), and such other consideration as described herein, the sufficiency of which is hereby acknowledged, the parties hereto, acting by and through their authorized agents, memorialize and agree as follows: 1. Amendment of Settlement Agreement. The provisions of this Stipulation of Amendment supplement the terms of the Settlement Agreement, which shall remain in full force and effect except insofar as they are expressly 3 revised by the provisions of this Stipulation of Amendment. Nothing in this Stipulation of Amendment shall be construed to release Settling Defendants from any of the obligations assumed in paragraphs 6 (Elimination of Billboards and Transit Advertisements), 8 (Initial Payments) and 9 (Pilot Program Payments) of the Settlement Agreement. 2. Voluntary Agreement of the Parties. This Stipulation of Amendment is entered into voluntarily by the parties hereto. The State and Settling Defendants understand that Congress may enact legislation dealing with some of the issues addressed in the Settlement Agreement, this Stipulation of Amendment or the Consent Decree. The MFN Settling Defendants and their assigns, affiliates, agents and successors hereby voluntarily waive any right to challenge the Settlement Agreement, this Stipulation of Amendment or the Consent Decree, directly or through third parties, on the ground that any term thereof or hereof is unconstitutional, outside the power or jurisdiction of the Court or preempted by or in conflict with any current or future federal legislation (except insofar as the non-economic terms of the Settlement Agreement (as revised hereby) or the Consent Decree are irreconcilable with any such future federal legislation). The Court may, upon the State's application, enter a Consent Decree in the form attached as Exhibit 1 hereto. 4 3. Definitions. For the purposes of the Settlement Agreement, this Stipulation of Amendment and the Consent Decree, the following terms shall have the meanings set forth below: (a) "Consumer Price Index" means the Consumer Price Index for All Urban Consumers for the most recent twelve-month period for which such percentage information is available, as published by the Bureau of Labor Statistics of the U.S. Department of Labor; (b) "Market Share" means a Settling Defendant's respective share of sales of Cigarettes, by number of individual Cigarettes shipped in the United States for domestic consumption, as measured by such Settling Defendant's audited reports of shipments of Tobacco Products provided to the U.S. Securities and Exchange Commission ("SEC") (or, in the case of any Settling Defendant that does not provide such reports to the SEC, audited reports of shipments containing the same shipment information as contained in the reports provided to the SEC) ("Shipment Reports"), during (i) with respect to payments made pursuant to paragraph 7 of this Stipulation of Amendment, the calendar year ending on the date on which the payment at issue is due (or, in the case of the payment due on November 1, 1998, the calendar year ending December 31, 1998), regardless of when such payment is made, and (ii) with respect to all other 5 payments made pursuant to this Stipulation of Amendment and the Settlement Agreement, the calendar year immediately preceding the year in which the payment at issue is due, regardless of when such payment is made; (c) "Cigarettes" means any product which contains nicotine, is intended to be burned or heated under ordinary conditions of use, and consists of or contains (i) any roll of tobacco wrapped in paper or in any substance not containing tobacco; or (ii) tobacco, in any form, that is functional in the product, which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette; or (iii) any roll of tobacco wrapped in any substance containing tobacco which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette described in subparagraph (i) of this paragraph; (d) "Smokeless Tobacco" means any product that consists of cut, ground, powdered or leaf tobacco that contains nicotine and that is intended to be placed in the oral cavity; (e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and 6 (f) "Children" means persons under the age of 18. The above definitions supplement the definitions provided in the Settlement Agreement and, insofar as they differ, supersede them. 4. Settlement Receipts. The payments to be made by Settling Defendants under this Stipulation of Amendment during the year 1998 are in settlement of the State's claims for reimbursement for public health expenditures of the State of Texas incurred in the year of payment or earlier years related to the subject matter of this Action, including without limitation expenditures made by the State's Employees' Health Insurance Program and Charity Care programs. All other payments made by Settling Defendants pursuant to this Stipulation of Amendment are in settlement of all of the State of Texas's claims for damages incurred by the State in the year of payment or earlier years related to the subject matter of this Action, including claims for reimbursement of Medicaid expenditures and punitive damages, except that no part of any payment under the Settlement Agreement or this Stipulation of Amendment is made in settlement of an actual or potential liability for a fine, penalty (civil or criminal) or enhanced damages or as the cost of a tangible or intangible asset or other future benefit. 5. Supplemental Initial Payment. Each MFN Settling Defendant severally shall cause to be paid into the registry of the court and in accordance with and subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion to 7 its Market Share, its share of $156,530,000, to be paid on or before January 4, 1999; its share of $605,090,000, to be paid on or before January 3, 2000; its share of $605,090,000, to be paid on or before January 2, 2001; its share of $605,090,000, to be paid on or before January 2, 2002; and its share of $303,200,000, to be paid on or before January 2, 2003. The payments made by MFN Settling Defendants pursuant to this paragraph shall be adjusted upward by the greater of 3% or the actual total percent change in the Consumer Price Index applied each year on the previous year, beginning with the payment due to be made on or before January 3, 2000. The payments due to be made by MFN Settling Defendants pursuant to this paragraph 5 on or before January 3, 2000, on or before January 2, 2001, on or before January 2, 2002, and on or before January 2, 2003, will also be decreased or increased, as the case may be, in accordance with the formula for adjustment of payments set forth in Appendix A hereto. The payment due to be made by MFN Settling Defendants pursuant to this paragraph 5 on or before January 4, 1999, shall not be subject to adjustment for inflation or in accordance with the formula for adjustment of payments set forth in Appendix A hereto. 6. Acceleration of Supplemental Initial Payment. In the event that any MFN Settling Defendant fails to make any payment required of it pursuant to paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the 8 applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of Texas shall provide notice to each of the MFN Settling Defendants of such non-payment. The Defaulting Defendant shall have 15 days after receipt of such notice to pay the Missed Payment, together with interest accrued from the original applicable due date at the prime rate as published in the Wall Street Journal on the latest publication date on or before the date of default plus 3%. If the Defaulting Defendant does not make such payment within such 15-day period, the State of Texas shall have the option of providing notice to each of the MFN Settling Defendants of such continued non-payment. In the event that the State of Texas elects to provide such notice, any or all of the MFN Settling Defendants (other than the Defaulting Defendant) shall have 15 days after receipt of such notice to elect (in such MFN Settling Defendant's or such MFN Settling Defendants' sole and absolute discretion) to pay the Missed Payment, together with interest accrued from the original applicable due date at the prime rate as published in the Wall Street Journal on the latest publication date on or before the date of default plus 3%. In the event that the State of Texas does not receive the Missed Payment, together with such accrued interest, within such additional 15-day period, all future payments required to be made by each of the respective MFN Settling Defendants pursuant to paragraph 5 of this Stipulation of Amendment shall at the end of such additional 15-day period be accelerated and immediately become due and owing to 9 the State of Texas from each MFN Settling Defendant, pro rata in proportion to its Market Share; provided, however, that such accelerated payments (a) shall all be adjusted upward by the greater of (i) the rate of 3% per annum or (ii) the actual total percent change in the Consumer Price Index, in either instance for the period between January 1 of the year in which the acceleration of payments pursuant to this paragraph occurs and the date on which such accelerated payments are made pursuant to this paragraph 6, and (b) shall all immediately be adjusted in accordance with the formula for adjustment of payments set forth in Appendix A hereto. Nothing in this paragraph 6 shall be deemed under any circumstance to create any obligation on the part of any MFN Settling Defendant to pay any amount owed or payable to the State of Texas by any other MFN Settling Defendant. All obligations of the MFN Settling Defendants pursuant to this paragraph 6 are intended to be and shall remain several, and not joint. 7. Annual Payments. Each of the Settling Defendants agrees that it shall severally cause to be paid into the registry of the Court, in accordance with and subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion to its Market Share, its share of the following payments (subject to adjustment for appropriate allocation among Settling Defendants by January 30, 1999): $89 10 million to be paid on or before November 1, 1998; and $201 million to be paid on or before December 31, 1998. Each of the Settling Defendants further agrees that, on December 31, 1999 and annually thereafter on December 31st of each year after 1999 (subject to final adjustment within 30 days), it shall severally cause to be paid into the registry of the Court and in accordance with and subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion to its Market Share, its share of 7.25% of the following amounts (in billions): Year 1999 2000 2001 2002 2003 thereafter ---- 2 3 4 5 6 Amount $4.5B $5B $6.5B $6.5B $8B $8B ------ The payments made by Settling Defendants pursuant to this paragraph 7 shall be adjusted upward by the greater of 3% or the actual total percent change in the Consumer Price Index applied each year on the previous year, beginning with the annual payment due on December 31, 1999. Such payments will also be decreased or increased, as the case may be, beginning with the annual payment due on December 31, 1999, in accordance with the formula for adjustment of payments set forth in Appendix A hereto. Settling Defendants shall pay the payments due pursuant to this paragraph 7 on November 1, 1998 and December 31, 1998 without adjustment for inflation or in accordance with the formula for adjustments of payments set forth in Appendix A hereto. This paragraph 7 supersedes paragraph 11 10 of the Settlement Agreement, which is hereby rendered null, void and of no further effect. 8. Determination of Market Share. In the event of a disagreement between or among any Settling Defendants as to their respective shares of any payment due to be paid on a Market Share basis pursuant to the Settlement Agreement and this Stipulation of Amendment, each Settling Defendant shall pay its undisputed share of such payment promptly on or before the date on which such payment is due, and shall, within 21 days of such date, submit its Shipment Reports for the year in question to a third party to be selected by agreement of Settling Defendants (the "Third Party"), who shall determine the Market Share of each Settling Defendant within three business days of receipt of such Shipment Reports. The decision of the Third Party shall be final and non-appealable, and shall be communicated by facsimile to each person designated to receive notice hereunder. Each Settling Defendant shall, within two business days of receipt of the Third Party's decision, pay the State or such other Settling Defendant, as appropriate, the difference, if any, between (1) the amount that such Settling Defendant has already paid with respect to the payment in question and (2) the amount of the payment in question that corresponds to such Settling Defendant's Market Share as determined by the Third Party, together with interest accrued from the original date on which the payment in question was due, at the prime rate as published in the Wall Street 12 Journal on the latest publication date on or before the original date on which the payment in question was due plus 3%. 9. Adjustments in Event of Federal Legislation. In the event that federal tobacco legislation is enacted before November 30, 2000 that provides for payments by tobacco companies (whether in the form of settlement payment, tax or otherwise) ("Tobacco Legislation"): (a) MFN Settling Defendants shall be entitled to receive a dollar for dollar offset against the annual payments required under paragraph 7 of this Stipulation of Amendment of any amounts that the State of Texas could elect to receive pursuant to such Tobacco Legislation ("Federal Settlement Funds"), up to the full amount of such annual payments, except to the extent that: (i) such Federal Settlement Funds are required to be used for purposes other than health care or tobacco-related purposes; (ii) such Tobacco Legislation provides the opportunity for other states to elect to receive Federal Settlement Funds but does not provide for the abrogation, settlement or relinquishment of any tobacco-related claims of such states that have not previously been resolved; or 13 (iii) state receipt of such Federal Settlement Funds is conditioned upon (A) the relinquishment of rights or benefits under the Settlement Agreement (including this Stipulation of Amendment and the Consent Decree) (excepting any annual payment amounts subject to the offset); or (B) actions or expenditures by the state unrelated to health care or tobacco (including but not limited to tobacco education, cessation, control or enforcement). (b) Nothing in this paragraph 9 shall reduce (i) the payments made to the State of Texas pursuant to paragraphs 8 and 9 of the Settlement Agreement and paragraphs 5 and 6 of this Stipulation of Amendment (by offset, credit, recoupment, refund or otherwise); or (ii) the percentage figure (7.25%) used to determine the State of Texas's annual payments pursuant to paragraph 7 of this Stipulation of Amendment. Nothing in this paragraph 9 is intended to or shall reduce the total amounts payable by MFN Settling Defendants to the State of Texas under the Settlement Agreement (as revised hereby) by an amount greater than the amount of Federal Settlement Funds that the State of Texas could elect to receive. This paragraph 9 supersedes paragraph 12 of the Settlement Agreement, which is hereby rendered null, void and of no further effect. 14 10. Clarification of Scope of State's Release. The release of claims provided in paragraph 14 of the Settlement Agreement shall, with respect to the Claims identified in subparagraph (2) thereof, apply only to monetary Claims. This paragraph 10 does not supersede but rather supplements and clarifies the scope of the release provided in paragraph 14 of the Settlement Agreement. 11. Limited Most-Favored Nation Provision. In partial consideration for the monetary payments to be made by MFN Settling Defendants pursuant to this Stipulation of Amendment, the State of Texas agrees that, if MFN Settling Defendants enter into any future pre-verdict settlement agreement of other similar litigation brought by a non-federal governmental plaintiff, or any amendment to any such existing settlement agreement, on terms more favorable to such non-federal governmental plaintiff than the terms of the Settlement Agreement (including this Stipulation of Amendment and the Consent Decree) (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement (including this Stipulation of Amendment and the Consent Decree) shall not be revised except as follows: to the extent, if any, such other pre-verdict settlement agreement includes terms that provide: (a) for joint and several liability among MFN Settling Defendants with respect to monetary payments to be made pursuant to such agreement; 15 (b) a guarantee by the parent company of any of MFN Settling Defendants or other assurances of payment or creditors' remedies with respect to monetary payments to be made pursuant to such agreement; (c) for the implementation of non-economic tobacco-related public health measures different from those contained in the Settlement Agreement (including this Stipulation of Amendment and the Consent Decree); (d) for no offset of Federal Settlement Funds against annual settlement payments pursuant to such settlement agreement; or (e) for an offset term more favorable to the plaintiff than the offset provisions of paragraph 9 of this Stipulation of Amendment, then the Settlement Agreement shall, at the option of the Office of the Attorney General of the State of Texas, be revised to include terms comparable to such terms. This paragraph 11 supersedes paragraph 16 of the Settlement Agreement, which is hereby rendered null, void and of no further effect as to any MFN Settling Defendant. The State of Texas hereby acknowledges that, pursuant to the terms of this paragraph 11, it has irrevocably waived any future claim against MFN Settling Defendants to revise the terms of the Settlement Agreement or this Stipulation of Amendment pursuant to paragraph 16 of the Settlement Agreement (except as 16 provided in paragraph 23 of this Stipulation of Amendment), and it hereby further covenants and agrees that, in consideration for MFN Settling Defendants' agreement to the terms of this Stipulation of Amendment, it shall not hereafter seek to revise the Settlement Agreement or this Stipulation of Amendment as to MFN Settling Defendants, except as expressly provided in this paragraph 11 (or pursuant to mutually agreeable amendment by the parties hereto as provided in paragraph 23 of the Settlement Agreement and paragraph 19 hereof). 12. MFN Settling Defendants' Assurances. MFN Settling Defendants agree: (a) to support the legislative initiatives to enact new laws and administrative initiatives to promulgate new rules described in paragraph 7 of the Settlement Agreement; and (b) not to support in Congress or any other forum legislation, rules or policies which would preempt, override, abrogate or diminish the State's rights or recoveries under the Settlement Agreement (as amended hereby). Except as specifically provided in the foregoing sentence, nothing in the Settlement Agreement (including this Stipulation of Amendment and the Consent Decree) shall be deemed to restrain the parties from advocating terms of any national settlement or taking any other positions on issues relating to tobacco. 17 13. Disclosure of Payments. Each MFN Settling Defendant shall disclose to the Office of the Attorney General and the Texas Ethics Commission, at the times and in the manner provided below, information about the following payments: (a) Any payment to a person required to register under Tex. Gov't Code Ann. ss.305.005 (West 1998), if the MFN Settling Defendant knows or has reason to know that the payment will be used, directly or indirectly, to influence legislative or administrative action or the official action of state or local government in Texas in any way relating to Tobacco Products or their use; (b) Any payment to a third party, if the MFN Settling Defendant knows the payment is partly in consideration for the third party attending, offering testimony at, or participating before a state or local government hearing in Texas in any way relating to Tobacco Products or their use; and (c) Any payment (other than a "political contribution" under 2 U.S.C. ss.431(8)(A)) to, or for the benefit of, a state or local official in Texas, whether made directly by the MFN Settling Defendant or indirectly through an employee of the MFN Settling Defendant acting within the scope of his employment, or through an affiliate, lobbyist or other agent acting under the substantial control of the MFN Settling Defendant. 18 Disclosures required under this paragraph 13 shall be filed with the Office of the Attorney General and the Texas Ethics Commission on the first day of February, May, August and November of each year (beginning November 1, 1998) for any and all payments made through the first day of the previous month, and shall be transmitted in electronic format or such format as the Attorney General may require, with the following information: o The name, address, telephone number and e-mail address of the recipient; o The amount of each payment described in this paragraph 13; and o The aggregate amount of all payments described in this paragraph 13 to the recipient in the calendar year. Information disclosed pursuant to this paragraph is "public information" within the meaning of Tex. Gov't Code Ann. ss. 552.002 (West 1998). 14. Prohibition of Certain Payments for Product Placement. MFN Settling Defendants shall not make or cause to be made, in connection with any motion picture made in the United States, any payment, direct or indirect, to any person to use, display, make reference to or use as a prop any cigarette, cigarette package, advertisement for cigarettes, or any other item bearing the brand name, logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia of product identification identical or similar to, or identifiable with, those used for any brand of domestic Tobacco Products. 19 15. Prohibition on Promotional Merchandise. On and after December 31, 1998, MFN Settling Defendants shall permanently cease marketing, licensing, distributing, selling or offering, directly or indirectly, including by catalogue or direct mail, in the State of Texas, any item (other than Tobacco Products or any item of which the sole function is to advertise Tobacco Products) which bears the brand name (alone or in conjunction with any other word), logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia of product identification identical or similar to, or identifiable with, those used for any brand of domestic Tobacco Products, except that nothing in this paragraph shall (i) require any MFN Settling Defendant to terminate, breach or violate any licensing agreement or contract in existence as of July 1, 1998 for the remaining term of such contract; (ii) prohibit the distribution to any employee (18 years of age or older) of an MFN Settling Defendant of any item described above that is intended for the personal use of such employee by such MFN Settling Defendant; or (iii) prohibit items necessarily incidental to or ordinarily distributed in connection with any sponsorship described in paragraph 4(e)(2) of the Settlement Agreement. 16. Document Production. MFN Settling Defendants shall, upon request, provide to the State of Texas a copy of any CD-ROMs of documents that MFN Settling Defendants have agreed to produce, pursuant to the Minnesota Settlement, 20 to the document depository established in connection with the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994), with a copy of the accompanying transmittal letter provided to each person designated to receive notice hereunder. 17. Court Approval. The parties hereto agree to submit this Stipulation of Amendment promptly to the Court for its review and approval. If the Court refuses to approve this Stipulation of Amendment and the Consent Decree in any respect unacceptable to either of the parties hereto or to enter the Order Granting Joint Motion for Approval of Agreement Regarding Disposition of Settlement Proceeds and to Withdraw with Predjudice All Political Subdivisions' Motions to Intervene (the "Political Subdivisions Order," in the form attached as Exhibit 2 hereto), or if such approval or the Political Subdivisions Order is modified in any respect unacceptable to either of the parties hereto or set aside on appeal, then this Stipulation of Amendment shall be canceled and terminated and it and all orders issued pursuant hereto (including the Consent Decree) shall become null and void and of no further effect. Any such cancellation or termination of this Stipulation of Amendment shall not of itself result in the cancellation or termination of, or otherwise affect, the Settlement Agreement as approved by the Court on January 22, 1998. All payments described in this Stipulation of Amendment shall be paid into a special escrow account, pursuant to the terms of a mutually acceptable 21 escrow agreement (the "MFN Escrow Agreement" in the form attached as Exhibit 3 hereto), and if so paid shall remain in said escrow account, until such time as (1) the 30-day time periods to seek review of the Court's order approving this Stipulation of Amendment and the Political Subdivisions Order have expired without the filing of any notice of appeal or petition for review; or (2) in the event of a timely appeal or petition, the appeal or the petition has been dismissed or the Court order in question has been affirmed in all material respects by the court of last resort to which such appeal or petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review. Any payments made into escrow shall be disbursed from escrow only in strict accordance with the terms of the MFN Escrow Agreement and upon disbursement shall be transferred into the registry of the Court. All payments described in this Stipulation of Amendment that are not required to be paid into the MFN Escrow Account pursuant to this paragraph 17 shall be paid into the registry of the Court. 18. Payment Responsibility. All obligations of the Settling Defendants pursuant to the Settlement Agreement and this Stipulation of Amendment are intended to be and shall remain several, and not joint. Due to the particular corporate structures of Settling Defendants R.J. Reynolds Tobacco Company ("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown & Williamson") with respect to their non-domestic tobacco operations, Settling 22 Defendants Reynolds and Brown & Williamson shall be severally liable for their respective shares of each payment due pursuant to the Settlement Agreement and this Stipulation of Amendment up to (and their liability hereunder shall not exceed) the full extent of their assets used in, and earnings derived from, the manufacture and sale in the United States of Tobacco Products intended for domestic consumption, and no recourse shall be had against any of their other assets or earnings to satisfy such obligations. 19. Applicable Provisions of Settlement Agreement. The provisions of paragraphs 18 (Representations of Parties), 20 (Headings), 21 (No Admission), 22 (Non-Admissibility), 23 (Amendment), 25 (Cooperation), 26 (Governing Law), 27 (Construction), 28 (Severability), 29 (Intended Beneficiaries) and 30 (Counterparts) of the Settlement Agreement shall be equally applicable to this Stipulation of Amendment as though fully set forth herein, and all references to the Settlement Agreement in the sections thereof specifically listed in this paragraph 19 shall be construed to include this Stipulation of Amendment. 20. Release of Right to Additional Compensation. In consideration for the terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the State of Texas hereby irrevocably releases MFN Settling Defendants from any claim for additional compensation pursuant to paragraphs 17(a) and (d) of the Settlement Agreement, and the provisions of paragraphs 17(a) and (d) regarding the State's 23 rights to additional compensation are hereby rendered null, void and of no further effect. 21. Discovery Materials. Paragraph 22 of the Settlement Agreement is hereby modified to permit the Attorney General of the State of Texas to seek the dissolution of any protective order in this Action governing treatment of discovery materials during the pendency of this Action (as well as existing confidentiality designations), but only with regard to materials that have been made public in other litigation pursuant to a final court order, subject to any defenses or objections as may be made by Settling Defendants. Except as expressly provided above, the provisions of paragraph 22 of the Settlement Agreement with respect to discovery materials shall remain in effect for the period of time specified therein. 22. Attorneys' Fees. Settling Defendants, the State of Texas, Private Counsel and the Law Offices of Marc D. Murr, P.C. have entered into a separate agreement on July 24, 1998 (the "Texas Fee Payment Agreement") that sets forth the entire obligation of Settling Defendants with respect to payment of attorneys' fees pursuant to paragraph 17 of the Settlement Agreement. The parties hereto agree that the Texas Fee Payment Agreement supersedes Exhibit 1 to the Settlement Agreement, which is hereby rendered null, void and of no further effect. The parties further agree that Settling Defendants shall not be required to perform any obligation pursuant to this Stipulation of Amendment (excepting Settling 24 Defendants' obligations with respect to the advance to be paid pursuant to section 12 of the Texas Fee Payment Agreement) until such time as (1) the Court issues an order confirming that amounts payable with respect to attorneys' fees of Texas Counsel pursuant to the Texas Fee Payment Agreement are not funds of the State of Texas and that Settling Defendants are under no obligation to pay such amounts to the State of Texas; (2) the 30-day period to seek review of such order has expired without the filing of any notice of appeal or petition for review; and (3) in the event of a timely appeal or petition, such appeal or petition has been dismissed or the order has been affirmed in all material respects by the court of last resort to which such appeal or petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review. Under no circumstances shall Settling Defendants' entry into this Stipulation of Amendment or the Texas Fee Payment Agreement be construed as, or deemed to be, evidence of or an admission or concession that the Settlement Agreement can be revised pursuant to the Most Favored Nation clause without incorporation of all terms of any settlement agreement that provides the occasion for any such revision, including all terms thereof with respect to attorneys' fees. 23. Conditioned on Minnesota Settlement. In the event that a court order or other judicial determination is issued on or before January 2, 2003 that overturns, voids or invalidates the Minnesota Settlement or otherwise declares it to 25 be unenforceable (such that MFN Settling Defendants are relieved from making payments required under the Minnesota Settlement) (the "Minnesota Order"), MFN Settling Defendants shall have the option to elect not to make any payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due on or after the date of such Minnesota Order. In the event that MFN Settling Defendants make such an election: (a) MFN Settling Defendants shall not be obligated to make any payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due on or after the date of the Minnesota Order; provided, however, that if the Minnesota Order is reversed on appeal or otherwise set aside, MFN Settling Defendants shall be obligated to make any payments pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were not made when initially due as result of the Minnesota Order; (b) the provisions of paragraph 11 of this Stipulation of Amendment shall not apply to preclude the application of paragraph 16 of the Settlement Agreement with respect to any pre-verdict settlement agreement described therein entered into after the date of the Minnesota Order; and (c) MFN Settling Defendants shall be entitled to a credit, in the amount of any payments made pursuant to paragraphs 5 and 6 of this 26 Stipulation of Amendment, against any payments due to the State of Texas as a result of application of paragraph 16 of the Settlement Agreement in connection with any pre-verdict settlement agreement entered into after the date of the Minnesota Order, pursuant to subparagraph (b) of this paragraph 23. No other provision of the Settlement Agreement, this Stipulation of Amendment or the Consent Decree shall be affected by the Minnesota Order. MFN Settling Defendants will provide the State of Texas with notice of any filing seeking to obtain a Minnesota Order. 24. Entire Agreement of Parties. The Settlement Agreement (including this Stipulation of Amendment, the Texas Fee Payment Agreement and the Consent Decree but excluding Exhibit 1 to the Settlement Agreement, which is hereby rendered null, void and of no further effect) contains an entire, complete and integrated statement of each and every term and provision agreed to by and among the parties hereto relating in any way to the settlement of the tobacco litigation brought by the State of Texas, and is not subject to any condition not provided for herein. 27 IN WITNESS WHEREOF, the parties hereto, through their fully authorized representatives, have agreed to this Stipulation of Amendment as of this 24th day of July, 1998. STATE OF TEXAS, acting by and through Dan Morales, its duly elected and authorized Attorney General By: /s/ Dan Morales ---------------------------------- Dan Morales Attorney General COUNSEL TO THE STATE OF TEXAS By: /s/ Walter Umphrey ---------------------------------- Walter Umphrey Provost & Umphrey By: /s/ John M. O'Quinn ---------------------------------- John M. O'Quinn By: /s/ John Eddie Williams, Jr. ---------------------------------- John Eddie Williams, Jr. 28 By: /s/ Wayne A. Reaud ---------------------------------- Wayne A. Reaud Reaud, Morgan & Quinn, Inc. By: /s/ Harold W. Nix ---------------------------------- Harold W. Nix The Nix Law Firm By: /s/ Cary Patterson ---------------------------------- Cary Patterson The Nix Law Firm By: /s/ Marc D. Murr ---------------------------------- Marc D. Murr Law Offices of Marc D. Murr, P.C. By: /s/ Grant Kaiser ---------------------------------- Grant Kaiser Kaiser & Morrison By: /s/ T. Richardson, Jr. ---------------------------------- For Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 29 PHILIP MORRIS INCORPORATED By: /s/ Meyer G. Koplow ---------------------------------- Meyer G. Koplow Counsel By: /s/ Martin J. Barrington by MGK ---------------------------------- Martin J. Barrington General Counsel R.J. REYNOLDS TOBACCO COMPANY By: /s/ Arthur F. Golden ---------------------------------- Arthur F. Golden Counsel By: /s/ Charles A. Blixt ---------------------------------- Charles A. Blixt General Counsel 30 BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton ---------------------------------- Stephen R. Patton Counsel By: /s/ F. Anthony Burke ---------------------------------- F. Anthony Burke Vice President & General Counsel LORILLARD TOBACCO COMPANY By: /s/ Arthur J. Stevens by MGK ---------------------------------- Arthur J. Stevens Senior Vice President & General Counsel UNITED STATES TOBACCO COMPANY By: /s/ Richard H. Verheij ---------------------------------- Richard H. Verheij Executive Vice President & General Counsel 31 APPENDIX A FORMULA FOR CALCULATING VOLUME ADJUSTMENTS Any payment that by the terms of the Stipulation of Amendment is to be adjusted pursuant to this Appendix (the "Applicable Base Payment") shall be adjusted pursuant to this Appendix in the following manner: (A) in the event the aggregate number of cigarettes shipped for domestic consumption by Settling Defendants in the Applicable Year (as defined hereinbelow) (the "Actual Volume") is greater than the aggregate number of cigarettes shipped for domestic consumption by Settling Defendants in 1997 (the "Base Volume"), the Applicable Base Payment shall be multiplied by the ratio of the Actual Volume to the Base Volume; (B) in the event the Actual Volume is less than the Base Volume, (i) the Applicable Base Payment shall be multiplied by the ratio of the Actual Volume to the Base Volume, and the resulting product shall be divided by 0.98; and (ii) if a reduction of the Applicable Base Payment results from the application of subparagraph (B)(i) of this Appendix, but the Settling Defendants' aggregate net operating profits from domestic sales of cigarettes for the Applicable Year (the "Actual Net Operating Profit") is greater than the Settling Defendants' aggregate net operating profits from domestic sales of cigarettes in 1997 (the "Base Net Operating Profit") (such Base Net Operating Profit being adjusted upward by the greater of the rate of 3% per annum or the actual total percent change in the Consumer Price Index, in either instance for the period between January 1, 1998 and the date on which the payment at issue is made), then the amount by which the Applicable Base Payment is reduced by the application of subparagraph (B)(i) shall be reduced (but not below zero) by 7.25% of 25% of such increase in such profits. For purposes of this Appendix, "net operating profits from domestic sales of cigarettes" shall mean net operating profits from domestic sales of cigarettes as reported to the United States Securities and Exchange Commission ("SEC") for the Applicable Year or, in the case of a Settling Defendant that does not report profits to the SEC, as reported in financial statements prepared in accordance with generally accepted accounting principles and audited by a nationally recognized accounting firm. The determination of Settling Defendants' aggregate net operating profits from domestic sales of cigarettes shall be derived using the same methodology as was employed in deriving such Settling Defendants' aggregate net operating profits from domestic sales of cigarettes in 1997. Any increase in an Applicable Base Payment pursuant to this subparagraph B(ii) shall be payable within 120 days after the date that the payment at issue was required to be made. (C) "Applicable Year" means (i) with respect to the payments made pursuant to paragraph 7 of the Stipulation of Amendment, the calendar year ending on the date on which the payment at issue is due, regardless of when such payment is made; and (ii) with respect to all other payments made pursuant to the Stipulation of Amendment, the calendar year immediately preceding the year in which the payment at issue is due, regardless of when such payment is made. 2 EXHIBIT 1 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TEXAS TEXARKANA DIVISION ____________________________________ ) STATE OF TEXAS, ) ) Plaintiff, ) ) vs. ) No. 5-96CV-91 ) AMERICAN TOBACCO ) COMPANY, et al., ) ) Defendants. ) ____________________________________) CONSENT DECREE WHEREAS, on January 16, 1998, the State of Texas and certain defendants entered into a Comprehensive Settlement Agreement and Release (the "Settlement Agreement") to settle and resolve with finality all present and future claims against all parties to this litigation relating to the subject matter of this litigation which have been or could have been asserted by any of the parties hereto; WHEREAS, the Settlement Agreement was approved and adopted as an enforceable order of the Court pursuant to Court Order dated January 22, 1998, in which the Court expressly retained continuing jurisdiction to enforce and implement the terms of the Settlement Agreement, including the Most Favored Nation clause of the Settlement Agreement; WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of the Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement shall be revised so that the State of Texas will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on May 8, 1998, Settling Defendants Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company (the "MFN Settling Defendants") entered into a pre-verdict settlement agreement with the State of Minnesota (the "Minnesota Settlement") to resolve the lawsuit State of Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994); WHEREAS, the State of Texas and MFN Settling Defendants agree that, pursuant to the Most Favored Nation clause of the Settlement Agreement, the Settlement Agreement is to be revised in light of the Minnesota Settlement; WHEREAS, the State of Texas and Settling Defendants have agreed on the terms of the revisions to the Settlement Agreement as set forth in a Stipulation 2 of Amendment to Settlement Agreement and for Entry of Consent Decree executed on July 24, 1998 (the "Stipulation of Amendment"); WHEREAS, the Stipulation of Amendment provides for entry of this Consent Decree, which sets forth certain terms of injunctive relief, and further, provides that the MFN Settling Defendants have waived as specified therein their right to challenge the terms of this Consent Decree as being superseded or preempted by future congressional enactments; and WHEREAS, the Attorney General believes the entry of this Consent Decree is appropriate and in the public interest; NOW, THEREFORE, the State of Texas and MFN Settling Defendants having come before the Court on their joint motion for approval of a Stipulation of Amendment to the Settlement Agreement, and the Court having reviewed and considered the Stipulation of Amendment and otherwise being fully advised in the premises, it is hereby ORDERED, ADJUDGED and DECREED as follows: 1. Approval. The Court finds that the terms of the Stipulation of Amendment are just and in the best interests of the State of Texas and Settling Defendants, and the same is hereby approved. The Court further finds that the Texas Fee Payment Agreement referred to in paragraph 22 of the Stipulation of Amendment sets forth the entire obligation of Settling Defendants with respect to payment of attorneys' fees pursuant to paragraph 17 of the Settlement Agreement and supersedes Exhibit 1 to the Settlement Agreement, which is hereby declared 3 to be null, void and of no further effect, that amounts payable with respect to attorneys' fees of Texas Counsel pursuant to the Texas Fee Payment Agreement are not funds of the State of Texas and that Settling Defendants are under no obligation to pay such amounts to the State of Texas. 2. Jurisdiction and Venue. In keeping with the Settlement Agreement and this Court's January 22, 1998 Order, the Court expressly retains jurisdiction for the purpose of enforcement of the Settlement Agreement (as amended by the Stipulation of Amendment) and this Consent Decree, as well as other issues relating to the settlement of this Action that are currently pending before the Court. Any party to this Consent Decree may apply to this Court at any time for such further orders and directions as may be necessary or appropriate for the construction and enforcement of the Settlement Agreement, the Stipulation of Amendment and this Consent Decree. 3. Definitions. The definitions set forth in the Settlement Agreement (as supplemented or superseded by the Stipulation of Amendment) are incorporated by reference herein. 4. Applicability. This Consent Decree applies only to MFN Settling Defendants in their corporate capacity acting through their respective successors and assigns, directors, officers, employees, agents, subsidiaries, divisions or other internal organizational units of any kind or any other entity acting in concert or participating with them, and only with respect to activities in connection with the 4 manufacture and sale in the United States of Tobacco Products intended for domestic consumption. The remedies and penalties for a violation of this Consent Decree shall apply only to MFN Settling Defendants, and shall not be imposed or assessed against any employee, officer or director of MFN Settling Defendants or other person or entity as a consequence of such a violation, and there shall be no jurisdiction under this Consent Decree to impose or assess a penalty against any employee, officer or director of MFN Settling Defendants or other person or entity as a consequence of a violation of this Consent Decree. 5. Effect on Third Parties. This Consent Decree is not intended to and does not vest standing in any third party with respect to the terms hereof, or create for any person other than the parties hereto a right to enforce the terms hereof. 6. Injunctive Relief. MFN Settling Defendants are permanently enjoined from: (a) On and after December 31, 1998, marketing, licensing, distributing, selling or offering, directly or indirectly, including by catalogue or direct mail, in the State of Texas, any item (other than Tobacco Products or any item the sole function of which is to advertise Tobacco Products) which bears the brand name (alone or in conjunction with any other word), logo, symbol, motto, selling message, recognizable color or pattern of colors, or any other indicia or product identification identical or similar to, or identifiable with, those used for any domestic 5 brand of Tobacco Products, except that nothing in this paragraph shall (i) require any MFN Settling Defendant to terminate, breach or violate any licensing agreement or contract in existence as of July 1, 1998 for the remaining term of such contract; (ii) prohibit the distribution to any employee (18 years of age or older) of an MFN Settling Defendant of any item described above that is intended for the personal use of such employee by such MFN Settling Defendant; or (iii) prohibit items necessarily incidental to or ordinarily distributed in connection with any sponsorship described in paragraph 4(e)(2) of the Settlement Agreement. (b) Making any material misrepresentation of fact regarding the health consequence of using any Tobacco Product, including any tobacco additives, filters, paper or other ingredients; provided, however, that nothing in this paragraph shall limit the exercise of any First Amendment right or any defense or position which persons bound by this Consent Decree may assert in any judicial, legislative or regulatory forum. (c) Entering into any contract, combination or conspiracy between or among themselves which has the purpose or effect of: (1) limiting competition in the production or distribution of information about the health hazards or other consequences of the use of Tobacco Products; (2) limiting or suppressing research into smoking and health; or 6 (3) limiting or suppressing research into, marketing, or development of new products. (d) Taking any action, directly or indirectly, to target children in Texas in the advertising, promotion, or marketing of cigarettes, or taking any action the primary purpose of which is to initiate, maintain or increase the incidence of underage smoking in Texas. 7. No Determination or Admission. The Settlement Agreement having been executed prior to the taking of any testimony, no final determination of any violation of any provision of law has been made in this Action. This Consent Decree is not intended to be and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of any liability or any wrongdoing whatsoever on the part of any person covered by the releases provided in paragraphs 14 and 15 of the Settlement Agreement; nor shall this Consent Decree be construed as, or deemed to be, an admission or concession or evidence of personal jurisdiction by any person not a party to this Consent Decree. Defendants specifically disclaim any liability or wrongdoing whatsoever with respect to the claims and allegations asserted against them in this Action and MFN Settling Defendants have entered into the Settlement Agreement and the Stipulation of Amendment, and have stipulated to entry of this Consent Decree, solely to avoid the further expense, inconvenience, burden and risk of litigation. 7 8. Modification. This Consent Decree shall not be modified unless the party seeking modification demonstrates, by clear and convincing evidence, that it will suffer irreparable harm from new and unforeseen conditions; provided, however, that the provisions of paragraph 4 of this Consent Decree shall in no event be subject to modification. Changes in the economic conditions of the parties shall not be grounds for modification. It is intended that MFN Settling Defendants will comply with this Consent Decree as originally entered, even if MFN Settling Defendants' obligations hereunder are greater than those imposed under current or future law. Therefore, a change in law that results, directly or indirectly, in more favorable or beneficial treatment of any one or more of the MFN Settling Defendants shall not support modification of this Consent Decree. The provisions of this paragraph shall not be construed to limit or affect any future modification of the Settlement Agreement (as amended by the Stipulation of Amendment) in the manner provided in paragraphs 11 and 23 of the Stipulation of Amendment. 9. Enforcement and Attorneys' Fees. In any proceeding which results in a finding that a MFN Settling Defendant violated this Consent Decree, the responsible MFN Settling Defendant or MFN Settling Defendants shall pay the State's costs and attorneys' fees incurred in such proceeding. 10. Non-Exclusivity of Remedy. The remedies in this Consent Decree are cumulative and in addition to any other remedies the State may have at law or 8 equity. Nothing herein shall be construed to prevent the State from bringing any action simply because the conduct that is the basis for such action may also violate this Consent Decree. DONE AND ORDERED at Texarkana, Texas, this the 24th day of July, 1998. /s/ David Folsom -------------------------------------- DAVID FOLSOM JUDGE, UNITED STATES DISTRICT COURT APPROVED: /s/ Dan Morales - ----------------------------------- Dan Morales, Attorney General, For the State of Texas Howard Waldrop By: /s/ Josh R. Morriss, III - ----------------------------------- Howard Waldrop For MFN Settling Defendants 9 EXHIBIT 2 IN THE UNITED STATES DISTRICT COURT EASTERN DISTRICT OF TEXAS TEXARKANA DIVISION THE STATE OF TEXAS, ) CIVIL NO.: 5:96-CV-0091 PLAINTIFF, ) ) VS. ) JUDGE: DAVID FOLSOM ) THE AMERICAN TOBACCO ) MAGISTRATE JUDGE: COMPANY, ET AL, ) WENDELL C. RADFORD DEFENDANTS. ) ORDER GRANTING JOINT MOTION FOR APPROVAL OF SETTLEMENT AGREEMENT REGARDING DISPOSITION OF SETTLEMENT PROCEEDS AND TO WITHDRAW WITH PREJUDICE POLITICAL SUBDIVISIONS' MOTIONS TO INTERVENE Before the Court is a Joint Motion for Approval of Settlement Agreement Regarding Disposition of Settlement Proceeds and to Withdraw with Prejudice Political Subdivisions(1) Motions to Intervene. After considering the filings related to this motion, the evidence, and the applicable law, the Court is of the opinion the Motion should be granted. The Court therefore makes the following findings of fact and conclusions of law. 1. The Court finds that the Agreement Regarding Disposition of Settlement Proceeds ("Disposition Agreement") is in the public interest and should be approved. The benefits of this agreement include certainty for the parties and movants as well as judicial economy. 2. Therefore, the Court approves and adopts the Disposition Agreement, attached hereto and incorporated herein, as an enforceable judgment of this Court. The parties and movants are ordered to comply with all terms and conditions contained in the Disposition Agreement. - -------------- (1)Dallas County, Dallas County Hospital District, El Paso County, El Paso County Hospital District, Harris County, Harris County Hospital District, Montgomery County Hospital District, Nueces County, Nueces County Hospital District, and Tarrant County Hospital District. 3. The Court further finds, as it has previously found, that the Attorney General brought this suit on behalf of the State in its quasi-sovereign capacity. SEE MEMORANDUM OPINION AND ORDER RE: DEFENDANTS' MOTION TO DISMISS COUNTS 1-3 AND COUNTS 4-17 OF THE STATE'S SECOND AMENDED COMPLAINT at 5 (Sept. 8, 1997). 4. The January 16, 1998, Comprehensive Settlement Agreement and Release (the "CSA") negotiated by the parties and approved by the Court defines the "State of Texas" to include "all of its officers acting in their official capacities and any department, subdivision or agency of the State, regardless of whether a named plaintiff". Paragraph 14 of the CSA further provides that the Waiver and Release given pursuant to paragraph 14 of the CSA constitutes a release of claims of "the State of Texas (including any of its past, present or future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions, divisions, subdivisions (political and otherwise), public entities, corporations, instrumentalities and educational institutions, and whether or not any such person or entity participates in the settlement)". 5. The Court further finds and declares that during the litigation of this action and the negotiation of the CSA, the Attorney General, acting on behalf of the State in its quasi-sovereign capacity, had the authority to and did adequately represent the State of Texas and the persons and entities enumerated in paragraph 14 of the CSA (as quoted in the preceding paragraph of this Order) (the "Releasing Parties"), including, without limitation, all political subdivisions and hospital districts of the State of Texas. Accordingly, the Court further finds and declares that all Releasing Parties are encompassed within and bound by the release provided pursuant to the CSA, that all Releasing Parties are further encompassed within and bound by the Court's January 22, 1998 Final Judgment approving and incorporating the CSA, and that all Released Claims (as defined in paragraph 14 of the CSA) of the Releasing Parties were fully and finally compromised, settled and released by the CSA. 6. The Court also grants the Movants' request that the Political Subdivisions withdraw their motions to intervene and all other motions with prejudice to refiling. All motions filed by the Political Subdivisions are hereby dismissed with prejudice. 7. It is further ordered that this Court shall have exclusive jurisdiction over the provisions of this Order and the Final Judgment in this case. All persons in privity with the parties, including all persons represented by the parties, who seek to raise any objections or challenges in any forum to any provision of this Judgment are hereby enjoined from proceeding in any other state or federal court. SEE, E.G., IN RE CORRUGATED CONTAINER ANTITRUST LITIGATION, 659 F.2d 1332, 1334-35 (5th Cir. 1981), CERT. DENIED, 456 U.S. 936 (1982); SOUTHWEST AIRLINES CO. V. TEXAS INTERNATIONAL AIRLINES, INC., 546 F.2d 84, 91 (5th Cir.), CERT. DENIED, 434 U.S. 832 (1977) 8. The Political Subdivisions' withdrawal of all their motions with prejudice leaves undisturbed the entirety of the merits of the January 22, 1998, Final Judgment in this cause. The Court's January 22, 1998, Final Judgment disposed of all claims in the underlying suit. It is therefore is a "final decision" as a matter of federal law under 28 U.S.C. Section 1291. SIGNED JULY 24, 1998. /s/ David Folsom ------------------------------ DAVID FOLSOM UNITED STATES DISTRICT JUDGE EXHIBIT 3 MFN ESCROW AGREEMENT This escrow agreement (the "MFN Escrow Agreement") is entered into as of July __, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company (collectively and severally, "MFN Settling Defendants" and each individually a "MFN Settling Defendant"), the State of Texas and __________ Bank, N.A., as escrow agent (the "MFN Escrow Agent"). WITNESSETH: WHEREAS, the State of Texas and Settling Defendants entered into a comprehensive settlement agreement and release as of January 16, 1998 (the "Settlement Agreement"), setting forth the terms and conditions of an agreement to settle and resolve with finality all present and future claims relating to the subject matter of the litigation entitled State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action"), in the United States District Court for the Eastern District of Texas (the "Court"); WHEREAS, the State of Texas and Settling Defendants entered into a Stipulation of Amendment to Settlement Agreement and for Entry of Consent Decree (the "Stipulation of Amendment") on July 24, 1998, paragraph 17 of which provides for Court approval of the Stipulation of Amendment and the entry by the Court of the Political Subdivisions Order attached to the Stipulation of Amendment as Exhibit 2 thereto; WHEREAS, the Stipulation of Amendment provides that, on the dates specified therein, each MFN Settling Defendant shall severally pay to the State of Texas, pro rata in proportion to its Market Share, its respective share of the amounts indicated for each date; WHEREAS, paragraph 17 of the Stipulation of Amendment further provides that all payments described in the Stipulation of Amendment shall be paid into a special escrow account (and if so paid shall remain in said escrow account) until such time as (1) the 30 day periods for appeal or to seek review of the Court's order approving this Stipulation of Amendment and the Court's entry of the Political Subdivisions Order have expired without the filing of any notice of appeal or petition for review; or (2) in the event of any such appeal or petition, the appeal or the petition has been dismissed or the order in question has been affirmed in all material respects by the court of last resort to which such appeal or EXHIBIT 3 petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review (the "Availability Date"); and WHEREAS, the parties hereto believe that at least one of the payments described in the preceding paragraphs may be made prior to the Availability Date: NOW, THEREFORE, the parties hereto agree as follows: SECTION 1. Appointment of MFN Escrow Agent. MFN Settling Defendants and the State of Texas hereby appoint the MFN Escrow Agent to act as escrow agent on the terms and conditions set forth herein, and the MFN Escrow Agent hereby accepts such appointment on such terms and conditions. SECTION 2. Deposit. In the event that any payment pursuant to the Stipulation of Amendment becomes due on a date prior to the Availability Date, each MFN Settling Defendant shall severally deliver to the MFN Escrow Agent in immediately available funds such MFN Settling Defendant's respective share of the payment in question (the sum of such shares being the "Initial Deposit"). Upon receipt, the MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow account established for such purpose and governed by the terms of this MFN Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to the Stipulation of Amendment that becomes due prior to the Availability Date shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the Initial Deposit and any subsequent payments deposited into the MFN Escrow Account, including any payments of interest or other income on investment of the MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and shall be governed by the terms of this MFN Escrow Agreement. All such deliveries of funds are subject to the right of MFN Settling Defendants to obtain, pursuant to section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN Escrow Amount (less appropriate deductions for administrative fees and expenses, including taxes and other related costs) in the event that the Stipulation of Amendment is cancelled and terminated pursuant to paragraph 17 of the Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested and disbursed by the MFN Escrow Agent strictly in accordance with this MFN Escrow Agreement. 2 EXHIBIT 3 SECTION 3. Investment of MFN Escrow Amount. The MFN Escrow Agent shall invest and reinvest the MFN Escrow Amount in either (i) direct obligations of, or obligations the principal and interest on which are unconditionally guaranteed by, the United States of America (including government-sponsored agencies) or the State of Texas; (ii) repurchase agreements fully collateralized by securities of the kind specified in clause (i) above; (iii) money market accounts maturing within 30 days of the acquisition thereof and issued by a bank or trust company organized under the laws of the United States of America or a State thereof (a "United States Bank") and having a combined capital surplus in excess of $250,000,000; or (iv) demand deposits with any United States Bank or any federal savings and loan institution having a combined capital surplus in excess of $250,000,000. Any loss on any such investment, including, without limitation, any penalty for any liquidation required to fund a disbursement, shall be borne pro rata by the parties in proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN Escrow Agent's fees and all expenses, including taxes and other related costs, shall, to the extent possible, be paid out of income earned. Whenever the MFN Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as provided herein, the MFN Escrow Agent shall also pay to such party all interest and profits earned to the date of payment on such amount, less deductions for fees and all expenses, including taxes and other related fees. SECTION 4. Release of the MFN Escrow Amount. After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as set forth below: (a) Following receipt of written notice signed by counsel for the MFN Settling Defendants certifying that such notice has been delivered by counsel for the MFN Settling Defendants to all parties hereto and stating that the Stipulation of Amendment has not received court approval or has been canceled, terminated or has otherwise become null and void for any reason, the MFN Escrow Agent shall upon the expiration of ten (10) business days following the MFN Escrow Agent's receipt of notice, and without an order of the Court, disburse the entire MFN Escrow Amount (including any interest thereon, as provided in Section 3) to the MFN Settling Defendants on the same pro rata basis as such funds were contributed to the MFN Escrow Account. 3 EXHIBIT 3 (b) Upon receipt of (i) written notice signed by counsel for the MFN Settling Defendants and counsel for the State of Texas stating that the Availability Date has occurred and (ii) an order of the Court so directing, the MFN Escrow Agent shall proceed to distribute the MFN Escrow Amount in accordance with such Court order. (c) For its services, the MFN Escrow Agent shall receive fees in accordance with the MFN Escrow Agent's customary fees in similar matters. All such fees shall constitute a direct charge against the MFN Escrow Amount, but the MFN Escrow Agent shall not debit the MFN Escrow Amount for any such charge until it shall have presented its statement to and received approval by counsel for the MFN Settling Defendants and counsel for the State of Texas, which approval shall not be unreasonably withheld. Such approval shall be deemed given if the MFN Escrow Agent has not received written objections from either counsel for MFN Settling Defendants or counsel for the State of Texas within 30 days after presentment of its statement. Such fees and all expenses charged against the MFN Escrow Amount shall, to the extent possible, be paid out of interest earned. In the event that counsel for MFN Settling Defendants or counsel for the State of Texas objects in writing to such fees, the MFN Escrow Agent shall not debit the MFN Escrow Amount except upon a court order approving such fees. SECTION 5. Substitute Form W-9; Qualified Settlement Fund. Each of the signatories to this MFN Escrow Agreement shall provide the MFN Escrow Agent with a correct taxpayer identification number on a substitute Form W-9 within 90 days of the date hereof and indicate thereon that it is not subject to backup withholding. It is anticipated that the MFN Escrow Account established pursuant to this MFN Escrow Agreement shall be treated as a Qualified Settlement Fund for federal tax purposes pursuant to Treas. Reg. ss. 1.468B-1. SECTION 6. Termination of MFN Escrow Account. This MFN Escrow Agreement (other than the MFN Escrow Agent's right to indemnification set forth in Section 7) shall terminate when the MFN Escrow Agent shall have released from the MFN Escrow Account all amounts pursuant to Section 4 hereof. 4 EXHIBIT 3 SECTION 7. MFN Escrow Agent. (a) The MFN Escrow Agent shall have no duty or obligation hereunder other than to take such specific actions as are required of it from time to time under the provisions hereof, and it shall incur no liability hereunder or in connection herewith for anything whatsoever other than as a result of its own negligence or willful misconduct. In the event the MFN Escrow Agent fails to receive the instructions contemplated by Section 4 hereof or receives conflicting instructions, the MFN Escrow Agent shall be fully protected in refraining from acting until such instructions are received or such conflict is resolved by written agreement or court order. (b) MFN Settling Defendants, on the same pro rata basis as the funds constituting the MFN Escrow Amount were contributed to the MFN Escrow Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent from and against any and all losses, claims, liabilities and reasonable expenses, including the reasonable fees of its counsel, which it may suffer or incur hereunder or in connection herewith prior to the Availability Date, except such as shall result solely and directly from its own negligence or willful misconduct. The MFN Escrow Agent shall not be bound in any way by any agreement or contract between MFN Settling Defendants and the State of Texas (whether or not the MFN Escrow Agent has knowledge thereof) and the only duties and responsibilities of the MFN Escrow Agent shall be to hold and invest the MFN Escrow Amount received hereunder and to release such MFN Escrow Amount in accordance with the terms of this MFN Escrow Agreement. (c) The MFN Escrow Agent may resign at any time by giving written notice thereof to the other parties hereto, but such resignation shall not become effective until a successor MFN Escrow Agent, selected by the MFN Settling Defendants and agreeable to the State of Texas, shall have been appointed and shall have accepted such appointment in writing. If an instrument of acceptance by a successor MFN Escrow Agent shall not have been delivered to the MFN Escrow Agent within 30 days after the giving of such notice of resignation, the resigning MFN Escrow Agent may, at the expense of MFN Settling Defendants and the State of Texas (to be shared equally between the State of Texas and the MFN Settling Defendants), petition the Court for the appointment of a successor MFN Escrow Agent. 5 EXHIBIT 3 (d) Upon the Availability Date having occurred, provided that MFN Settling Defendants have performed all of their obligations required to be performed prior to the Availability Date, all duties and obligations of MFN Settling Defendants hereunder shall cease, with the exception of any indemnification obligation of MFN Settling Defendants incurred prior to the Availability Date. SECTION 8. Miscellaneous. (a) Notices. All notices or other communications to any party or other person hereunder shall be in writing (which shall include telex, telecopy or similar writing) and shall be given to the respective parties or persons at the following addresses. Any party or person may change the name and address of the person designated to receive notice on behalf of such party or person by notice given as provided in this paragraph. State of Texas: Hon. Dan Morales Office of the Attorney General P.O. Box 12548 Capitol Station Austin, TX 78711 (512) 463-2063 With a copy to: Walter Umphrey Provost & Umphrey 490 Park Street P.O. Box 4905 Beaumont, TX 77704 Fax: (409) 838-8888 6 EXHIBIT 3 Settling Defendants: Philip Morris Incorporated: R.J. Reynolds Tobacco Company: Martin J. Barrington, Esq. Charles A. Blixt, Esq. Philip Morris Incorporated R.J. Reynolds Tobacco Company 120 Park Avenue 401 North Main Street New York, NY 10017-5592 Winston-Salem, NC 27102 Fax: (212) 907-5399 Fax: (336) 741-2998 With a copy to: With a copy to: Meyer G. Koplow, Esq. Arthur F. Golden, Esq. Wachtell, Lipton, Rosen & Katz Davis Polk & Wardwell 51 West 52nd Street 450 Lexington Avenue New York, NY 10019 New York, NY 10017 Fax: (212) 403-2000 Fax: (212) 450-4800 For Brown & Williamson Tobacco Lorillard Tobacco Company: Corporation: Michael Walter Arthur J. Stevens, Esq. Brown & Williamson Tobacco Corp. Lorillard Tobacco Company 200 Brown & Williamson Tower 714 Green Valley Road 401 South Fourth Avenue Greensboro, NC 27408 Louisville, KY 40202 Fax: (336) 335-7707 Fax: (502) 568-7187 With a copy to: F. Anthony Burke Brown & Williamson Tobacco Corporation 200 Brown & Williamson Tower 401 South Fourth Avenue Louisville, KY 40202 Fax: (502) 568-7187 MFN Escrow Agent: _________________ Bank, N.A. Phone: Fax: Wire Transfer Instructions: ABA #: Account #: Account Name: 7 EXHIBIT 3 (b) Successors and Assigns. The provisions of this MFN Escrow Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. (c) Governing Law. This MFN Escrow Agreement shall be construed in accordance with and governed by the laws of the State of Texas, without regard to the conflicts of law rules of such state. (d) Jurisdiction and Venue. The parties hereto irrevocably and unconditionally submit to the jurisdiction of the United States District Court for the Eastern District of Texas for purposes of any suit, action or proceeding seeking to enforce any provision of, or based on any right arising out of, this MFN Escrow Agreement, and the parties hereto agree not to commence any such suit, action or proceeding except in such Court. The parties hereto hereby irrevocably and unconditionally waive any objection to the laying of venue of any such suit, action or proceeding in the Court and hereby further irrevocably waive and agree not to plead or claim in such Court that any such suit, action or proceeding has been brought in an inconvenient forum. (e) Definitions. Terms used herein that are defined in the Settlement Agreement or the Stipulation of Amendment are, unless otherwise defined herein, used in this MFN Escrow Agreement as defined in the Settlement Agreement or the Stipulation of Amendment, as appropriate. (f) Amendments. This MFN Escrow Agreement may be amended only by written instrument executed by all parties hereto. The waiver of any rights conferred hereunder shall be effective only if made by written instrument executed by the waiving party. The waiver by any party of any breach of this MFN Escrow Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this MFN Escrow Agreement. (g) Counterparts; Effectiveness. This MFN Escrow Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This MFN Escrow Agreement shall become effective when each party hereto shall have signed a counterpart hereof. Delivery by facsimile of a signed agreement shall be deemed delivery for 8 EXHIBIT 3 purposes of acknowledging acceptance hereof; however, an original executed signature page must promptly thereafter be appended to this MFN Escrow Agreement, and an original executed agreement shall promptly thereafter be delivered to each party hereto. (h) Captions. The captions herein are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as of the day and year first hereinabove written. STATE OF TEXAS By: ------------------------------- Dan Morales Attorney General PHILIP MORRIS INCORPORATED By: ------------------------------- Meyer G. Koplow Counsel 9 EXHIBIT 3 R.J. REYNOLDS TOBACCO COMPANY By: ------------------------------- Arthur F. Golden Counsel BROWN & WILLIAMSON TOBACCO CORPORATION By: ------------------------------- Stephen R. Patton Counsel LORILLARD TOBACCO COMPANY By: ------------------------------- Arthur J. Stevens Senior Vice President & General Counsel 10 EXHIBIT 3 _____________________ BANK, N.A. as MFN Escrow Agent By: ------------------------------- Name: Title: 11 EX-10.5 6 TEXAS FEE PAYMENT AGREEMENT Exhibit 10.5 TEXAS FEE PAYMENT AGREEMENT This Texas Fee Payment Agreement (the "Agreement") is entered into as of July 24, 1998, by and among Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation, Lorillard Tobacco Company and United States Tobacco Company (collectively and severally "Settling Defendants" and each individually a "Settling Defendant"), Walter Umphrey, John M. O'Quinn, P.C., John Eddie Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm and Ness, Motley, Loadholt, Richardson & Poole (collectively, "Private Counsel"), the Law Offices of Marc D. Murr, P.C. ("Other Texas Counsel") and the State of Texas, in connection with the lawsuit State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action"). WITNESSETH: WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants entered into a comprehensive settlement agreement to settle and resolve with finality all present and future civil claims relating to the subject matter of the Action (the "Settlement Agreement"), which Settlement Agreement was approved by the United States District Court for the Eastern District of Texas (the "Court") and adopted as an enforceable order of the Court pursuant to Court Order dated January 22, 1998. WHEREAS, paragraph 17 of the Settlement Agreement and Exhibit 1 thereto provide that Settling Defendants shall pay reasonable attorneys' fees to Private Counsel and Other Texas Counsel (collectively "Texas Counsel"), in an amount set by arbitration, subject to an appropriate annual cap on all such payments of attorneys' fees by Settling Defendants, as well as other conditions set forth therein; WHEREAS, paragraph 16 of the Settlement Agreement contains a "Most Favored Nation" clause which provides that, in the event that Settling Defendants enter into a future pre-verdict settlement agreement of other litigation brought by a non-federal governmental plaintiff on terms more favorable to such governmental plaintiff than the terms of the Settlement Agreement (after due consideration of relevant differences in population or other appropriate factors), the terms of the Settlement Agreement shall be revised so that the State of Texas will obtain treatment at least as relatively favorable as any such non-federal governmental entity; WHEREAS, on May 8, 1998, certain Settling Defendants entered into a pre-verdict settlement agreement with the State of Minnesota (the "Minnesota Settlement"), which includes provisions for payment of attorneys' fees to private counsel for the State of Minnesota; WHEREAS, on July 24, 1998, Settling Defendants and the State of Texas entered into a Stipulation of Amendment to Settlement Agreement and for Entry of Consent Decree (the "Stipulation of Amendment") to resolve any disputes with respect to the Most Favored Nation clause of the Settlement Agreement, including any disputes regarding payment of attorneys' fees, in light of the Minnesota Settlement; and WHEREAS, Settling Defendants, the State of Texas and Texas Counsel, in order to resolve any disputes with respect to paragraphs 16 and 17 of the Settlement Agreement, and to describe more fully the procedures that will govern Settling Defendants' payment of fees to Texas Counsel, have agreed to the terms of this Agreement: NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual agreement to the terms of this Agreement, the State of Texas's and Settling Defendants' mutual agreement to the terms of the Stipulation of Amendment, and such other consideration described herein, including the release of certain claims against Settling Defendants, the sufficiency of which is hereby acknowledged, the parties hereto, acting by and through their authorized agents, memorialize and agree as follows: SECTION 1. Agreement to Pay Fees. Settling Defendants will pay reasonable attorneys' fees to Texas Counsel (as identified by the Attorney General pursuant to section 21 hereof) for their representation of the State of Texas in connection with the Action. The amount of such fees will be set by a panel of three independent arbitrators (the "Panel") whose decisions as to the amount of fees to be paid in connection with this Agreement ("Fee Award(s)") shall be final and not appealable. The procedures governing Settling Defendants' obligation to pay any such Fee Awards, including the procedures for making, and the timing of payments in satisfaction of, such Fee Awards shall be as provided herein. 2 SECTION 2. Aggregate National Caps on Payment of Certain Fees. Settling Defendants' payment of any Fee Award pursuant to this Agreement shall be subject to the payment schedule and the annual and quarterly aggregate national caps specified in sections 13, 14, 15 and 16 hereof, which shall apply to: (a) all payments of attorneys' fees pursuant to an award arbitrated by the Panel ("Fee Award") in connection with the settlement of any tobacco and health cases (other than non-class action personal injury cases brought directly by or on behalf of a single natural person or the survivor of such person or for wrongful death, or any non-class action consolidation of two or more such cases) ("Tobacco Cases") on terms that provide for payment by Settling Defendants or other defendants acting in agreement with Settling Defendants (collectively, "Participating Defendants") of fees with respect to private counsel retained by the plaintiff in connection with any such case ("Outside Counsel"), subject to an annual cap on payment of all such fees; (b) all payments of attorneys' fees (other than fees for attorneys of Participating Defendants) pursuant to a Fee Award for activities in connection with Tobacco Cases resolved by operation of federal legislation that either (i) implements the terms of the June 20, 1997 Proposed Resolution (or a substantially equivalent federal program) (the "Proposed Resolution") or (ii) imposes an enforceable obligation on Participating Defendants to pay attorneys' fees with respect to Outside Counsel (any such legislation hereinafter referred to as "Federal Legislation"); and (c) all payments of attorneys' fees and certain other professional fees (other than fees for attorneys or agents of Participating Defendants) pursuant to a Fee Award for contributions made toward enacted Federal Legislation. In the event that Federal Legislation is enacted, the terms "Outside Counsel" and "Eligible Counsel" shall apply not only to persons otherwise falling within the definitions of such terms herein but also to all persons granted Fee Awards for such contributions (such persons being Eligible Counsel with respect to each month beginning with the month the Federal Legislation was enacted). Nothing in this Agreement shall be construed to require any Settling Defendant to pay Fee Awards in connection with any litigation other than the Action. 3 SECTION 3. Exclusive Obligation of Settling Defendants; Release. The provisions set forth herein constitute the entire obligation of Settling Defendants with respect to payment of attorneys' fees in connection with the Action and the exclusive means by which Texas Counsel may seek payment of fees by Settling Defendants in connection with the Action. The parties hereto acknowledge that the provisions for payment set forth herein are the entirety of Settling Defendants' obligations with respect to payment of attorneys' fees pursuant to paragraph 17 of the Settlement Agreement. The State of Texas agrees that Settling Defendants have no obligation to pay attorneys' fees pursuant to paragraph 17 of the Settlement Agreement with respect to any counsel other than Texas Counsel (as identified by the Attorney General pursuant to section 21 hereof), and that Settling Defendants have no other obligation to pay fees or otherwise compensate Texas Counsel, any other counsel or representative of the State of Texas or the State of Texas itself with respect to attorneys' fees in connection with the Action. Each Texas Counsel hereby irrevocably releases Settling Defendants and their respective present and former parents, subsidiaries, divisions, affiliates, officers, directors, employees, representatives, insurers, agents and attorneys (as well as the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing) from any and all claims that such counsel ever had, now has or hereafter can, shall or may have in any way related to the Action (including but not limited to any negotiations related to the settlement of the Action). The foregoing shall not be construed as a release of any person or entity as to any of the obligations undertaken in this Agreement in connection with a breach thereof. SECTION 4. No Effect on Texas Counsel's Fee Contracts. The State of Texas has entered into a contingent-fee contract with certain Private Counsel ("Private Counsel's Contract") and has entered into a fee contract with Other Texas Counsel ("Other Texas Counsel's Contract"). The rights and obligations, if any, of the parties to Private Counsel's Contract and Other Texas Counsel's Contract shall be unaffected by this Agreement. Those Private Counsel that are parties to Private Counsel's Contract shall not be deemed to have waived any rights under Private Counsel's Contract, nor shall Other Texas Counsel be deemed to have waived any rights under Other Texas Counsel's Contract, as a result of their acceptance of payments made pursuant to this Agreement. However, any Private Counsel Payments made in connection with this Action shall be credited against any amounts that may be due to Private Counsel that are parties to Private Counsel's Contract from the State of Texas under Private 4 Counsel's Contract, and any payments received pursuant to this Agreement by Other Texas Counsel shall be credited against any amounts that may be due to Other Texas Counsel from the State of Texas under Other Texas Counsel's Contract. SECTION 5. Composition of the Panel. (a) The first and the second members of the Panel shall both be permanent members of the Panel and, as such, will participate in the determination of all Fee Awards. The third Panel member shall not be a permanent Panel member, but instead shall be a state-specific member selected to determine Fee Awards on behalf of Outside Counsel retained in connection with litigation within a single state. Accordingly, the third, state-specific member of the Panel for purposes of determining Fee Awards with respect to litigation in the State of Texas shall not participate in any determination as to any Fee Award with respect to litigation in any other state (unless selected to participate in such determinations by such persons as may be authorized to make such selections under other agreements). (b) The members of the Panel shall be selected as follows: (i) The first member shall be a natural person selected by Participating Defendants, who shall advise Texas Counsel of the name of the person selected by October 8, 1998. (ii) The second member shall be a natural person selected by agreement of Participating Defendants and a majority of the members of a committee composed of the following members: Joseph F. Rice, Richard F. Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the Castano Plaintiffs' Legal Committee and, at the option of Participating Defendants, one additional representative to serve on behalf of counsel for any one or more states that, subsequent to the date hereof, enter into settlement agreements with Participating Defendants that provide for payment of such states' Outside Counsel pursuant to an arbitrated award of fees. Such second member shall be selected by October 1, 1998. (iii) The third, state-specific member for purposes of determining Fee Awards with respect to litigation in the State of Texas shall be a natural person selected by Private Counsel, who shall notify Settling 5 Defendants and Other Texas Counsel of the name of the person selected by October 15, 1998. SECTION 6. Commencement of Panel Proceedings. No application for a Fee Award shall be presented to the Panel or any Panel member until November 3, 1998. The Panel shall consider and render decisions on applications for Fee Awards in the order in which they are submitted or pursuant to notice by counsel having priority that they have ceded their place to others. In the event that more than one application for a Fee Award is submitted on the same date, the Panel shall consider and render decisions on such applications in the order in which their respective cases were settled. Private Counsel may seek permission from the Panel to make combined presentations of aspects of their respective applications. Settling Defendants shall not oppose any request to combine presentations of applications for Fee Awards in connection with the Action, the lawsuit In re Mike Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429 (Miss. Ch. Ct., Jackson County), or the lawsuit State of Florida v. American Tobacco Co., No. 95-1466 AH (15th Jud. Circuit, Palm Beach County). SECTION 7. Costs of Arbitration. All costs and expenses of the arbitration proceedings held by the Panel, including compensation of Panel members (but not including any costs, expenses or compensation of counsel making applications to the Panel), shall be borne by Settling Defendants in proportion to their respective Market Shares. SECTION 8. Application of Private Counsel. Private Counsel shall make a collective written application to the Panel for a single Fee Award (the "Private Counsel Fee Award") on November 3, 1998. All interested persons, including persons not parties hereto, may submit to the Panel any information that they wish; but interested persons not parties hereto may submit only written materials. The Panel shall consider all such submissions by any party hereto and may consider any such materials submitted by other interested persons. All written submissions relating to applications for a Fee Award in connection with the Action shall be served on all parties hereto by November 13, 1998. Presentations to the Panel shall, to the extent possible, be based on affidavit or video presentation rather than live testimony. The Panel shall preserve the confidentiality of any attorney work-product materials or other 6 similar confidential information that may be submitted. Settling Defendants will not take any position adverse to the amount of the Fee Award requested by Private Counsel, nor will they or their representatives express any opinion (even upon request) as to the appropriateness or inappropriateness of the amount of any proposed Private Counsel Fee Award. The undersigned outside counsel for Settling Defendants Philip Morris Incorporated and R.J. Reynolds Tobacco Company will appear, if requested, to provide information as to the nature and efficacy of the work of Private Counsel and to advise the Panel that they support a Private Counsel Fee Award of full reasonable compensation under the circumstances. SECTION 9. Award of Fees to Private Counsel. The members of the Panel will consider all relevant information submitted to them in reaching a decision as to a Fee Award that fairly provides for full reasonable compensation of Private Counsel for their representation of the State of Texas in connection with the Action. The Panel shall determine the amount of the Private Counsel Fee Award for all Private Counsel collectively no later than December 10, 1998. Given the significance and uniqueness of the Action, the Panel shall not be limited to an hourly-rate or lodestar analysis in determining the amount of the Private Counsel Fee Award, but shall take into account the totality of the circumstances. In considering the amount of the Private Counsel Fee Award, the Panel shall not consider Fee Awards that already have been or yet may be awarded in connection with any other Tobacco Case. The Panel's decisions as to Fee Awards shall be in writing and shall report the amount of the fee awarded (with or without explanation or opinion, at the Panel's discretion). SECTION 10. Application of Other Texas Counsel. Other Texas Counsel may submit an application for a Fee Award separate from Private Counsel. The procedures, schedule and process with respect to such application on behalf of Other Texas Counsel shall be the same as the procedures, schedule and process set forth in sections 6, 7, 8 and 9 hereof with respect to the fee application on behalf of Private Counsel, except that Settling Defendants shall be in no way constrained from contesting Other Texas Counsel's entitlement to receive a Fee Award or the amount of the Fee Award requested by Other Texas Counsel. 7 SECTION 11. Allocation of Payments among Private Counsel. All payments (including advances) made by Settling Defendants with respect to the Private Counsel Fee Award pursuant to this Agreement ("Private Counsel Payments") shall be paid in the first instance to Walter Umphrey, Esq. (or such other person designated in writing by Private Counsel), on behalf of Private Counsel. Each Private Counsel shall be entitled to receive a percentage of such payment equal to the percentage of any fee recovery allocated to such Private Counsel under the terms of the fee-sharing agreement among Private Counsel (or any written amendment thereto). Settling Defendants shall have no obligation, responsibility or liability with respect to the allocation among Private Counsel, or with respect to any claim of misallocation, of any amounts of any Private Counsel Payment. SECTION 12. Advances on Payment of Fees. Each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of Private Counsel, its respective share of $50 million, as listed in Rider B to Exhibit 1 to the Settlement Agreement, as an advance against later Private Counsel Payments. On or before the later of July 31, 1998 or the fifth business day following entry by the Court of an order approving the Stipulation of Amendment, each Settling Defendant shall severally pay to Private Counsel, pro rata in proportion to its Market Share indicated on Schedule A hereto, its respective share of $50 million, as a further advance against later Private Counsel Payments. Each of the advances described in this section shall be credited as provided in section 16 hereof. SECTION 13. Annual Amount for 1998; Allocation. (a) For 1998, Settling Defendants shall pay, in the manner described in section 14 hereof, the unsatisfied amount of the Fee Awards (the "Unpaid Fees") of Texas Counsel, and those Participating Defendants so obligated shall make payments with respect to the Unpaid Fees of all other Outside Counsel, in an amount not to exceed $500 million for all such payments described in this subsection. (b) The amount payable by Settling Defendants with respect to each Fee Award for 1998 shall be determined as follows: The $500 million annual cap for 1998 shall be allocated equally among each month of the year. Except as provided in section 14(b) hereof, each monthly amount shall be allocated to those 8 Outside Counsel retained in connection with Tobacco Cases settled by Participating Defendants or resolved by Federal Legislation before or during such month, up to the amounts of their respective Unpaid Fees (such counsel being "Eligible Counsel" with respect to such monthly amount). In the event that the monthly amount is less than the sum of Eligible Counsel's Unpaid Fees, the monthly amount shall be allocated to Eligible Counsel in proportion to the amounts of their respective Unpaid Fees (the amount so allocated to each Eligible Counsel for a given month being such counsel's Allocable Share for such month, and the sum of each Outside Counsel's Allocable Shares for each month being such counsel's Allocable Share for 1998). (c) Settling Defendants represent that, as of the date of this Agreement, the only Tobacco Cases (other than the Action) that have been settled by Participating Defendants on terms that allow for Outside Counsel retained in connection with such cases to seek a Fee Award from the Panel are In re Mike Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429 (Miss. Ch. Ct., Jackson County), State of Florida v. American Tobacco Co., No. 95-1466 AH (15th Jud. Cir., Palm Beach County), and Mangini v. R.J. Reynolds Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County). In addition, Outside Counsel retained in connection with Mangini v. Brown & Williamson Tobacco Corp., No. 993893 (Cal. Super. Ct., San Francisco County), may under the terms of the settlement in that action "apply to participate in any national, reasonable, 'public benefit' fee award or arbitration process created by a 'national settlement' or 'Congressional Resolution.'" SECTION 14. Payments with Respect to Annual Amount for 1998. (a) On December 15, 1998, each Settling Defendant shall severally pay, pro rata in proportion to its Market Share, its share of an initial fee payment with respect to the Private Counsel Award and the Fee Award, if any, on behalf of Other Texas Counsel (the "Initial Texas Fee Payment"), which shall include Texas Counsel's Allocable Share for 1998 as provided in section 13 hereof for each month of 1998 except those with respect to which Texas Counsel's Allocable Share could not be determined as of December 8, 1998, as a result of there being other Eligible Counsel that, as of such date, had not yet been granted or denied a Fee Award by the Panel (either because such counsel's application for a Fee Award was still under consideration by the Panel or for any other reason). (b) On January 15, 1999, each Settling Defendant shall severally pay, pro rata in proportion to its Market Share, its share of Texas Counsel's Allocable 9 Share for those months of 1998 not included in the Initial Texas Fee Payment. Texas Counsel's Allocable Share for any such month shall be based on an allocation of the monthly amount among Eligible Counsel having Fee Awards as of December 31, 1998, without regard to whether there may be other Eligible Counsel that have not been granted or denied a Fee Award by the Panel as of such date. (c) Notwithstanding any provision of this Agreement, Private Counsel shall defer payment of the Private Counsel Payment due from Settling Defendant R.J. Reynolds Tobacco Company ("Reynolds") on December 15, 1998, insofar as necessary for the sum of all deferred amounts of any payments by Reynolds in 1998 with respect to Fee Awards to equal $62 million. Under no circumstances shall this subsection require any increase in any payment to be made by any other Settling Defendant. On January 5, 1999, Reynolds shall pay to Private Counsel the amount, if any, of the Initial Texas Fee Payment deferred pursuant to this subsection. SECTION 15. Quarterly Amounts for 1999 and Subsequent Years; Allocation. Within 10 business days after the end of each calendar quarter beginning with the first calendar quarter of 1999, Settling Defendants shall pay, in the manner provided in subsection (d) of this section, the Unpaid Fees of Texas Counsel, and those Participating Defendants so obligated shall make payments with respect to the Unpaid Fees of all other Outside Counsel, in an amount not to exceed $125 million for all such payments, as follows: (a) In the event that Federal Legislation has been enacted by the end of the calendar quarter with respect to which such quarterly payment is being made (the "Applicable Quarter"): (i) the quarterly amount shall be allocated among Outside Counsel, up to the amount of their respective Unpaid Fees. Each Outside Counsel shall be allocated an amount of each quarterly payment for the calendar year up to (or, in the event that the sum of such Outside Counsel's Unpaid Fees exceeds the quarterly amount, in proportion to) the amount of such Outside Counsel's Unpaid Fees. Each quarterly payment shall be allocated among Outside Counsel having Unpaid Fees, without regard to whether there are other Outside Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter. Subsequent quarterly payments shall be adjusted, if 10 necessary, to account for Outside Counsel that are granted Fee Awards in a subsequent quarter of the calendar year, as provided in paragraph (ii)(B) of this subsection. (ii) In the event that a quarterly payment for the calendar year is less than the sum of all Outside Counsel's Unpaid Fees: (A) in the case of the first such quarterly payment, the quarterly amount shall be allocated among Outside Counsel in proportion to the amounts of their respective Unpaid Fees. (B) in the case of a quarterly payment after the first quarterly payment that is less than the sum of all such Unpaid Fees, the quarterly amount shall be allocated only to those Outside Counsel, if any, that were not paid a proportionate share of all prior quarterly payments for the calendar year (either because such Outside Counsel's applications for Fee Awards were still under consideration as of the end of the calendar quarters with respect to which such quarterly payments were made or for any other reason), until each such Outside Counsel has been allocated a proportionate share of all prior quarterly payments. In the event that the sum of all such shares exceeds the amount of the quarterly payment, such payment shall be allocated among such Outside Counsel in proportion to the amounts of their respective Unpaid Fees (without regard to whether there are other Outside Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter). (b) In the event that Federal Legislation has not been enacted by the end of the Applicable Quarter: (i) the quarterly amount shall be allocated equally among each of the three months of the calendar quarter. The amount for each such month shall be allocated among those Outside Counsel retained in connection with Tobacco Cases settled before or during such month (such Outside Counsel being "Eligible Counsel" with respect to such monthly amount), each of whom shall be allocated a portion of each such monthly amount up to (or, in the event that the sum of Eligible Counsel's respective Unpaid Fees exceeds such monthly amount, in proportion to) the amount of such Eligible Counsel's Unpaid Fees. The monthly amount 11 for each month of the calendar quarter shall be allocated among Eligible Counsel having Unpaid Fees, without regard to whether there may be Eligible Counsel that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter. Subsequent quarterly payments shall be adjusted, as necessary, to account for Eligible Counsel that are granted Fee Awards in a subsequent quarter of the calendar year, as provided in paragraph (ii)(B) of this subsection. (ii) In the event that the amount for a given month is less than the sum of all Eligible Counsel's Unpaid Fees: (A) in the case of a first quarterly payment, such monthly amount shall be allocated among Eligible Counsel for such month in proportion to the amount of their respective Unpaid Fees. (B) in the case of a quarterly payment after the first quarterly payment, the quarterly amount shall be allocated among only those Outside Counsel, if any, that were Eligible Counsel with respect to any monthly amount paid in a prior quarter of the calendar year but were not allocated a proportionate share of such monthly amount (either because such counsel's applications for Fee Awards were still under consideration as of the end of the calendar quarter containing the month in question or for any other reason), until each such Eligible Counsel has been allocated a proportionate share of all such prior monthly payments for the calendar year. In the event that the sum of all such shares exceeds the amount of the quarterly payment, the quarterly payment shall be allocated among Eligible Counsel in proportion to the amounts of their respective Unpaid Fees (without regard to whether there may be other Eligible Counsel with respect to such prior monthly amounts that have not yet been granted or denied a Fee Award by the Panel as of the end of the Applicable Quarter). (c) Adjustments pursuant to paragraphs (a)(ii)(B) and (b)(ii)(B) of this section shall be made separately for each calendar year. No amounts paid in any calendar year shall be subject to refund, nor shall any payment in any given calendar year affect the allocation of payments to be made in any subsequent calendar year. 12 (d) Each Settling Defendant shall severally pay, pro rata in proportion to its respective Market Share, its share of the amounts, if any, allocated to Texas Counsel pursuant to this section. SECTION 16. Credits and Limitations. Notwithstanding any other provision of this Agreement, all payments by Settling Defendants with respect to Fee Awards shall be subject to the following: (a) The advances against future Private Counsel Payments described in section 12 hereof shall be credited against and shall reduce subsequent Private Counsel Payments, beginning with the first quarterly payment for 1999 pursuant to section 15 hereof, in an amount equal to 50% of the Private Counsel Payment in question, until the advances paid by Settling Defendants are fully credited; provided, however, that the sum of all such credits applied in any calendar year with respect to the advances made to Private Counsel described in section 12 hereof shall not exceed $50 million. The amount of any credit made against any such Private Counsel Payment shall be counted toward the annual and quarterly aggregate national caps on all payments made with respect to Outside Counsel, in the amount of the credit applied to any such Private Counsel Payment in any quarterly or annual period. All credits against Private Counsel Payments pursuant to this section shall be allocated among Settling Defendants in proportion to their respective contributions toward the amounts of the advances described in section 12 hereof. (b) Under no circumstances shall Settling Defendants be required to make payments that would result in aggregate national payments and credits by Participating Defendants with respect to Fee Awards: (i) during 1998, totaling more than $500 million, except insofar as payments to certain Outside Counsel with respect to 1997 are made in 1998, and except insofar as advances are made in 1998 against payments due in years after 1998; (ii) during any year beginning with 1999, totaling more than $500 million, excluding payments with respect to any Outside Counsel's Allocable Shares for 1998 that are paid in 1999; and (iii) during any calendar quarter beginning with the first calendar quarter of 1999, totaling more than $125 million, excluding payments with 13 respect to any Outside Counsel's Allocable Shares for 1998 that are paid in 1999 and except to the extent that payments and credits with respect to any prior quarter of the calendar year did not total $125 million. SECTION 17. Contribution to National Legislation. If Federal Legislation is enacted that implements the Proposed Resolution, a three-member national panel including the two permanent members of the Panel shall consider any application for Fee Awards on behalf of Outside Counsel for contributions made toward the enactment of such Federal Legislation, along with all applications for Fee Awards for professional fees by any other persons who claim to have made similar contributions (other than attorneys or agents of Participating Defendants). No person shall make more than one application for a Fee Award in connection with any such contributions toward enactment of such Federal Legislation. All payments with respect to such Fee Awards, if any, shall be paid on the payment schedule and subject to, and counted in computing, the annual and quarterly national caps described in sections 13, 14, 15 and 16 hereof. SECTION 18. Payments on Market Share Basis. All payments due hereunder shall be paid by Settling Defendants pro rata in proportion to their respective Market Shares as provided herein, and each Settling Defendant shall be severally liable for its share of all such payments. Due to the particular corporate structures of Settling Defendants R.J. Reynolds Tobacco Company ("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown & Williamson") with respect to their non-domestic tobacco operations, Settling Defendants Reynolds and Brown & Williamson shall be severally liable for their repsective shares of each payment due pursuant to this Agreement up to (and their liability hereunder shall not exceed) the full extent of their assets used in, and earnings and revenues derived from, their manufacture and sale in the United States of Tobacco Products intended for domestic consumption, and no recourse shall be had against any of their other assets or earnings to satisfy such obligations. Under no circumstances shall any payment due hereunder or any portion thereof become the joint obligation of Settling Defendants or the obligation of any party other than the Settling Defendant from which such payment is originally due, nor shall any Settling Defendant be required to pay a portion of any such payment greater than its respective Market Share. With respect to the advance to be paid pursuant to section 12 hereof, the Market Share of each Settling Defendant shall be as provided in Schedule A hereto. With respect to the amount for 1998 described in section 13 hereof, the Market Share of 14 each Settling Defendant shall be its respective share pursuant to Appendix A hereto for 1998. With respect to all other payments pursuant to this Agreement, each Settling Defendant's Market Share shall be its respective share pursuant to Appendix A hereto for the 12 month period ending on the last day of the calendar quarter immediately preceding the calendar quarter with respect to which such payment is made. SECTION 19. Determination of Market Share. In the event of a disagreement between or among any Settling Defendants as to their respective shares of any payment pursuant to this Agreement (except payments for which each Settling Defendant's Market Share is expressly provided herein), each Settling Defendant shall pay its undisputed share of such payment promptly, on or before the date on which such payment is due, and shall within 21 days submit copies of its audited reports of shipments of Tobacco Products provided to the U.S. Securities and Exchange Commission ("SEC") for the period in question (or, in the case of any Settling Defendant that does not provide such reports to the SEC, audited reports of shipments containing the same shipment information as contained in the reports provided to the SEC) ("Shipment Reports") to a third party to be selected by agreement of Settling Defendants (the "Third Party"), who shall within three business days determine the Market Share of each Settling Defendant. The decision of the Third Party shall be final and non-appealable, and shall be communicated by facsimile to each party hereto. Each Settling Defendant shall, within two business days of receipt of the Third Party's decision, pay Texas Counsel or such other Settling Defendant, as appropriate, the difference, if any, between (1) the amount that such Settling Defendant has already paid with respect to the payment in question and (2) the amount of the payment in question that corresponds to such Settling Defendant's Market Share as determined by the Third Party, together with interest accrued from the original date on which the payment in question was due, at the prime rate as published in the Wall Street Journal on the latest publication date on or before the original date on which the payment in question was due plus 3%. SECTION 20. Limited Waiver as to Other Terms. In consideration of Settling Defendants' agreement to the terms hereof, each Texas Counsel hereby covenants and agrees that it will not argue in any forum (other than in proceedings before the Panel relating to their Fee Award application) that the arrangements made in connection with the Florida Settlement, the Mississippi Settlement or the Minnesota Settlement for payment 15 of fees to Outside Counsel for the States of Florida, Mississippi or Minnesota give rise to any claim or entitlement on the part of Texas Counsel (or any other person) in connection with this Action. SECTION 21. State's Identification of Texas Counsel. The Attorney General represents and warrants that Schedule B hereto identifies all Texas Counsel. SECTION 22. Private Counsel's Costs. Settling Defendants have agreed to reimburse Private Counsel for reasonable costs and expenses incurred in connection with the Action, provided that such costs and expenses are of the same nature as costs and expenses for which Settling Defendants would reimburse their own counsel or agents. To this end, each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of Private Counsel, the respective amount listed for such Settling Defendant in Rider A to Exhibit 1 to the Settlement Agreement, the sum of such payments being $40 million, which equals Private Counsel's best estimate as of the date of the Settlement Agreement of such costs and expenses. Private Counsel shall provide Settling Defendants with an appropriately documented statement of their costs and expenses consistent with the criteria set forth above. Settling Defendants shall promptly pay the amounts of such costs and expenses in excess of $40 million, or shall receive a refund if the total of such costs and expenses is less than $40 million. Any dispute as to the nature or amount of reimbursable costs and expenses shall be decided with finality by the Panel. SECTION 23. Intended Beneficiaries. No part of this Agreement creates any rights on the part of, or is enforceable by, any person or entity that is not a party hereto or a person covered by the release described in section 3 hereof. Nor shall any part of this Agreement bind any non-party or determine, limit or prejudice the rights of any such person or entity. SECTION 24. Definitions. Terms used herein that are defined in the Settlement Agreement or the Stipulation of Amendment are, unless otherwise defined herein, used in this Agreement as defined in the Settlement Agreement or the Stipulation of Amendment, as applicable. 16 SECTION 25. Representations of Parties. The parties hereto hereby represent that this Agreement has been duly authorized and, upon execution, will constitute a valid and binding contractual obligation, enforceable in accordance with its terms, of each of the parties hereto. SECTION 26. No Admission. This Agreement is not intended to be and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of any liability or wrongdoing whatsoever on the part of any party hereto or any person covered by the release provided under section 3 hereof. Settling Defendants specifically disclaim and deny any liability or wrongdoing whatsoever with respect to the claims released under section 3 hereof and enter into this Agreement for the sole purposes of memorializing Settling Defendants' rights and obligations with respect to payment of attorneys' fees pursuant to the Settlement Agreement and avoiding the further expense, inconvenience, burden and uncertainty of potential litigation. SECTION 27. Non-admissibility. This Agreement having been undertaken by the parties hereto in good faith and for settlement purposes only, neither this Agreement nor any evidence of negotiations relating hereto shall be offered or received in evidence in any action or proceeding other than an action or proceeding arising under this Agreement. SECTION 28. Amendment and Waiver. This Agreement may be amended only by a written instrument executed by the Attorney General, Texas Counsel and Settling Defendants. The waiver of any rights conferred hereunder shall be effective only if made by written instrument executed by the waiving party. The waiver by any party of any breach of this Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this Agreement. SECTION 29. Notices. All notices or other communications to any party hereto shall be in writing (including but not limited to telex, telecopy or similar writing) and shall be given to the respective parties listed on Schedule C hereto at the addresses therein 17 indicated. Any party hereto may change the name and address of the person designated to receive notice on behalf of such party by notice given as provided in this section including an updated list conformed to Schedule C hereto. SECTION 30. Governing Law. This Settlement Agreement shall be governed by the laws of the State of Texas, without regard to the conflict of law rules of such State. SECTION 31. Construction. None of the parties hereto shall be considered to be the drafter of this Agreement or any provision hereof for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter hereof. SECTION 32. Captions. The captions of the sections of this Agreement are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. SECTION 33. Execution of Agreement. This Agreement may be executed in counterparts. Facsimile or photocopied signatures shall be considered valid signatures as of the date hereof, although the original signature pages shall thereafter be appended to this Agreement. SECTION 34. Certain Court Orders Conditions Precedent. The terms of this Agreement shall supersede the terms of Exhibit 1 to the Settlement Agreement, and the parties hereto will promptly file a joint motion requesting that the Court approve this Agreement. The parties further agree that Settling Defendants shall not be required to perform any obligation hereunder (excepting Settling Defendants' obligations with respect to the advance to be paid pursuant to section 12 hereof) until such time as (1) the Court issues an order declaring Exhibit 1 to the Settlement Agreement to be null, void and of no further effect; (2) the Court issues an order approving the Stipulation of Amendment; (3) the Court issues the Political Subdivisions Order in the form attached to the 18 Stipulation of Amendment as Exhibit 2 thereto; (4) the Court issues an order confirming that amounts payable to Texas Counsel pursuant to this Agreement are not funds of the State of Texas and are not subject to appropriation by the State of Texas and that Settling Defendants are under no obligation to pay such amounts to the State of Texas; (5) the 30-day periods to seek review of such orders have expired without the filing of any notice of appeal or petition for review; and (6) in the event of a timely appeal or petition, such appeal or petition has been dismissed or the order in question has been affirmed in all material respects by the court of last resort to which such appeal or petition has been taken and such dismissal or affirmance has become no longer subject to further appeal or review. SECTION 35. Entire Agreement of Parties. This Agreement contains an entire, complete and integrated statement of each and every term and provision agreed to by and among the parties hereto with respect to payment of attorneys' fees by Settling Defendants in connection with the Action and is not subject to any condition not provided for herein. IN WITNESS WHEREOF, the parties hereto, through their fully authorized representatives, have agreed to this Texas Fee Payment Agreement as of this 24th day of July, 1998. STATE OF TEXAS, acting by and through Dan Morales, its duly elected and authorized Attorney General By: /s/ Dan Morales ----------------------------------------- Dan Morales Attorney General 19 PHILIP MORRIS INCORPORATED By: /s/ Meyer G. Koplow -------------------------------- Meyer G. Koplow Counsel By: /s/ Martin J. Barrington by MGK -------------------------------- Martin J. Barrington General Counsel R.J. REYNOLDS TOBACCO COMPANY By: /s/ Arthur F. Golden -------------------------------- Arthur F. Golden Counsel By: /s/ Charles A. Blixt -------------------------------- Charles A. Blixt General Counsel 20 BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton ------------------------------------ Stephen R. Patton Counsel By: /s/ F. Anthony Burke ------------------------------------ F. Anthony Burke Vice President & General Counsel LORILLARD TOBACCO COMPANY By: /s/ Arthur J. Stevens by MGK ------------------------------------ Arthur J. Stevens Senior Vice President & General Counsel UNITED STATES TOBACCO COMPANY By: /s/ Richard H. Verheij ----------------------------------- Richard H. Verheij Executive Vice President & General Counsel 21 TEXAS COUNSEL By: /s/ Walter Umphrey ------------------------------------ Walter Umphrey Provost & Umphrey By: /s/ John M. O'Quinn, P.C. ------------------------------------ John M. O'Quinn, P.C. By: /s/ John Eddie Williams, Jr. ------------------------------------ John Eddie Williams, Jr. By: /s/ Wayne A. Reaud ------------------------------------ Wayne A. Reaud Reaud, Morgan & Quinn, Inc. By: /s/ Harold W. Nix ------------------------------------ Harold W. Nix The Nix Law Firm 22 By: /s/ Cary Patterson ------------------------------------ Cary Patterson The Nix Law Firm By: /s/ Marc D. Murr by Roy Q. Minton with permission ------------------------------------ Marc D. Murr Law Offices of Marc D. Murr, P.C. By: /s/ T. Richardson, Jr. ------------------------------------ For Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 1 APPENDIX A MARKET SHARE CALCULATION The Market Share of each Settling Defendant for purposes of any payment required hereunder shall be equal to the proportion of (1) such Settling Defendant's Aggregate Sales Volume for the period in question to (2) the sum of all Settling Defendants' Aggregate Sales Volumes for the period in question. For purposes of the foregoing: (a) Each Settling Defendant's Aggregate Sales Volume shall be the sum of such Settling Defendant's Sales Volumes with respect to each type of Tobacco Product. (b) Each Settling Defendant's Sales Volume with respect to each type of Tobacco Product shall be the number of Units of such type of Tobacco Product sold within the United States by such Settling Defendant during the period in question, as measured by such Settling Defendant's applicable Shipment Reports. (c) A Unit of Tobacco Product means: (1) one Cigarette; (2) .12 ounces of Moist Snuff; (3) .3 ounces of Loose Leaf, Plug, Twist, Roll or other form of chewing tobacco; (4) .25 ounces of Dry Snuff; and (5) .16 ounces of Loose Leaf tobacco suitable for user preparation of cigarettes. SCHEDULE A MARKET SHARE PERCENTAGES Settling Defendant Percentage - ------------------ -------------- Philip Morris Incorporated .................................49.26 R.J. Reynolds Tobacco Company...............................24.49 Brown & Williamson Tobacco Corp.............................16.20 Lorillard Tobacco Company....................................8.77 United States Tobacco Company................................1.28 ---------- TOTAL 100.00 SCHEDULE B DESIGNATION OF TEXAS COUNSEL by the Attorney General Pursuant to section 21 of the Texas Fee Payment Agreement, I hereby identify as Texas Counsel: (1) Walter Umphrey, John M. O'Quinn, P.C., John Eddie Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm and Ness, Motley, Loadholt, Richardson & Poole ("Private Counsel") and (2) the Law Offices of Marc D. Murr, P.C. ("Other Texas Counsel"). There are no other Texas Counsel entitled to seek any payment of attorneys' fees by Settling Defendants under the Settlement Agreement or the Texas Fee Payment Agreement. /s/ Dan Morales ----------------------------- Dan Morales Attorney General SCHEDULE C NOTICES State of Texas Hon. Dan Morales Attorney General P.O. Box 12548 Capitol Station Austin, TX 78711 Fax: (512) 463-2063 With copies to: Harold W. Nix Walter Umphrey Cary Patterson Provost & Umphrey The Nix Law Firm 490 Park Street 205 Linda Drive P.O. Box 4905 P.O. Box 679 Beaumont, TX 77704 Daingerfield, TX 75638 Fax: (409) 838-8888 Fax: (903) 645-5389 John M. O'Quinn John Eddie Williams, Jr. 440 Louisiana Street, Suite 2300 8441 Gulf Freeway, Suite 600 Houston, TX 77002 Houston, TX 77017 Fax: (713) 222-6903 Fax: (713) 649-0126 Wayne A. Reaud Marc D. Murr Reaud, Morgan & Quinn, Inc. Law Offices of Marc D. Murr, P.C 801 Laurel 1001 Texas Avenue, Suite 1250 Beaumont, TX 77701 Houston, TX 77002-3131 Fax: (409) 833-8236 Fax: (713) 229-8003 Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 151 Meeting Street, Suite 600 Charleston, SC 29402 Fax: (803) 720-9290 (continued) Settling Defendants Philip Morris Incorporated: R.J. Reynolds Tobacco Company: Martin J. Barrington, Esq. Charles A. Blixt, Esq. Philip Morris Incorporated R.J. Reynolds Tobacco Company 120 Park Avenue 401 North Main Street New York, NY 10017-5592 Winston-Salem, NC 27102 Fax: (212) 907-5399 Fax: (336) 741-2998 With a copy to: With a copy to: Meyer G. Koplow, Esq. Arthur F. Golden, Esq. Wachtell, Lipton, Rosen & Katz Davis Polk & Wardwell 51 West 52nd Street 450 Lexington Avenue New York, NY 10019 New York, NY 10017 Fax: (212) 403-2000 Fax: (212) 450-4800 Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company: F. Anthony Burke, Esq. Arthur J. Stevens, Esq. Brown & Williamson Tobacco Corp. Lorillard Tobacco Company 200 Brown & Williamson Tower 714 Green Valley Road 401 South Fourth Avenue Greensboro, NC 27408 Louisville, KY 40202 Fax: (336) 335-7707 Fax: (502) 568-7297 With a copy to: United States Tobacco Company: Stephen R. Patton, Esq. Richard H. Verheij Kirkland & Ellis UST Inc. 200 East Randolph Dr. 100 West Putnam Avenue Chicago, IL 60601 Greenwich, CT 06830 Fax: (312) 861-2200 Fax: (203) 863-7233 (continued) 2 Texas Counsel Walter Umphrey Wayne A. Reaud Provost & Umphrey Reaud, Morgan & Quinn, Inc. 490 Park Street 801 Laurel P.O. Box 4905 Beaumont, TX 77701 Beaumont, TX 77704 Fax: (409) 833-8236 Fax: (409) 838-8888 John Eddie Williams, Jr. John M. O'Quinn 8441 Gulf Freeway, Suite 600 440 Louisiana Street, Suite 2300 Houston, TX 77017 Houston, TX 77002 Fax: (713) 649-0126 Fax: (713) 222-6903 Harold W. Nix Marc D. Murr Cary Patterson Law Offices of Marc D. Murr, P.C. The Nix Law Firm 1001 Texas Avenue, Suite 1250 205 Linda Drive Houston, TX 77002-3131 P.O. Box 679 Fax: (713) 229-8003 Daingerfield, TX 75638 Fax: (903) 645-5389 Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 151 Meeting Street, Suite 600 Charleston, SC 29402 Fax: (803) 720-9290 3 EX-12 7 COMPUTATION OF RATIOS EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) --------------------
Six Months Ended Three Months Ended June 30, 1998 June 30, 1998 ---------------- ------------------ Earnings before income taxes $5,221 $2,902 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (104) (55) Dividends from less than 50% owned affiliates 71 43 Fixed charges 688 342 Interest capitalized, net of amortization (2) (1) ------ ------ Earnings available for fixed charges $5,874 $3,231 ====== ====== Fixed charges: Interest incurred: Consumer products $ 577 $ 286 Financial services 37 19 ------ ------ 614 305 Portion of rent expense deemed to represent interest factor 74 37 ------ ------ Fixed charges $ 688 $ 342 ====== ====== Ratio of earnings to fixed charges 8.5 9.4 ====== ======
EXHIBIT 12 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES Computation of Ratios of Earnings to Fixed Charges (in millions of dollars) --------------------
Years Ended December 31, ------------------------------------------------------------------------ 1997 1996 1995 1994 1993 -------- -------- -------- -------- ------ Earnings before income taxes and cumulative effect of accounting changes $10,611 $10,683 $ 9,347 $ 8,216 $ 6,196 Add (Deduct): Equity in net earnings of less than 50% owned affiliates (207) (227) (246) (184) (164) Dividends from less than 50% owned affiliates 138 160 202 165 151 Fixed charges 1,438 1,421 1,495 1,537 1,716 Interest capitalized, net of amortization (16) 13 2 (1) (13) ------- ------- ------- ------- ------- Earnings available for fixed charges $11,964 $12,050 $10,800 $ 9,733 $ 7,886 ======= ======= ======= ======= ======= Fixed charges: Interest incurred: Consumer products $ 1,224 $ 1,197 $ 1,281 $ 1,317 $ 1,502 Financial services and real estate 67 81 84 78 87 ------- ------- ------- ------- ------- 1,291 1,278 1,365 1,395 1,589 Portion of rent expense deemed to represent interest factor 147 143 130 142 127 ------- ------- ------- ------- ------- Fixed charges $ 1,438 $ 1,421 $ 1,495 $ 1,537 $ 1,716 ======= ======= ======= ======= ======= Ratio of earnings to fixed charges 8.3 8.5 7.2 6.3 4.6 ======= ======= ======= ======= =======
EX-27 8 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 June 30, 1998 and is qualified in its entirety by reference to such financial statements. 1,000,000 6-MOS DEC-31-1998 JUN-30-1998 4,605 0 5,466 173 9,119 20,857 20,595 8,740 59,363 15,976 13,127 0 0 935 15,087 59,363 37,361 37,361 13,590 22,009 9,649 0 482 5,221 2,103 3,118 0 0 0 3,118 1.28 1.28
EX-99 9 CERTAIN PENDING LITIGATION EXHIBIT 99 CERTAIN PENDING LITIGATION MATTERS AND RECENT DEVELOPMENTS As described in Note 3 ("Note 3") to the Condensed Consolidated Financial Statements included in Part I, Item 1, of this Quarterly Report on Form 10-Q, there are legal proceedings covering a wide range of matters pending in various U.S. and foreign jurisdictions against the Company, its subsidiaries and affiliates, including PM Inc. and PMI, and their respective 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. 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 cases brought by state and local governments seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking, as well as similar cases, including class actions, brought by non-governmental plaintiffs such as unions, HMOs, federal and state taxpayers, native American tribes and others. The following lists the pending claims included in the latter two of these categories. Certain developments in these cases since April 1, 1998 are also described. SMOKING AND HEALTH LITIGATION The following lists the smoking and health class actions pending against PM Inc. and, in some cases, the Company and/or its other subsidiaries and affiliates, including PMI, as of August 1, 1998, and describes certain developments since April 1, 1998. ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO CO., ET AL., CIRCUIT COURT, DADE COUNTY, FLORIDA, FILED MAY 5, 1994. Jury selection began in July 1998. In May 1998, the court denied defendants' motions for summary judgment as to plaintiffs' express and implied warranty claims, and defendants' motion for summary judgment against certain named plaintiffs. GRANIER, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED SEPTEMBER 26, 1994. CAPUTO (formerly LETOURNEAU) V. IMPERIAL TOBACCO LIMITED, ET AL., ONTARIO COURT OF JUSTICE, TORONTO, CANADA, FILED JANUARY 13, 1995. THE SMOKER HEALTH DEFENSE ASSOCIATION, ET AL. V. SOUZA CRUZ, S.A. AND PHILIP MORRIS MARKETING, S.A., 19TH LOWER CIVIL COURT OF THE CENTRAL COURTS OF THE JUDICIARY DISTRICT OF SAO PAULO, BRAZIL, FILED JULY 25, 1995. NORTON, ET AL. V. RJR NABISCO HOLDINGS CORPORATION, ET AL., SUPERIOR COURT, MADISON COUNTY, INDIANA, FILED MAY 3, 1996. RICHARDSON, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, BALTIMORE CITY, MARYLAND, FILED MAY 24, 1996. Trial is scheduled for September 1999. SCOTT, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., DISTRICT COURT, ORLEANS PARISH, LOUISIANA, FILED MAY 24, 1996. FROSINA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED JUNE 19, 1996. In July 1998, a New York appeals court 1 EXHIBIT 99 overturned the trial court's certification of the class, and dismissed the underlying claims, thus dismissing this case in its entirety. REED, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, DISTRICT OF COLUMBIA, FILED JUNE 21, 1996. BARNES (formerly ARCH), ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, PENNSYLVANIA, FILED AUGUST 8, 1996. LYONS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED AUGUST 8, 1996. HOLMES (formerly CROZIER) V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, MONTGOMERY COUNTY, ALABAMA, FILED AUGUST 8, 1996. In April 1998, the court denied defendants' motion to dismiss in most respects, but required plaintiffs to file an amended complaint to address certain deficiencies. Plaintiffs subsequently filed an amended complaint that deletes their health care cost reimbursement claims. The amended complaint seeks class certification on behalf of two subclasses, one directed to claims concerning youth smoking and to comprise minors and parents, and the second directed to antitrust claims and to comprise Alabama residents who have purchased tobacco products in Alabama during a period to be set by the court. Trial has been scheduled for August 1999. CHAMBERLAIN, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OHIO, FILED AUGUST 14, 1996. THOMPSON, ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES DISTRICT COURT, MINNESOTA, FILED SEPTEMBER 4, 1996. PERRY/CHAMPION, ET AL. V. AMERICAN TOBACCO CO., INC., ET AL., CIRCUIT COURT FOR COFFEE COUNTY, TENNESSEE, AT MANCHESTER, FILED SEPTEMBER 6, 1996. CONNOR, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SECOND JUDICIAL DISTRICT COURT, BERNALILLO COUNTY, NEW MEXICO, FILED OCTOBER 10, 1996. RUIZ, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, PUERTO RICO, FILED OCTOBER 23, 1996. HANSEN, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, ARKANSAS, FILED NOVEMBER 4, 1996. MCCUNE, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT OF KANAWHA COUNTY, WEST VIRGINIA, FILED JANUARY 31, 1997. BAKER, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, WAYNE COUNTY, MICHIGAN, FILED FEBRUARY 4, 1997. WOODS (formerly INGLE), ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, MCDOWELL COUNTY, WEST VIRGINIA, FILED FEBRUARY 4, 1997. GREEN (formerly EMIG), ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, KANSAS, FILED FEBRUARY 6, 1997. PETERSON, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, HAWAII, FILED FEBRUARY 6, 1997. 2 EXHIBIT 99 WALLS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OKLAHOMA, FILED FEBRUARY 6, 1997. In July 1998, the court ruled that plaintiffs' claims for breach of implied warranty are inappropriate for class treatment. SELCER, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NEVADA, FILED MARCH 3, 1997. INSOLIA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, WISCONSIN, FILED APRIL 21, 1997. Trial is scheduled for May 1999. WHITE, ET AL. V. PHILIP MORRIS, INC., ET AL., CHANCERY COURT, JEFFERSON COUNTY, MISSISSIPPI, FILED APRIL 18, 1997. GEIGER, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPREME COURT, QUEENS COUNTY, NEW YORK, FILED APRIL 30, 1997. In July 1998, the appellate court decertified the class and remanded the case back to the trial court for further proceedings on whether plaintiffs meet the requirements for class certification. The appellate court also dismissed plaintiffs' claims of negligent misrepresentation and implied warranties of merchantability and fitness to the extent based on a failure to warn after 1969. COLE, ET AL. V. THE TOBACCO INSTITUTE, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TEXAS, TEXARKANA DIVISION, FILED MAY 5, 1997. COSENTINO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, NEW JERSEY, FILED MAY 21, 1997. CLAY, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ILLINOIS, BENTON DIVISION, FILED MAY 22, 1997. In April 1998, the court vacated the August 1998 trial date, and scheduled the trial to begin during August 1999. ANDERSON, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TENNESSEE, FILED MAY 23, 1997. TAYLOR, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., CIRCUIT COURT, WAYNE COUNTY, MICHIGAN, FILED MAY 23, 1997. LYONS, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, GEORGIA, FILED MAY 27, 1997. KIRSTEIN (formerly ENRIGHT), ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT, CAMDEN COUNTY, NEW JERSEY, FILED MAY 28, 1997. TEPPER, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, BERGEN COUNTY, NEW JERSEY, FILED MAY 28, 1997. BROWN, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT, SAN DIEGO COUNTY, CALIFORNIA, FILED JUNE 10, 1997. LIPPINCOTT, ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT, CAMDEN COUNTY, NEW JERSEY, FILED JUNE 13, 1997. BRAMMER, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, IOWA, FILED JUNE 20, 1997. 3 EXHIBIT 99 KNOWLES, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED JUNE 30, 1997. DALEY, ET AL. V. AMERICAN BRANDS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED JULY 7, 1997. PISCITELLO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, NEW JERSEY, FILED JULY 28, 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. AMERICAN TOBACCO COMPANY, 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. YOUNG, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIVIL DISTRICT COURT, ORLEANS PARISH, STATE OF LOUISIANA, FILED NOVEMBER 12, 1997. AKSAMIT, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED STATES DISTRICT COURT, SOUTH CAROLINA, FILED NOVEMBER 20, 1997. DIENNO, ET AL. V. LIGGETT GROUP, INC., ET AL., UNITED STATES DISTRICT COURT, NEVADA, FILED DECEMBER 22, 1997. HERRERA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, CENTRAL DISTRICT, UTAH, FILED JANUARY 28, 1998. JACKSON, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, CENTRAL DISTRICT, UTAH, FILED FEBRUARY 13, 1998. PARSONS, ET AL. V. A C & S, INC., ET AL. CIRCUIT COURT, KANAWHA COUNTY, WEST VIRGINIA, FILED FEBRUARY 27, 1998. NATIONAL ASSOCIATION FOR ASSISTANCE TO CONSUMERS AND WORKERS V. SOUZA CRUZ S.A. AND PHILIP MORRIS BRASIL S.A., THE FIFTH COURT OF BANKRUPTCIES AND REORGANIZATIONS OF THE CAPITAL DISTRICT OF THE STATE OF RIO DE JANEIRO, BRAZIL, FILED MARCH 16, 1998. BASIK (formerly MENDYS), ET AL. V. LORILLARD TOBACCO COMPANY, ET AL., CIRCUIT COURT OF COOK COUNTY, ILLINOIS, FILED MARCH 17, 1998. DANIELS, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, CALIFORNIA, FILED APRIL 2, 1998. 4 EXHIBIT 99 CHRISTIANSON, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., UNITED STATES DISTRICT COURT, NEVADA, FILED APRIL 3, 1998. AVALLONE, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., NEW JERSEY SUPERIOR COURT, ATLANTIC COUNTY LAW DIVISION, FILED APRIL 23, 1998. COLLIER, ET AL. V. PHILIP MORRIS INCORPORATED, UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF MISSISSIPPI, FILED MAY 26, 1998. CLEARY, ET AL. V. PM INC., ET AL., CIRCUIT COURT, COOK COUNTY ILLINOIS, COUNTY LAW DEPARTMENT, LAW DIVISION, FILED JUNE 3, 1998. VAUGHAN, ET AL. V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT OF VIRGINIA, FILED JULY 30, 1998. ------------------------------------------------------------------------ HEALTH CARE COST RECOVERY LITIGATION The following lists the health care cost recovery actions pending against PM Inc. and, in some cases, the Company and/or its other subsidiaries and affiliates as of August 1, 1998, and describes certain developments since April 1, 1998. MOORE V. THE AMERICAN TOBACCO COMPANY, ET AL., CHANCERY COURT, JACKSON COUNTY, MISSISSIPPI, FILED MAY 23, 1994. The parties entered into a settlement agreement in July 1997 (see the Company's 1997 Form 10-K). In July 1998, the parties amended the settlement agreement (see Note 3. Contingencies hereto). STATE OF MINNESOTA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., DISTRICT COURT, RAMSEY COUNTY, MINNESOTA, FILED AUGUST 17, 1994. The parties entered into a settlement agreement in May 1998 (see the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). MCGRAW V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, KANAWHA COUNTY, WEST VIRGINIA, FILED SEPTEMBER 20, 1994. THE STATE OF FLORIDA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, PALM BEACH COUNTY, FLORIDA, FILED FEBRUARY 21, 1995. The parties entered into a settlement agreement in September 1997 (see the Company's 1997 Form 10-K). In April 1998, the court issued an order incorporating additional provisions into the settlement agreement pursuant to its "most favored nation" clause. The court order provides that the settling defendants are required to pay $50 million to the state's contingency fee counsel as an advance on attorneys' fees to be awarded in arbitration proceedings that will commence in November 1998. The court's order is under appeal. Also in April 1998, the court dismissed the remaining equitable claims without prejudice. COMMONWEALTH OF MASSACHUSETTS V. PHILIP MORRIS INC., ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, MASSACHUSETTS, FILED DECEMBER 19, 1995. In June 1998, the court ruled that a three-year statute of limitations applies to all of plaintiff's claims, except for those asserted under the Massachusetts Trade Practices Act, which are limited to four years. Trial is scheduled for February 1999. IEYOUB V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, LOUISIANA, FILED MARCH 13, 1996. 5 EXHIBIT 99 THE STATE OF TEXAS V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TEXAS, FILED MARCH 28, 1996. The parties entered into a settlement agreement in January 1998 (see the Company's 1997 Form 10-K). In July 1998, the parties amended the settlement agreement (see Note 3. Contingencies hereto). STATE OF MARYLAND V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, BALTIMORE CITY, MARYLAND, FILED MAY 1, 1996. Trial is scheduled for April 1999. In April 1998, the Maryland legislature amended the statute governing recovery for health care costs to permit the state to pursue claims for health care costs without proceeding via subrogation. The statute also permits the state to use a statistical model to prove causation and the amount of medical assistance expenditures attributable to the use of a tobacco product. The amendment took effect on July 1, 1998. STATE OF WASHINGTON V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, KING COUNTY, WASHINGTON, FILED JUNE 5, 1996. In July 1998, the court dismissed plaintiff's claim for restitution. The court denied defendants' motions seeking dismissal of plaintiff's other claims, including plaintiff's conspiracy claim, but it invited defendants to address the scope of permissible relief under the conspiracy claim by further motion at trial. The court also ordered that defendants may seek a damages offset for plaintiff's tobacco-related tax revenues and that defendants are entitled to challenge the methodology used by plaintiff in estimating its damages and to present alternate methodologies. The court also granted plaintiff's motion for summary judgment as to defendants' defenses that subrogation is plaintiff's exclusive remedy, but denied the motion as to defendants' defenses based on the comparative fault of individual smokers, holding that defendants must be permitted to meet plaintiff's allegations of misrepresentation, deception, and fraud by showing that individual smokers were not misled. Trial is scheduled for September 1998. CITY AND COUNTY OF SAN FRANCISCO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, CALIFORNIA, FILED JUNE 6, 1996. STATE OF CONNECTICUT V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, LITCHFIELD DISTRICT, CONNECTICUT, FILED JULY 18, 1996. In July 1998, plaintiff filed a motion that seeks prejudgment orders of attachment that attach assets in the amount of $2 billion of each tobacco company defendant, excluding Liggett, in order to secure the state's potential recovery. Plaintiff also filed a motion to bifurcate the case as to its claims under the Connecticut Unfair Trade Practices Act ("CUPTA"), and to set the case immediately for trial as to the injunctive relief claims under CUPTA. Defendants' motion to dismiss the CUPTA claims was denied in July 1998. COUNTY OF LOS ANGELES V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT, SAN DIEGO COUNTY, CALIFORNIA, FILED AUGUST 5, 1996. A trial on certain issues is scheduled for February 1999. In July 1998, the San Diego Superior Court recommended that this case be consolidated with certain other pending California cases. STATE OF ARIZONA V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, MARICOPA COUNTY, ARIZONA, FILED AUGUST 20, 1996. In June 1998, the court denied defendants' motion to dismiss a claim of negligent entrustment relating to the alleged sale of tobacco products to minors. Trial is scheduled for March 1999. 6 EXHIBIT 99 STATE OF KANSAS V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, SHAWNEE COUNTY, KANSAS, FILED AUGUST 20, 1996. KELLEY V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, INGHAM COUNTY, MICHIGAN, FILED AUGUST 21, 1996, BY THE ATTORNEY GENERAL OF MICHIGAN. In July 1998, the court granted defendants' motion to dismiss plaintiff's claim of breach of voluntary duty undertaken and plaintiff's exemplary damages claim, and denied the motion with respect to unjust enrichment as untimely. STATE OF OKLAHOMA, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, CLEVELAND COUNTY, OKLAHOMA, FILED AUGUST 22, 1996. In June 1998, the court granted defendants' motion for partial summary judgment on the state's unjust enrichment claim. The court also granted the state's motion for partial summary judgment against defendants' affirmative defenses of statute of limitations, unclean hands, estoppel and statute of repose. In July 1998, the court granted in part and denied in part defendants' motion for summary judgment on the state's public nuisance claim. The motion was granted to the extent the state's public nuisance claim was based on the lawful sale of cigarettes; it was denied to the extent the state's claim was based on defendants' alleged unlawful conduct. Also in July, the court denied defendants' motion for summary judgment on the state's claims for reimbursement of health care costs. The grounds for defendants' motion were (i) subrogation is the exclusive method of recovering the state's health care costs and (ii) the state is too remote a plaintiff. In August 1998, the court granted defendants' motion for partial summary judgment on the state's voluntary undertaking claim. Trial is scheduled for January 1999. PEOPLE OF THE STATE OF CALIFORNIA V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED SEPTEMBER 5, 1996. This action, based on state law consumer protection theories, is scheduled for trial in March 1999. In April 1998, the court issued an order striking defendants' equitable defenses and the defense of discriminatory prosecution. In July 1998, the San Diego Superior Court recommended that this case be consolidated with certain other pending California cases. STATE OF NEW JERSEY V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, NEW JERSEY, FILED SEPTEMBER 10, 1996. Trial is scheduled for May 1999. COYNE, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OHIO, FILED SEPTEMBER 17, 1996. PERRY, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, COFFEE COUNTY, TENNESSEE, FILED SEPTEMBER 30, 1996. STATE OF UTAH V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, CENTRAL DIVISION, UTAH, FILED SEPTEMBER 30, 1996. CITY OF NEW YORK, ET AL. V. THE TOBACCO INSTITUTE, ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED OCTOBER 17, 1996. PEOPLE OF THE STATE OF ILLINOIS V. PHILIP MORRIS, INC., ET AL., CIRCUIT COURT, COOK COUNTY, ILLINOIS, FILED NOVEMBER 12, 1996. STATE OF IOWA V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, FIFTH JUDICIAL DISTRICT, POLK COUNTY, IOWA, FILED NOVEMBER 27, 1996. In April 1998, the Iowa Supreme Court affirmed the trial court's dismissal of plaintiff's claims for deception, breach of assumed duty and indemnity. 7 EXHIBIT 99 COUNTY OF ERIE V. THE TOBACCO INSTITUTE, INC., ET AL., SUPREME COURT, ERIE COUNTY, NEW YORK, FILED JANUARY 14, 1997. STATE OF NEW YORK V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED JANUARY 21, 1997. Trial is scheduled for May 1999. STATE OF HAWAII V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., CIRCUIT COURT, FIRST CIRCUIT, HAWAII, FILED JANUARY 31, 1997. Trial is scheduled for September 1999. STATE OF WISCONSIN V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, DANE COUNTY, WISCONSIN, FILED FEBRUARY 5, 1997. Trial is scheduled for September 1999. STATE OF INDIANA V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, MARION COUNTY, INDIANA, FILED FEBRUARY 19, 1997. In July 1998, the trial court dismissed this case in its entirety. STATE OF ALASKA V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, FIRST JUDICIAL DISTRICT, ALASKA, FILED APRIL 14, 1997. In April 1998, the court granted defendants' motion to dismiss plaintiff's claims for public nuisance (with leave to amend), unjust enrichment, restitution and breach of special duty. Defendants' motion was denied with respect to claims for violations of antitrust and consumer protection statutes, negligence PER SE and conspiracy. Trial is scheduled for February 2000. COUNTY OF COOK V. PHILIP MORRIS, INCORPORATED, ET AL., CIRCUIT COURT, COOK COUNTY, ILLINOIS, FILED APRIL 18, 1997. COMMONWEALTH OF PENNSYLVANIA V. PHILIP MORRIS, INC., ET AL., COURT OF COMMON PLEAS, PHILADELPHIA COUNTY, PENNSYLVANIA, FILED APRIL 23, 1997. STATIONARY ENGINEERS LOCAL 39 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, CALIFORNIA, FILED APRIL 25, 1997. In April 1998, the court granted defendants' motion to dismiss with prejudice the RICO claims, the state and federal antitrust claims, the intentional breach of special duty claim, the unfair business practices claim, and the restitution and unjust enrichment claim. The court dismissed without prejudice plaintiff's claim for fraud and misrepresentation. The court denied defendants' motion to dismiss plaintiff's claim for negligent breach of special duty. STATE OF ARKANSAS V. THE AMERICAN TOBACCO COMPANY, ET AL., CHANCERY COURT, SIXTH DIVISION, PULASKI COUNTY, ARKANSAS, FILED MAY 5, 1997. STATE OF MONTANA V. PHILIP MORRIS, INCORPORATED, ET AL., FIRST JUDICIAL COURT, LEWIS AND CLARK COUNTY, MONTANA, FILED MAY 5, 1997. STATE OF OHIO V. PHILIP MORRIS, INCORPORATED, ET AL., COURT OF COMMON PLEAS, FRANKLIN COUNTY, OHIO, FILED MAY 8, 1997. Trial is scheduled for May 2000. STATE OF TENNESSEE ET AL., EX. REL. BECKOM, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TENNESSEE, FILED MAY 8, 1997. STATE OF MISSOURI V. AMERICAN TOBACCO COMPANY, INC., ET AL., CIRCUIT COURT, CITY OF ST. LOUIS, MISSOURI, FILED MAY 12, 1997. Trial is scheduled for January 2000. 8 EXHIBIT 99 STATE OF SOUTH CAROLINA V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., COURT OF COMMON PLEAS, RICHLAND COUNTY, SOUTH CAROLINA, FILED MAY 12, 1997. IRON WORKERS LOCAL UNION NO. 17 INSURANCE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OHIO, EASTERN DIVISION, FILED MAY 20, 1997. Trial is scheduled for February 1999. NORTHWEST LABORERS-EMPLOYERS HEALTH AND SECURITY TRUST FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, WASHINGTON, FILED MAY 21, 1997. Trial is scheduled for September 1999. STATE OF NEVADA V. PHILIP MORRIS, INCORPORATED, ET AL., SECOND JUDICIAL DISTRICT, WASHOE COUNTY, NEVADA, FILED MAY 21, 1997. In April 1998, the court granted defendants' motion to dismiss plaintiff's claims for targeting minors in violation of the Nevada Deceptive Trade Practices Act, negligent/intentional breach of a special duty, public nuisance, negligence, negligence PER SE, strict products liability and breach of express or implied warranties. Trial is scheduled for June 2000. UNIVERSITY OF SOUTH ALABAMA V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED MAY 23, 1997. STATE OF NEW MEXICO V. THE AMERICAN TOBACCO COMPANY, ET AL., FIRST JUDICIAL DISTRICT COURT, SANTA FE COUNTY, NEW MEXICO, FILED MAY 27, 1997. CITY OF BIRMINGHAM, ALABAMA, AND THE GREENE COUNTY RACING COMMISSION V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ALABAMA, FILED MAY 28, 1997. STATE OF VERMONT V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, CHITTENDEN COUNTY, VERMONT, FILED MAY 29, 1997. Trial is scheduled for November 1999. CENTRAL LABORERS WELFARE FUND, ET AL. V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ILLINOIS, FILED MAY 30, 1997. MASSACHUSETTS LABORERS HEALTH AND WELFARE FUND V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT, MASSACHUSETTS, FILED JUNE 2, 1997. STATE OF NEW HAMPSHIRE V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT, MERRIMACK COUNTY, NEW HAMPSHIRE, FILED JUNE 4, 1997. THE LOWER BRULE SIOUX TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, LOWER BRULE SIOUX TRIBE, FILED JUNE 4, 1997. STATE OF COLORADO V. R.J. REYNOLDS TOBACCO CO., ET AL., DISTRICT COURT, CITY AND COUNTY OF DENVER, COLORADO, FILED JUNE 5, 1997. STATE OF OREGON V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, MULTNOMAH COUNTY, OREGON, FILED JUNE 9, 1997. In July 1998, the court dismissed with prejudice plaintiff's unjust enrichment claim. The court denied defendants' motion to dismiss plaintiff's public nuisance claim but struck with prejudice that portion of the claim based on defendants' alleged interference with the "right to health care." Trial is scheduled for April 1999. 9 EXHIBIT 99 THE CROW TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, CROW TRIBE, FILED JUNE 10, 1997. In April 1998, plaintiff voluntarily dismissed the case without prejudice. STATE OF IDAHO V. PHILIP MORRIS, INC., ET AL., DISTRICT COURT, FOURTH JUDICIAL DISTRICT, ADA COUNTY, IDAHO, FILED JUNE 11, 1997. PEOPLE OF THE STATE OF CALIFORNIA V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SACRAMENTO COUNTY, CALIFORNIA, FILED JUNE 12, 1997. In May 1998, the court held that the state's reimbursement claims, which were based on a product liability theory, were barred by a California statute, which, until amended in 1997, did not permit product liability claims to be asserted with respect to tobacco products. The court held that the 1997 amendment of the law could not be applied retroactively. In addition, the court held that the statute, as enacted in 1987, did not permit claims that arose from pre-1987 conduct. However, the court further held that the statute did not apply to fraud claims, and granted the state leave to amend the complaint to assert a fraud claim. The court also dismissed without leave to amend the state's request for punitive damages and the cause of action alleging numerous violations of California's False Claims Act. In July 1998, the San Diego Superior Court recommended that this case be consolidated with certain other pending California cases. HAWAII HEALTH AND WELFARE TRUST FUND FOR OPERATING ENGINEERS V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, HAWAII, FILED JUNE 13, 1997. STATE OF MAINE V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, KENNEBEC COUNTY, MAINE, FILED JUNE 17, 1997. ROSSELLO, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED STATES DISTRICT COURT, PUERTO RICO, FILED JUNE 17, 1997. In June 1998, the court denied defendants' motion to dismiss the Commonwealth of Puerto Rico's racketeering claims, and a motion to dismiss certain defendant parent companies. The court also ruled that the Commonwealth has standing to pursue claims for health care costs without having to proceed via subrogation. The court dismissed plaintiff's claims of unjust enrichment, indemnity, voluntary assumption of a special duty, and a claim for injunctive relief. Trial is scheduled for September 1999. STATE OF RHODE ISLAND V. AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT, PROVIDENCE, RHODE ISLAND, FILED JUNE 17, 1997. LABORERS LOCAL 17 HEALTH AND BENEFIT FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JUNE 19, 1997. In April 1998, the court denied defendants' motion to dismiss for failure to join necessary parties. THE MUSCOGEE CREEK NATION, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., DISTRICT COURT, MUSCOGEE CREEK NATION, OKMULGEE DISTRICT, FILED JUNE 20, 1997. In July 1998, the appellate court dismissed defendants' appeal from the lower court's denial of a motion to dismiss based on lack of jurisdiction. KENTUCKY LABORERS DISTRICT COUNCIL HEALTH AND WELFARE TRUST FUND, ET AL. V. HILL & KNOWLTON, INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, KENTUCKY, LOUISVILLE DIVISION, FILED JUNE 20, 1997. OREGON LABORERS -- EMPLOYERS HEALTH AND WELFARE TRUST FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, OREGON, FILED JUNE 20, 1997. In August 1998, the court dismissed this case in its entirety against PM Inc. and certain other defendants. 10 EXHIBIT 99 UNITED FEDERATION OF TEACHERS WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JUNE 25, 1997. In April 1998, the court denied defendants' motion to dismiss for failure to join necessary parties. 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. In July 1998, the court dismissed all claims with prejudice. 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. WEST VIRGINIA LABORERS' PENSION FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, WEST VIRGINIA, HUNTINGTON DIVISION, FILED JULY 11, 1997. In August 1998, the court denied defendants' motion to dismiss. Trial is scheduled for June 2000. RHODE ISLAND LABORERS HEALTH AND WELFARE FUND V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, RHODE ISLAND, FILED JULY 20, 1997. EASTERN STATES HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF 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 21, 1997. In April 1998, the court granted defendants' motion to dismiss this case and ordered the class allegations stricken. 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. THE ARKANSAS CARPENTERS HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, ARKANSAS, FILED SEPTEMBER 4, 1997. SOUTHEAST FLORIDA LABORERS DISTRICT COUNCIL HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, FLORIDA, FILED SEPTEMBER 11, 1997. In April 1998, the court granted defendants' motion to dismiss this case. WEST VIRGINIA--OHIO VALLEY AREA INTERNATIONAL BROTHERHOOD OF ELECTRICAL WORKERS WELFARE FUND V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, WEST VIRGINIA, FILED SEPTEMBER 11, 1997. In August 1998, the court denied defendants' motion to dismiss. Trial is scheduled for March 2000. 11 EXHIBIT 99 TEAMSTERS UNION NO. 142 HEALTH AND WELFARE TRUST FUND AND SHEET METAL WORKERS LOCAL UNION NO. 20 WELFARE AND BENEFIT FUND V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT OF ST. JOSEPH COUNTY, INDIANA, FILED SEPTEMBER 12, 1997. CROW CREEK SIOUX TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, CROW CREEK SIOUX TRIBE, FILED SEPTEMBER 14, 1997. OPERATING ENGINEERS LOCAL 12 HEALTH AND WELFARE TRUST V. AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT OF CALIFORNIA, LOS ANGELES COUNTY, FILED SEPTEMBER 16, 1997. In July 1998, the court dismissed, without leave to amend, plaintiffs' claims for strict products liability, negligent breach of special duty, breach of express and implied warranties, restitution, unjust enrichment, violation of California antitrust law and intentional breach of special duty. The court dismissed, with leave to amend, plaintiffs' claims for fraud and misrepresentation, civil conspiracy and unfair business practices. PUERTO RICAN ILGWU HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF 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. 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 V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED OCTOBER 20, 1997. INTERNATIONAL BROTHERHOOD OF TEAMSTERS, LOCAL 734 V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, 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. UNITED FOOD AND COMMERCIAL WORKERS UNION AND EMPLOYERS HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ALABAMA, FILED NOVEMBER 13, 1997. B.A.C. LOCAL 32 INSURANCE TRUST FUND, ET AL. V. PHILIP MORRIS, INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, MICHIGAN, FILED NOVEMBER 14, 1997. SCREEN ACTORS GUILD-PRODUCERS HEALTH PLAN, ET AL. V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, LOS ANGELES COUNTY, CALIFORNIA, FILED NOVEMBER 20, 1997. In June 1998, the court dismissed, without leave to amend, plaintiffs' claims of intentional breach of special duty, negligent breach of special duty, indemnity and unjust enrichment, and dismissed, with leave to amend, plaintiffs' fraud and negligence claims. The court declined to dismiss plaintiffs' unfair business practices claim. In July 1998, the court dismissed, without leave to amend, plaintiffs' antitrust claim. 12 EXHIBIT 99 IBEW LOCAL 25 HEALTH AND BENEFIT FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997. IBEW LOCAL 363 WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997. LOCAL 138, 138A AND 138B INTERNATIONAL UNION OF OPERATING ENGINEERS WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997. LOCAL 840, INTERNATIONAL BROTHERHOOD OF TEAMSTERS HEALTH AND INSURANCE FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997. LONG ISLAND REGIONAL COUNCIL OF CARPENTERS WELFARE FUND V. PHILIP MORRIS, INC., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997. DAY CARE COUNCIL - LOCAL 205 D.C. 1707 WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED DECEMBER 8, 1997. LOCAL 1199 HOME CARE INDUSTRY BENEFIT FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED DECEMBER 8, 1997. LOCAL 1199 NATIONAL BENEFIT FUND FOR HEALTH AND HUMAN SERVICES EMPLOYEES V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED DECEMBER 8, 1997. MASON, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, TEXAS, FILED DECEMBER 23, 1997. OPERATING ENGINEERS LOCAL 324 HEALTH CARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, MICHIGAN, FILED DECEMBER 30, 1997. CARPENTERS & JOINERS WELFARE FUND, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, MINNESOTA, FILED DECEMBER 31, 1997. Trial is scheduled for March 2000. STEAMFITTERS LOCAL UNION NO. 614 HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., CIRCUIT COURT, THIRTEENTH JUDICIAL DISTRICT, TENNESSEE, FILED JANUARY 7, 1998. WOODS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, MIDDLE DISTRICT, NORTH CAROLINA, FILED FEBRUARY 13, 1998. STATE OF SOUTH DAKOTA, ET AL. V. PHILIP MORRIS, INC., ET AL., CIRCUIT COURT, HUGHES COUNTY, SOUTH DAKOTA, FILED FEBRUARY 19, 1998. BELK, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED FEBRUARY 20, 1998. In August 1998, this case was voluntarily dismissed. NATIONAL ASBESTOS WORKERS MEDICAL FUND, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF NEW YORK, FILED FEBRUARY 27, 1998. 13 EXHIBIT 99 MILWAUKEE CARPENTERS, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, WISCONSIN, FILED MARCH 4, 1998. GROUP HEALTH PLAN, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, MINNESOTA, FILED MARCH 11, 1998. Trial is scheduled for March 2000. WILLIAMS & DRAKE COMPANY, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, PENNSYLVANIA, FILED MARCH 23, 1998. MANGINI, ON BEHALF OF THE GENERAL PUBLIC OF THE STATE OF CALIFORNIA V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED MARCH 26, 1998. This action sought injunctive and other relief regarding the advertising of tobacco products on outdoor billboards in California allegedly in violation of a recently-enacted statute that prohibits the placement of such billboards within 1000 feet of certain schools and "public playgrounds." In July 1998, this case was dismissed with prejudice in exchange for defendants' agreement to take certain actions with respect to its billboard advertising in California, including the removal of certain billboards. UNITED ASSOCIATION OF PLUMBING AND PIPEFITTING INDUSTRY LOCAL 467 V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, SAN MATEO, CALIFORNIA, FILED MARCH 31, 1998. UNITED ASSOCIATION LOCAL NO. 467 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN MATEO COUNTY, CALIFORNIA, FILED MARCH 31, 1998. CONWED CORPORATION AND LEUCADIA, INC. V. RJ REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, MINNESOTA, FILED APRIL 10, 1998. TEAMSTERS BENEFIT TRUST V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 15, 1998. UNITED ASSOCIATION LOCAL NO. 159 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 15, 1998. NEWSPAPER PERIODICAL DRIVERS LOCAL 921 SAN FRANCISCO NEWSPAPER AGENCY HEALTH & WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN MATEO COUNTY, CALIFORNIA, FILED APRIL 15, 1998. UNITED ASSOCIATION LOCAL NO. 343 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 16, 1998. BAY AREA AUTOMOTIVE GROUP WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 16, 1998. PIPE TRADES DISTRICT COUNCIL NO. 36 HEALTH & WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 16, 1998. SIGN, PICTORIAL AND DISPLAY INDUSTRY WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 16, 1998. SAN FRANCISCO NEWSPAPER PUBLISHERS AND NORTHERN CALIFORNIA NEWSPAPER GUILD HEALTH & WELFARE TRUST V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 17, 1998. NORTH COAST TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 24, 1998. 14 EXHIBIT 99 NORTHERN CALIFORNIA BAKERY DRIVERS SECURITY FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 24, 1998. ARKANSAS BLUE CROSS AND BLUE SHIELD, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED APRIL 29, 1998. BLUE CROSS AND BLUE SHIELD OF NEW JERSEY, INC., ET AL. V. PHILIP MORRIS, INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, NEW YORK, FILED APRIL 29, 1998. REGENCE BLUESHIELD, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, WASHINGTON, FILED APRIL 29, 1998. BAY AREA DELIVERY DRIVERS SECURITY FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 30, 1998. SISSETON-WAHPETON SIOUX TRIBE V. PHILIP MORRIS INCORPORATED, ET AL., TRIBAL COURT OF THE SISSETON-WAHPETON SIOUX TRIBE, FILED MAY 8, 1998. STANDING ROCK SIOUX TRIBE V. PHILIP MORRIS INCORPORATED, ET AL., TRIBAL COURT OF THE STANDING ROCK SIOUX INDIAN RESERVATION, FILED MAY 8, 1998. THE REPUBLIC OF GUATEMALA V. THE TOBACCO INSTITUTE, INC., ET AL., UNITED STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED MAY 11, 1998. LANDRY, ET AL. V. LOUISIANA HEALTH SERVICE AND INDEMNITY CO., INC., ET AL., 19TH JUDICIAL COURT, EAST BATON ROUGE, LOUISIANA, FILED MAY 18, 1998. NORTHERN CALIFORNIA PLASTERERS HEALTH & WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED MAY 21, 1998. UNITED ASSOCIATION LOCAL NO. 393 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED MAY 21, 1998. SERVICE EMPLOYEES INTERNATIONAL UNION HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS, ET AL., UNITED STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED MAY 21, 1998. NORTHERN CALIFORNIA GENERAL TEAMSTERS SECURITY FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED MAY 22, 1998. UTAH LABORERS' HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, UTAH, FILED JUNE 13, 1998. JOINT BENEFIT TRUST V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED JUNE 15, 1998. NORTHERN CALIFORNIA PIPE TRADES V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED JUNE 16, 1998. S.E.I.U. LOCAL 74 WELFARE FUND, ET AL. V. PHILIP MORRIS, ET AL., UNITED STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED JUNE 22, 1998. PLASTERING INDUSTRY WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 1, 1998. 15 EXHIBIT 99 CENTRAL VALLEY PAINTING & DECORATING HEALTH & WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 6, 1998. STATE OF VERMONT V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, BURLINGTON, VERMONT, FILED JULY 7, 1998. Effective April 23, 1998, Vermont enacted a statute permitting the state to seek recovery from a "tobacco manufacturer" for the amount paid or likely to be paid in Medicaid benefits for tobacco-related health conditions, and for punitive damages, costs, reasonable attorneys' fees, and other relief. Among other things, the statute abrogated certain affirmative defenses, listed elements of the state's new direct cause of action, and authorized the use of statistical analysis to prove damages. PM Inc. and four other domestic cigarette manufacturers brought suit in federal court in Vermont against state officials for declaratory and injunctive relief on the grounds that enforcement of the statute would violate the United States Constitution and federal law. In July 1998, the State of Vermont brought a state court action under the new statute seeking damages in an amount sufficient to reimburse the state for expenditures made or to be made after the effective date of the statute for health conditions allegedly caused by the tobacco companies' tobacco products, for punitive damages, and certain other relief. MICHAEL H. HOLLAND, ET AL. V. PHILIP MORRIS, ET AL., UNITED STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED JULY 9, 1998. PEOPLE OF THE STATE OF CALIFORNIA, ET AL. V. PHILIP MORRIS INC., ET AL., SUPERIOR COURT, LOS ANGELES COUNTY, CALIFORNIA, FILED ON JULY 14, 1998. NORTHERN CALIFORNIA TILE INDUSTRY HEALTH & WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 29, 1998. SAN FRANCISCO CULINARY, BARTENDERS AND SERVICE EMPLOYEES WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 30, 1998. IBEW LOCAL 595 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., ALAMEDA COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 30, 1998. SHOP IRONWORKERS LOCAL 790 WELFARE PLAN V. PHILIP MORRIS, INC., ET AL., ALAMEDA COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 31, 1998. In addition to the foregoing actions, other foreign, state and local government entities and others, including unions, have announced they are considering filing health care cost recovery actions. 16 -----END PRIVACY-ENHANCED MESSAGE-----