-----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, WxowyQZ4scZh7xAQEA+619F0dGD94M1DbxZ9LhWtwn701twXq6ELXodj/RpGy/zw wuNc3YpYhimTZ0etN7cEWw== 0001047469-98-008784.txt : 19980309 0001047469-98-008784.hdr.sgml : 19980309 ACCESSION NUMBER: 0001047469-98-008784 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980306 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-K405 SEC ACT: SEC FILE NUMBER: 001-08940 FILM NUMBER: 98558603 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-K405 1 FORM 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 --------------------- FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 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, N.Y. 10017 (Address of principal executive offices) (Zip Code)
------------------------ REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 212-880-5000 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED - -------------------------------------------------------- -------------------------------------------------------- Common Stock, $0.33 1/3 par value New York Stock Exchange
------------------------ 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ ------------------------ The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock on February 26, 1998, was approximately $103.0 billion. At such date, there were 2,427,925,717 shares of the registrant's Common Stock outstanding. ------------------------ DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's annual report to stockholders for the year ended December 31, 1997, are incorporated in Part I, Part II and Part IV hereof and made a part hereof. The registrant's definitive proxy statement for use in connection with its annual meeting of stockholders to be held on April 30, 1998, is incorporated in Part III hereof and made a part hereof. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. DESCRIPTION OF BUSINESS. (A) GENERAL DEVELOPMENT OF BUSINESS GENERAL Philip Morris Companies Inc. is a holding company whose principal wholly-owned subsidiaries, Philip Morris Incorporated, Philip Morris International Inc., Kraft Foods, Inc., and Miller Brewing Company, are engaged in the manufacture and sale of various consumer products. A wholly-owned subsidiary of the Company, Philip Morris Capital Corporation, engages in various financing and investment activities. As used herein, unless the context indicates otherwise, the term "Company" means Philip Morris Companies Inc. and its subsidiaries. The Company is the largest consumer packaged goods company in the world.* Philip Morris Incorporated ("PM Inc."), which conducts business under the trade name "Philip Morris U.S.A.," and its subsidiaries and affiliates are engaged in the manufacture and sale of cigarettes. PM Inc. is the largest cigarette company in the United States. Philip Morris International Inc. ("Philip Morris International") is a holding company whose subsidiaries and affiliates and their licensees are engaged primarily in the manufacture and sale of tobacco products (mainly cigarettes) internationally. A subsidiary of Philip Morris International is the leading United States exporter of cigarettes. MARLBORO, the principal cigarette brand of these companies, has been the world's largest-selling cigarette brand since 1972. Certain subsidiaries and affiliates of Philip Morris International manufacture and sell a wide variety of food products in Latin America. Kraft Foods, Inc. ("Kraft"), is the largest processor and marketer of retail packaged foods in the United States. A wide variety of cheese, processed meat products, coffee and grocery products are manufactured and marketed in the United States and Canada by Kraft. Subsidiaries and affiliates of Kraft Foods International, Inc. ("Kraft Foods International"), a subsidiary of Kraft, manufacture and market coffee, confectionery, cheese, grocery and processed meat products primarily in Europe and the Asia/ Pacific region. Miller Brewing Company ("Miller") is the second largest brewing company in the United States. SOURCE OF FUNDS--DIVIDENDS Because the Company is a holding company, its principal source of funds is dividends from its subsidiaries. The Company's principal wholly-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock. (B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS In 1997, the Company's significant industry segments were tobacco products (principally cigarettes), food products, beer, and financial services and real estate. Operating revenues, operating profit (together with a reconciliation to operating income) and identifiable assets attributable to each such segment for each of the last three years are set forth in Note 12 to the Company's consolidated financial statements and are incorporated herein by reference to the Company's annual report to stockholders for the year ended December 31, 1997 (the "1997 Annual Report"). - ------------------------ * References to the Company's competitive ranking in its various businesses are based on sales data or, in the case of cigarettes and beer, shipments, unless otherwise indicated. 1 In 1997, operating profit from tobacco products was approximately 64% of the Company's total operating profit, down from 67% in 1996. This decrease was due primarily to charges recorded in 1997 in connection with tobacco litigation settlements discussed below in Item 3. LEGAL PROCEEDINGS. PM Inc. and Philip Morris International contributed 27% and 37%, respectively, to 1997 operating profit (compared with 34% and 33%, respectively, in 1996). Food products, beer, and financial services and real estate accounted for approximately 30%, 4% and 2%, respectively, of the Company's total operating profit in 1997 (compared with 27%, 4% and 2%, respectively, in 1996). (C) NARRATIVE DESCRIPTION OF BUSINESS TOBACCO PRODUCTS PM Inc. manufactures, markets and sells cigarettes in the United States. Subsidiaries and affiliates of Philip Morris International and their licensees manufacture, market and sell tobacco products outside the United States and export tobacco products from the United States. DOMESTIC TOBACCO PRODUCTS PM Inc. is the largest tobacco company in the United States, with total cigarette shipments in the United States of 235.2 billion units in 1997, an increase of 1.9% from 1996. PM Inc. accounted for 48.9% of the cigarette industry's total shipments in the United States in 1997 (an increase of 1.2 share points from 1996). The industry's cigarette shipments in the United States decreased by 0.6% in 1997. The following table+ sets forth the industry's cigarette shipments in the United States, PM Inc.'s shipments and its share of United States industry shipments:
YEARS ENDED PM INC. DECEMBER 31 INDUSTRY* PM INC. SHARE OF INDUSTRY - ---------------------------------------------------------- ----------- ----------- ------------------- (IN BILLIONS OF UNITS) (%) 1997...................................................... 480.6 235.2 48.9 1996...................................................... 483.2 230.8 47.8 1995...................................................... 481.4 221.8 46.1
PM Inc.'s major premium brands are MARLBORO, VIRGINIA SLIMS, MERIT, BENSON & HEDGES and PARLIAMENT. Its principal discount brands are BASIC and CAMBRIDGE. All of its brands are marketed to take into account differing preferences of adult smokers. MARLBORO is the largest-selling cigarette brand in the United States, with shipments of 164 billion units in 1997 (up 5.0% from 1996), equating to 34.1% of the United States market (up from 32.3% in 1996). In 1997, the premium and discount segments accounted for approximately 72.5% and 27.5%, respectively, of domestic cigarette industry volume, versus 71.5% and 28.5%, respectively, in 1996. In 1997, PM Inc.'s share of the premium segment was 57.8%, an increase of 1.5 share points over 1996. Shipments of premium cigarettes accounted for 85.7% of PM Inc.'s 1997 volume, up from 84.4% in 1996. In 1997, United States industry shipments within the discount segment declined 4.0% from 1996 levels; PM Inc.'s 1997 shipments within this category declined 6.4%, resulting in a share of 25.6% of the discount segment (down 0.6 share points from 1996). PM Inc. cannot predict future change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, shipment market share or retail market share; however, it believes that implementation of the proposed Resolution, discussed below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues," would materially adversely affect PM Inc.'s shipments. - ------------------------ + Data presented in this table differ in some cases from data discussed above due to rounding differences. * Source: Management Science Associates. 2 INTERNATIONAL TOBACCO PRODUCTS Philip Morris International's total cigarette shipments grew 7.8% in 1997, to 711.5 billion units, including shipments of local Portuguese brands acquired in 1997 (see discussion below). Philip Morris International estimates that its share of the international cigarette market (excluding the United States) was 13.6% in 1997, up from 12.8% in 1996. Philip Morris International estimates that international cigarette industry shipments (excluding the United States) were approximately 5.2 trillion units in 1997, which represent an increase of 1.4% over 1996. Philip Morris International unit shipments (including brands acquired through acquisitions) have grown at a compounded annual growth rate of 11% over the last five years versus compounded annual industry growth of approximately 1.5% over the same period. Philip Morris International's leading international brands--MARLBORO, L&M, PHILIP MORRIS, BOND STREET, CHESTERFIELD, LARK, PARLIAMENT, MERIT and VIRGINIA SLIMS--collectively accounted for approximately 49% of the international cigarette industry growth (excluding the United States) in 1997. Unit sales of Philip Morris International's principal brand, MARLBORO, increased 5.5% in 1997, to 319 billion units, representing more than 6% of the international cigarette market (excluding the United States). Philip Morris International has a cigarette market share of at least 15%, and in a number of instances substantially more than 15%, in more than 40 markets, including Argentina, Australia, Belgium, the Czech Republic, Finland, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, the Philippines, Poland, Portugal, Saudi Arabia, Singapore, Spain, Switzerland and Turkey. In 1997, Philip Morris International increased capacity and improved productivity through various acquisitions and capital projects. Major capital expenditures included modernization and expansion of facilities in Germany, the Netherlands, Switzerland, Poland, Russia, Lithuania, the Ukraine, Turkey, Malaysia and Brazil. In January 1997, Philip Morris International acquired a controlling interest in Tabaqueira-Empresa Industrial de Tabacos, S.A., Portugal's formerly state-owned tobacco company, and later in the year restructured its interests in the business of Cigarros La Tabacalera Mexicana S.A. de C.V., a Mexican cigarette company, increasing its ownership in that business from 28.8% to 50.0%. TAXES, LEGISLATION, REGULATION AND OTHER MATTERS REGARDING TOBACCO AND SMOKING 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 volume, operating revenues, cash flows, operating income and financial position of PM Inc., Philip Morris International and the Company. In the United States, these issues include proposed federal regulatory controls (including, as discussed below, the issuance of final regulations by the United States Food and Drug Administration (the "FDA") that regulate cigarettes as "drugs" or "medical devices"); actual and proposed excise tax increases; 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; proposed legislation and regulations to require additional health warnings on cigarette packages and in advertising, and to eliminate the tax deductibility of tobacco advertising and promotional costs; actual and proposed requirements regarding disclosure of cigarette ingredients and other proprietary information; actual and proposed requirements regarding disclosure of the yields of "tar," nicotine and other constituents found in cigarette smoke; increased assertions of adverse health effects associated with both smoking and exposure to environmental tobacco smoke ("ETS"); legislation or other governmental action seeking to ascribe to the industry responsibility and liability for the purported adverse health effects associated with both smoking and exposure to ETS; the diminishing social acceptance of smoking; increased pressure from anti-smoking groups; unfavorable press reports; governmental and grand jury investigations; increased smoking and health litigation, including private plaintiff class action litigation and health care cost recovery actions brought by state and local governments, unions and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking; and the proposed Resolution discussed below. 3 Cigarettes are subject to substantial excise taxes in the United States and to similar taxes in most foreign markets. The United States federal excise tax on cigarettes is currently $12 per 1,000 cigarettes ($0.24 per pack of 20 cigarettes). In August 1997, legislation was enacted that will raise the federal excise tax to $17 per 1,000 cigarettes ($0.34 per pack of 20 cigarettes) starting in the year 2000 and then to $19.50 per 1,000 cigarettes ($0.39 per pack of 20 cigarettes) in 2002. In general, excise taxes and other cigarette- related taxes levied by the federal government and by various states, counties and municipalities have been increasing, and additional increases have been proposed at the federal level and in a number of states. 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. In the opinion of PM Inc. and Philip Morris International, 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 Philip Morris International, and might cause sales to shift from the premium segment to the discount segment. Reports with respect to the alleged harmful physical effects of cigarette smoking have been publicized for many years, and the sale, promotion and use of cigarettes continue to be subject to increasing governmental regulation. Since 1964, the Surgeon General of the United States and the Secretary of Health and Human Services have released a number of reports linking cigarette smoking with a broad range of health hazards, including various types of cancer, coronary heart disease and chronic lung disease, and recommending various governmental measures to reduce the incidence of smoking. The 1988, 1990, 1992 and 1994 reports focus upon the "addictive" nature of cigarettes, the effects of smoking cessation, the decrease in smoking in the United States, and the economic and regulatory aspects of smoking in the Western Hemisphere, and cigarette smoking by adolescents, particularly the "addictive" nature of cigarette smoking in adolescence. Studies with respect to the alleged health risks of ETS to nonsmokers (including lung cancer, respiratory and coronary illnesses, and other conditions) have also received significant publicity. In 1986, the Surgeon General of the United States and the National Academy of Sciences reported that nonsmokers were at increased risk of lung cancer and respiratory illness due to ETS. In January 1993, the United States Environmental Protection Agency (the "EPA") issued a report concluding, among other things, that ETS is a human lung carcinogen and that ETS increases certain health risks for young children. In June 1993, PM Inc. joined five other representatives of the tobacco manufacturing and related industries in a lawsuit against the EPA, seeking a declaration that the EPA does not have the authority to regulate ETS, and that, in view of the available scientific evidence and the EPA's failure to follow its own guidelines in making the determination, the EPA's final risk assessment be declared arbitrary and capricious and ordered withdrawn. The outcome of this lawsuit cannot be predicted. The EPA report, together with adverse publicity on ETS, has resulted in the adoption of governmental and privately imposed limitations that restrict or ban cigarette smoking in certain public places and places of employment. The Comprehensive Smoking Education Act (the "Smoking Education Act"), enacted in 1984, requires cigarette manufacturers and importers to include the following warning statements in rotating sequence on cigarette packages and in advertisements: "SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy"; "SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health"; "SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, And Low Birth Weight"; and "SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide." The Smoking Education Act also covers the size and format of warnings on cigarette packages and in cigarette advertising, and prescribes a modified version of the warnings for outdoor billboard advertisements. 4 Most of the cigarettes sold by Philip Morris International are sold in countries where warning statement requirements for cigarette packages have been adopted. In markets where such statements are not legally required, Philip Morris International's policy is to place the United States Surgeon General's warnings on all cigarette packages. In October 1997, at the request of the United States Senate Judiciary Committee, the Company provided the Committee with a document setting forth the Company's position on a number of issues. On the issues of the 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, as reflected in the proposed new health warnings set out in the proposed Resolution. In furtherance of the proposed Resolution, 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 discussed below (see Item 3. LEGAL PROCEEDINGS.). 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. On February 27, 1998, the first installment of these documents was made available via the Internet, consisting of the vast majority of the documents selected from the document depository by the attorney general of Minnesota in connection with Minnesota's health care cost recovery action. 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. 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 marketing, 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. The outcome of this litigation cannot be predicted. 5 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. 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. 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 "tar" and nicotine deliveries for its products sold in the Commonwealth based on standards established by the DPH for determining "tar" and nicotine deliveries under average smoking conditions. The "tar" and nicotine deliveries produced using the DPH test parameters are higher than the yields produced using the test parameters 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 disclosed 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. The ultimate outcome of this proposal cannot be predicted. On February 10, 1998, a regulation went into effect in Thailand that would require manufacturers and importers of tobacco products, including a subsidiary of Philip Morris International, to disclose to the Ministry of Public Health ("MPH") the ingredients of their products to be sold in Thailand on a by-brand basis. Although this regulation does not require the MPH to make public the submitted ingredient lists, there are no assurances that the confidentiality of lists to be submitted will be maintained. Cigarette manufacturers and importers are also required to provide annually to the Secretary of Health and Human Services a composite list of ingredients added to tobacco in the manufacture of cigarettes, and the Secretary is directed to treat the list as trade secret information and report to Congress concerning the health effects, if any, of such ingredients. In April 1994, the United States Occupational Safety and Health Administration ("OSHA") issued a proposed rule that could, as a practical matter, ultimately ban smoking in the workplace. Hearings on this proposed rule were held from September 1994 through March 1995. The period for post-hearing submissions on the proposed rule ended in February 1996. OSHA has not yet issued either a final rule or a proposed revised rule. Television and radio advertising of cigarettes is prohibited in the United States, and prohibited or restricted in many other countries. In June 1995, PM Inc. entered into a consent decree with the Department of Justice, pursuant to which it agreed to reposition its brand advertising at professional football, baseball, basketball and hockey arenas so as to minimize incidental television coverage. In June 1995, PM Inc. announced that it had voluntarily undertaken a program to further 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. 6 For several years, Congress has provided funds for the development of test methodologies and standards aimed at measuring the propensity of cigarettes to ignite upholstered furniture or mattresses. The Company cannot predict whether these efforts will result in further legislation or regulation. In recent years, various members of Congress have introduced legislation, some of which has been the subject of hearings or floor debate, that would subject cigarettes to various regulations under the Department of Health and Human Services or regulation under the Consumer Products Safety Act, establish anti-smoking educational campaigns or anti-smoking programs, or provide additional funding for governmental anti-smoking activities, further restrict the advertising of cigarettes, including requiring additional warnings on packages and in advertising, provide that the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act could not be used as a defense against liability under state statutory or common law, allow state and local governments to restrict the sale and distribution of cigarettes, and further restrict certain advertising of cigarettes and eliminate or reduce the tax deductibility of tobacco advertising. Some foreign countries have also taken steps to restrict or prohibit cigarette advertising and promotion, to require ingredient disclosure, to impose maximum constituent levels, to increase taxes on cigarettes, to control prices, to restrict imports, to ban or severely restrict smoking in workplaces and public places, and otherwise to discourage cigarette smoking. It is not possible to determine the outcome of the FDA regulatory initiative or the related litigation discussed above, or to predict what, if any, other foreign or domestic governmental legislation or regulations will be adopted relating to the manufacturing, advertising, sale or use of cigarettes, or to the tobacco industry generally. However, if any or all of the foregoing were to be implemented, the volume, operating revenues, cash flows and operating income of PM Inc., Philip Morris International and the Company could be adversely affected, in amounts that cannot be determined. PM Inc. has received requests for information (including grand jury subpoenas) in connection with governmental investigations of the tobacco industry, and is cooperating with respect to such requests. Certain present and former employees of PM Inc. have testified or have been asked to testify in connection with certain of these matters. The investigations are as follows: PM Inc. has been informed that an investigation by the United States Attorney for the Southern District of New York, which had been initiated following the publication of an article in THE NEW YORK TIMES that made allegations about PM Inc. documents and supposedly secret research relating to nicotine, has been consolidated with the United States Department of Justice investigation discussed immediately below. PM Inc. has been informed of an investigation by the United States Attorney for the Eastern District of New York relating to The Council for Tobacco Research-U.S.A., Inc., a research organization of which PM Inc. is a sponsor; and an investigation by the United States Department of Justice relating to issues raised in testimony provided by tobacco industry executives before Congress and other related matters. PM Inc. has been advised that the staff of the FTC has commenced a preliminary inquiry to determine whether PM Inc. unfairly restricts the distribution of competing manufacturers' cigarette brands through its merchandising practices at the wholesale and retail levels. While the outcomes of these investigations cannot be predicted, PM Inc. believes it has acted lawfully. PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES 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 7 business and capital markets. The complete text of the proposed Resolution is filed as an Exhibit to this Form 10-K, and the discussion herein is qualified by reference thereto. There can be no assurance that federal legislation in the form of the proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to the Company or that any modification would be acceptable to the Company or that, if enacted, the legislation would not face legal challenges. Moreover, the negotiation and signing of the proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry and regulation of the international tobacco industry. The proposed Resolution includes provisions relating to advertising and marketing restrictions, product warnings and labeling, access restrictions, licensing of tobacco retailers, the adoption and enforcement of "no sales to minors" laws by states, surcharges against the industry for failure to achieve underage smoking reduction goals, regulation of tobacco products by the FDA, public disclosure of industry documents and research, smoking cessation programs, compliance programs by the industry, public smoking and smoking in the workplace, enforcement of the proposed Resolution, industry payments and litigation. SURCHARGE FOR FAILURE TO ACHIEVE UNDERAGE SMOKING REDUCTION GOALS--The proposed Resolution would require the FDA to impose annual surcharges on the industry if targeted reductions in underage smoking incidence are not achieved in accordance with a legislative timetable. The surcharge would be based upon an approximation of the present value of the profit the companies would earn over the lives of all underage consumers in excess of the target, and would be allocated among participating manufacturers based on their market share of the United States cigarette industry. INDUSTRY PAYMENTS--The proposed Resolution would require participating manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10 billion initial Industry Payment on the date that federal legislation implementing the terms of the proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations, and the Company currently estimates that PM Inc.'s share of the initial Industry Payment would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions described below in Item 3. LEGAL PROCEEDINGS.). Thereafter, the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels)--year 1: $8.5 billion; year 2: $9.5 billion; year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15 billion. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate, and would be adjusted to reflect changes from 1996 domestic sales volume levels. The Industry Payments would be separate from any surcharges discussed above. The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities selling tobacco products in the United States (and not their affiliated companies). The proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use. EFFECTS ON LITIGATION--If enacted, the federal legislation provided for in the proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity other than the federal government), PARENS PATRIAE and smoking and health 8 class actions and all "addiction"/dependence claims, and would bar similar actions from being maintained in the future. However, the proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. In recent months, PM Inc. and other companies in the domestic tobacco industry agreed to settle three health care cost recovery actions in Mississippi, Florida and Texas, and a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft. The Company may enter into discussions to postpone or settle other actions, pending the enactment of the legislation contemplated by the proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved or, if achieved, as to the terms thereof. The proposed Resolution would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective. Under the proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis, and could be maintained only against tobacco manufacturing companies (and not their retailers, distributors or affiliated companies). In addition, all punitive damage claims based on past conduct would be resolved as part of the proposed Resolution, and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only if based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party. The proposed Resolution contemplates that participating tobacco manufacturers would enter into a joint sharing agreement for civil liabilities relating to past conduct. Judgments and settlements arising from tort actions would be paid as follows. The proposed Resolution would set an annual aggregate cap of up to 33% of the annual base Industry Payment (including any reductions for volume declines). Any judgments or settlements exceeding the cap in a particular year would roll over into the next year. While judgments and settlements would run against the defendant, they would give rise to an 80-cents-on-the-dollar credit against the annual Industry Payment. Finally, any individual judgments in excess of $1 million would be paid at the rate of $1 million per year unless every other judgment and settlement could first be satisfied within the annual aggregate cap. In all circumstances, however, the companies would remain fully responsible for costs of defense and certain costs associated with the fees of attorneys representing certain plaintiffs in the litigation that would be settled by the proposed Resolution. FINANCIAL EFFECTS--The Company anticipates that PM Inc.'s share of the industry's $10 billion initial payment, which it currently estimates would be approximately $6.6 billion (adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions), would be charged to expense in the period in which federal legislation implementing the terms of the proposed Resolution is enacted. In addition, the Company currently anticipates that implementation of the proposed Resolution would require a significant charge to expense in the period of enactment to comply with the proposed Resolution's regulations on advertising, marketing and production. The initial payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The initial payment would have a material adverse effect on the Company's operating income and cash flows in the quarter and year in which the proposed Resolution is enacted and on its financial position. The initial payment would result in higher debt and higher interest expense, the amounts of which would depend upon the final form of the proposed Resolution, borrowing requirements and interest rates. The Company anticipates that PM Inc.'s share of future annual Industry Payments related to cigarette sales would be charged to expense as the related sales occur, and would be funded through price increases. 9 The Company anticipates that annual surcharges, if any, imposed by the FDA for failure to meet required reduction levels in underage smoking incidence, beginning in the fifth year after the proposed Resolution is implemented, would be charged to expense in the year of assessment or in the year prior thereto if it is then probable that such assessment will be made. The Company believes that implementation of the proposed Resolution would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. The degree of the adverse impact would depend, among other things, on the rates of decline in United States cigarette sales in the premium and discount segments, PM Inc.'s share of the domestic premium and discount cigarette segments, interest rates and the timing of principal payments on debt incurred to finance the initial payment due under the proposed Resolution, and the effect of the proposed Resolution on cigarette consumption and the regulatory and litigation environment outside the United States. In view of the foregoing, the Company may reevaluate its share repurchase and dividend policies. TOBACCO-RELATED LITIGATION See Item 3. LEGAL PROCEEDINGS. below for a discussion of the tobacco-related litigation pending against PM Inc. and, in some cases, the Company and its subsidiaries and related entities. DISTRIBUTION, COMPETITION AND RAW MATERIALS PM Inc. sells its tobacco products principally to wholesalers (including distributors), large retail organizations, including chain stores, and the armed services. Subsidiaries and affiliates of Philip Morris International and their licensees market cigarettes and other tobacco products worldwide, directly or through export sales organizations and other entities with which they have contractual arrangements. The market for tobacco products is highly competitive, characterized by brand recognition and loyalty, with product quality, price, marketing and packaging constituting the significant methods of competition. Promotional activities include, in certain instances and where permitted by law, allowances, the distribution of incentive items, price reductions and other discounts. The tobacco products of the Company's subsidiaries, affiliates and their licensees are advertised and promoted through various media, although television and radio advertising of cigarettes is prohibited in the United States and is prohibited or restricted in many other countries. PM Inc. and Philip Morris International's subsidiaries and affiliates and their licensees purchase domestic burley and flue-cured leaf tobaccos of various grades and types each year, primarily at domestic auction. In addition, oriental tobacco and certain other tobaccos are purchased outside the United States. The tobacco is then graded, cleaned, stemmed and redried prior to its storage for aging up to three years. Large quantities of leaf tobacco inventory are maintained to support cigarette manufacturing requirements. Tobacco is an agricultural commodity subject to United States government controls, including the tobacco price support (subject to Congressional review) and production adjustment programs administered by the United States Department of Agriculture (the "USDA"), either of which can substantially affect market prices. PM Inc. and Philip Morris International believe there is an adequate supply of tobacco in the world markets to satisfy their current production requirements. FOOD PRODUCTS Over the past three years, the Company's subsidiaries sold several domestic and international food businesses. During 1997, Philip Morris International sold its Brazilian ice cream businesses, Kraft sold North American maple-flavored syrup businesses and Kraft Foods International sold a Scandinavian sugar confectionery business. During 1996, Kraft sold its bagel business and Kraft Foods International sold its margarine businesses in the U.K. and Italy. During 1995, Kraft sold its North American bakery, margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. Kraft and Kraft 10 Foods International also sold several smaller non-strategic businesses in 1997, 1996 and 1995. The sales of these businesses have not had and are not expected to have a material effect on the Company's results of operations and have improved the profit margins of its food operations. During the fourth quarter of 1997, the international food businesses recorded pretax realignment charges of $630 million, 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. NORTH AMERICA Kraft is the largest packaged food company in North America. Kraft's principal products include cheese and cheese products, processed meat and poultry products, coffee, ready-to-eat cereals, salad and other dressings, powdered and ready-to-drink beverages, frozen pizza, packaged and ready-to-eat desserts and snacks, packaged pasta dinners, lunch combinations, barbecue sauces, frozen toppings and other cultured dairy and grocery products. Its principal brands include KRAFT, VELVEETA and CRACKER BARREL cheese and cheese products; PHILADELPHIA BRAND cream cheese; CHEEZ WHIZ cheese sauce; OSCAR MAYER luncheon meats, hot dogs, bacon, ham and other meat products; LOUIS RICH luncheon meats, poultry franks, turkey bacon and other poultry products; LUNCHABLES lunch combinations; CLAUSSEN pickles; MAXWELL HOUSE, YUBAN and NABOB coffees; GENERAL FOODS INTERNATIONAL COFFEES flavored coffees; POST ready-to-eat cereals; MIRACLE WHIP salad dressing; KRAFT spoonable and pourable salad dressings; KOOL-AID, TANG, CAPRI SUN, CRYSTAL LIGHT and COUNTRY TIME powdered and ready-to-drink beverages; TOMBSTONE and JACK'S frozen pizzas and DI GIORNO pastas, sauces, cheeses and frozen pizzas; JELL-O desserts; HANDI-SNACKS snack combinations and desserts; KRAFT Macaroni & Cheese dinners; KRAFT and BULL'S-EYE barbecue sauces; COOL WHIP whipped toppings; STOVE TOP stuffing mix; MINUTE rice; SHAKE 'N BAKE coatings; LIGHT N' LIVELY and BREYERS cultured dairy products; and TACO BELL grocery products. INTERNATIONAL Subsidiaries and affiliates of Kraft Foods International manufacture and market a wide variety of coffee, confectionery, cheese, grocery and processed meat products in Europe, with distribution to the Middle East and Africa. In the Asia/Pacific region, select grocery products are produced in, and other Company branded products are sourced from, Europe and the United States. In Latin America, subsidiaries and affiliates of Philip Morris International manufacture and market a wide variety of food products, including confectionery products, various powdered soft drinks, and other grocery products sold by Kraft. In 1997, approximately 80% of operating revenues for the international food businesses were derived from sales made in Europe. International brands include JACOBS CAFE, GEVALIA, CARTE NOIRE, JACQUES VABRE, KAFFE HAG, GRAND' MERE, KENCO, SAIMAZA and SPLENDID coffees; MILKA, SUCHARD, COTE D'OR, MARABOU, TOBLERONE, FREIA, TERRY'S, DAIM and CALLARD & BOWSER confectionery products; HOLLYWOOD chewing gum; DAIRYLEA, EL CASERIO and INVERNIZZI cheeses; MIRACOLI pasta dinners and sauces; VEGEMITE spread; ESTRELLA and MAARUD snacks; and SIMMENTHAL and NEGRONI meats as well as a variety of products sold by Kraft in the United States, including PHILADELPHIA BRAND cream cheese. In 1996, Philip Morris International acquired nearly all of the remaining voting shares of Industrias de Chocolate Lacta S.A., the leading confectionery company in Brazil. DISTRIBUTION, COMPETITION AND RAW MATERIALS Kraft's products in North America are generally sold to supermarket chains, wholesalers, club stores, mass merchandisers, distributors, convenience stores, individual stores and other retail food outlets. Products are distributed through distribution centers, satellite warehouses, company-operated and public cold-storage facilities, depots and other facilities. Selling efforts are supported by national and regional advertising on television and radio and in magazines and newspapers, as well as by sales promotions, product displays, trade incentives, informative material offered to customers and other promotional 11 activities. Subsidiaries and affiliates of Kraft Foods International and Philip Morris International sell their food products primarily in the same manner and also engage the services of independent sales offices and agents. Advertising is tailored by product and country to reach targeted audiences. Kraft is subject to highly competitive conditions in all aspects of its business. Competitors include large national and international companies and numerous local and regional companies. Its food products also compete with generic products and private-label products of food retailers, wholesalers and cooperatives. Kraft competes primarily on the basis of product quality, service, marketing, advertising and price. Kraft is a major purchaser of milk, cheese, green coffee beans, cocoa, corn, wheat, poultry, pork, beef, vegetable oil, and sugar and other sweeteners. Kraft continuously monitors worldwide supply and cost trends of these commodities to enable it to take appropriate action to obtain ingredients needed for production. Kraft purchases all of its milk requirements and a substantial portion of its cheese requirements from independent sources, principally from cooperatives and individual producers. The prices for United States milk and other dairy product purchases are substantially influenced by government programs, as well as market supply and demand. The most significant cost item in coffee products is green coffee beans, which are purchased on world markets. Green coffee bean prices are affected by the quality and availability of supply, trade agreements among producing and consuming nations, the unilateral policies of the producing nations, changes in the value of the United States dollar in relation to certain other currencies and consumer demand for coffee products. A significant cost item in confectionery products is cocoa, which is purchased on world markets, and the price of which is affected by market supply and demand and changes in the value of the British pound sterling relative to certain other currencies. The purchase price of poultry and meat cuts is the major factor in the cost of Kraft's processed meat products. Poultry and meat prices are cyclical and are affected by market supply and demand. Kraft is also a major user of packaging materials purchased from many suppliers. The prices paid for raw materials used in food products generally reflect external factors such as weather conditions, commodity market activities, currency fluctuations, and the effects of governmental agricultural programs. Although the prices of the principal raw materials can be expected to fluctuate as a result of government actions and/or market forces (which would directly affect the cost of products and value of inventories), Kraft and Philip Morris International believe such raw materials to be in adequate supply and generally available from numerous sources. REGULATION Almost all of Kraft's United States food products (and packaging materials therefor) are subject to regulations administered by the FDA or, with respect to products containing meat and poultry, the USDA. Among other things, these agencies enforce statutory prohibitions against misbranded and adulterated foods, establish ingredients and/or manufacturing procedures for certain standard foods, establish standards of identity for food, determine the safety of food substances, and establish labeling standards and nutrition labeling requirements for food products. In addition, various states regulate the business of Kraft's United States operating units by licensing dairy plants, enforcing federal and state standards of identity for food, grading food products, inspecting plants, regulating certain trade practices in connection with the sale of dairy products and imposing their own labeling requirements on food products. 12 Many of the food commodities on which Kraft's United States businesses rely are subject to governmental agricultural programs. These programs have substantial effects on prices and supplies and are subject to Congressional review. Almost all of the activities of the Company's food operations outside of the United States are subject to local and national regulations similar to those applicable to Kraft's United States businesses and, in some cases, international regulatory provisions (such as those of the European Community) relating to labeling, packaging, food content, pricing, marketing and advertising, and related areas. BEER PRODUCTS Miller's brands include MILLER LITE, MILLER LITE ICE, MILLER GENUINE DRAFT, MILLER GENUINE DRAFT LIGHT, MILLER BEER and ICEHOUSE in the premium segment; the MILLER HIGH LIFE FAMILY, including MILLER HIGH LIFE, MILLER HIGH LIFE LIGHT and MILLER HIGH LIFE ICE, and RED DOG in the near-premium segment; Lowenbrau, brewed and sold in the United States under license from Lowenbrau Munchen AG in the above-premium segment; MEISTER BRAU, MILWAUKEE'S BEST and MAGNUM MALT LIQUOR in the below-premium segment; and SHARP'S non-alcohol brew. Miller's brands in the specialty segment are LEINENKUGEL, CELIS and SHIPYARD. Miller also owns a majority interest in Molson USA, LLC, one of the largest beer importers in the United States, whose brands include MOLSON and FOSTER'S. Other brands in the import segment include PRESIDENTE and ASAHI. Miller's total shipment volume (which excludes international shipments of Miller products by other brewers under license and contract brewing arrangements) of 43.7 million barrels for 1997 decreased 0.3% from 1996, reflecting lower export shipments of premium-priced brands, partially offset by increased domestic shipments. Miller's estimated market share of the U.S. malt beverage industry (based on shipments) was 21.8% in 1997, the same as in the prior year. Wholesalers' sales of Miller's products to retailers in 1997 increased slightly from 1996, reflecting higher sales of MILLER LITE, as Miller's new advertising and promotional campaigns renewed focus on major brands. Domestic shipments rose 0.8%, while export shipments decreased in 1997, reflecting a shift toward international licensing and contract brewing arrangements. International sales of Miller products under such arrangements more than offset the 1997 decrease in export shipments. Total shipments of premium-priced brands in 1997 decreased slightly to 81.9% of total shipments, down from 82.5% in 1996. The following table sets forth, based on shipments (including imports and exports), the U.S. industry's sales of beer and brewed non-alcohol beverages, as estimated by Miller; Miller's unit sales; and Miller's estimated share of industry sales:
YEARS ENDED MILLER'S DECEMBER 31 INDUSTRY MILLER SHARE OF INDUSTRY - --------------------------------------------------- ------------- ------------- ------------------- (IN THOUSANDS OF BARRELS) (%) 1997............................................... 200,700 43,675 21.8 1996............................................... 200,707 43,799 21.8 1995............................................... 198,754 45,006 22.6
During 1997, Miller sold its 20% interest in Molson Breweries of Canada, and a minority ownership interest in Molson USA, LLC. During 1996, Miller initiated a number of actions intended to restore growth, streamline its organization and reduce costs, including a workforce reduction. DISTRIBUTION, COMPETITION AND RAW MATERIALS Beer is distributed primarily through independent wholesalers. The United States malt beverage industry is highly competitive, with the principal methods of competition being product quality, price, distribution, marketing and advertising. Miller engages in a wide variety of advertising and sales promotion activities. Barley malt, hops, corn grits and water represent the principal ingredients used in manufacturing Miller's products, and are generally available in the market. The production process, which includes fermentation and aging periods, is conducted throughout the year. Containers (bottles, cans and kegs) for beer are purchased from various suppliers. 13 REGULATION The Alcoholic Beverage Labeling Act of 1988 requires all alcoholic beverages manufactured for sale in the United States to include the following statement on containers: "GOVERNMENT WARNING: (1) According to the Surgeon General, women should not drink alcoholic beverages during pregnancy because of the risk of birth defects; (2) Consumption of alcoholic beverages impairs your ability to drive a car or operate machinery and may cause health problems." The statute empowers the Bureau of Alcohol, Tobacco and Firearms to regulate the size and format of the warning. The federal excise tax is 32 cents per package of six 12-ounce containers. Excise taxes, sales taxes and other taxes affecting beer are also levied by various states, counties and municipalities. In the opinion of Miller, increases in excise taxes have had, and could continue to have, an adverse effect on shipments. Advertising of alcoholic beverages, including beer, has come under increased scrutiny by governmental agencies and others. The FTC's Division of Advertising Practices conducted an investigation of advertising of alcoholic beverages. Following discussions between representatives of the Beer Institute, of which Miller is a member, and senior FTC officials, a number of revisions to the Beer Institute Advertising and Marketing Code were made. Key changes to the Code include the following: a revised introduction clarifying that the Code applies to advertising and marketing in cyberspace, including the Internet; an undertaking that the Beer Institute will make a list of brewer web sites available to all major Internet service providers so they can be included in parental control software; and an obligation for brewers to include additional notices on their web sites reminding users of the legal purchase age. Consistent with brewers' commitment to marketing their products only to persons of legal purchase age, the revised Code requires that TV survey data purchased by brewers reflect the proportion of viewers in the sample survey who are over legal purchase age and also obligates brewers to review their ad placements at least every six months to insure the majority of viewers of brewer-sponsored TV programs are above the legal purchase age. FINANCIAL SERVICES AND REAL ESTATE Philip Morris Capital Corporation ("PMCC") invests in leveraged and direct finance leases, other tax-oriented financing transactions and third-party financial instruments. During 1997, PMCC sold its wholly-owned subsidiary, Mission Viejo Company, which was engaged in land planning, development and sales activities in Southern California and in the Denver, Colorado area. Total assets of PMCC were $5.9 billion at December 31, 1997, and 1996, reflecting an increase in net finance assets, offset by the sale of real estate assets. OTHER MATTERS CUSTOMERS None of the Company's business segments is dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on the Company's results of operations. EMPLOYEES At December 31, 1997, the Company employed approximately 152,000 people worldwide. On February 25, 1998, the Company announced voluntary early retirement and separation programs for salaried and hourly employees, primarily at PM Inc.'s manufacturing facilities in Richmond, Virginia and Louisville, Kentucky. It is estimated that approximately 1,900 employees are likely to be affected by the programs, which do not apply to the Company's food or beer operations. The Company estimates that the programs will result in pretax charges in the first and second quarters of 1998 totalling approximately $290 million. 14 TRADEMARKS Trademarks are of material importance to all three of the Company's consumer products businesses and are protected by registration or otherwise in the United States and most other markets where the related products are sold. ENVIRONMENTAL REGULATION The Company and its subsidiaries are subject to various federal, state and local laws and regulations concerning the discharge of materials into the environment, or otherwise related to environmental protection, including the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act, which imposes joint and several liability on each responsible party (commonly known as "Superfund"). In 1997, subsidiaries (or former subsidiaries) of the Company were involved in approximately 225 matters subjecting them to potential remediation costs under Superfund or otherwise. The Company and its subsidiaries expect to continue to make capital and other expenditures in connection with environmental laws and regulations. Although it is not possible to predict precise levels of environmental-related expenditures, compliance with such laws and regulations, including the payment of any remediation costs and the making of such expenditures, has not had and is not expected to have a material adverse effect on the Company's results of operations, capital expenditures or financial position. SHARE REPURCHASE PROGRAM During 1997, the Company repurchased 18.2 million shares of its Common Stock. Of these purchases, 16.9 million shares were made pursuant to remaining authority under the Company's repurchase program, announced in 1994, to purchase up to $6.0 billion of its Common Stock in the open market. The remaining shares were repurchased under an $8.0 billion share repurchase program approved by the Board of Directors in the first quarter of 1997. In view of the uncertainty surrounding the proposed Resolution discussed above in Item 1, the Company has suspended its share repurchase program and has not repurchased any shares since April 1997. COMMON STOCK SPLIT In February 1997, the Company declared a three-for-one split of its Common Stock, effected by a distribution on April 10, 1997, of two shares for each share held of record at the close of business on March 17, 1997. All share and per-share data reported in the Company's consolidated financial statements, incorporated herein by reference to the Company's 1997 Annual Report, have been restated to reflect this stock split for all periods presented. 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, of the proposed Resolution discussed above. Each of the Company's operating subsidiaries is subject to intense competition, changes 15 in consumer preferences, the effects of changing prices for its raw materials and local economic conditions. The performance of each of Philip Morris International and Kraft Foods International is affected by foreign economies and currency movements. Developments in any of these areas, which are more fully described elsewhere in Part I hereof and in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") on pages 21-35 of the Company's 1997 Annual Report, each of which is 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. (D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES The amounts of operating revenues, operating profit and identifiable assets attributable to each of the Company's geographic segments and the amount of export sales from the United States for each of the last three fiscal years are set forth in Note 12 to the Company's consolidated financial statements, incorporated herein by reference to the Company's 1997 Annual Report. Subsidiaries of the Company export tobacco and tobacco-related products, coffee products, grocery products, cheese, processed meats and beer. In 1997, the value of all exports from the United States by these subsidiaries amounted to approximately $6.7 billion. ITEM 2. DESCRIPTION OF PROPERTY. TOBACCO PRODUCTS PM Inc. owns nine tobacco manufacturing and processing facilities--six in the Richmond, Virginia, area, two in Louisville, Kentucky, and one in Cabarrus County, North Carolina. Subsidiaries and affiliates of Philip Morris International own, lease or have an interest in 52 cigarette or component manufacturing facilities in 29 countries outside the United States, including cigarette manufacturing facilities in Bergen Op Zoom, the Netherlands, and in Berlin, Germany. FOOD PRODUCTS The Company's subsidiaries have 54 manufacturing and processing facilities and 252 distribution centers and depots throughout the United States, as well as 103 foreign manufacturing and processing facilities in 35 countries, and various distribution and other facilities outside the United States. All significant plants and properties used for production of food products are owned, although the majority of the domestic distribution centers and depots are leased. BEER Miller owns and operates eight breweries, located in Milwaukee, Wisconsin (two); Fort Worth, Texas; Eden, North Carolina; Albany, Georgia; Irwindale, California; Trenton, Ohio; and Chippewa Falls, Wisconsin. Miller owns a majority interest in the Celis Brewery in Austin, Texas, and the Shipyard Brewery in Portland, Maine. Miller also owns a hops-processing facility in Wisconsin, and owns or leases warehouses in several locations. GENERAL The plants and properties owned and operated by the Company's subsidiaries are maintained in good condition and are believed to be suitable and adequate for present needs. In the fourth quarter of 1993, the Company provided for the costs of restructuring its worldwide operations. The charge related primarily to the downsizing or closure of approximately 40 manufacturing and other facilities. Write-downs of such facilities included in the restructuring charge were, on a pretax basis, $429 million, of which $141 million, 16 $211 million and $77 million related to tobacco, food and beer facilities, respectively. The 1993 restructuring and its impact on the Company's financial statements are described in the MD&A, incorporated herein by reference to the Company's 1997 Annual Report. During 1997, the Company's international food businesses recorded a pretax charge of $342 million, related primarily to the downsizing or closure of manufacturing and other facilities, as well as the discontinuance of certain low-margin product lines. Facility write-downs included in the charge totaled $209 million. ITEM 3. LEGAL PROCEEDINGS. Legal proceedings covering a wide range of matters are pending in various U.S. and foreign jurisdictions against the Company, its subsidiaries, including PM Inc., 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, including class actions, brought by state and local governments, unions, federal and state taxpayers, native American tribes and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking. 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, a trend that accelerated in 1997. As of February 27, 1998, there were approximately 390 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. Seventeen of the individual cases involve allegations of various personal injuries allegedly related to exposure to ETS. In addition, as of February 27, 1998, there were approximately 50 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including six 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. As of February 27, 1998, there were three purported smoking and health class actions pending overseas against affiliates and subsidiaries of the Company, one each in Canada, Brazil and Nigeria. The number of health care cost recovery actions also increased, with approximately 105 such cases pending as of February 27, 1998, compared with approximately 105 such cases on December 31, 1997, and 25 such cases on December 31, 1996. 17 RECENT VERDICTS In August 1996, a Florida jury awarded a former smoker and his spouse $750,000 in a smoking and health case against another United States cigarette manufacturer (CARTER V. AMERICAN TOBACCO CO., ET AL.), and that manufacturer was subsequently ordered to pay approximately $1.8 million in attorneys' fees and costs. Neither PM Inc. nor the Company was a party to that litigation. The defendant in that action has appealed the verdict. Later that month, a jury returned a verdict for defendants in a smoking and health case in Indiana against United States cigarette manufacturers, including PM Inc. (ROGERS V. R.J. REYNOLDS TOBACCO COMPANY, ET AL.). Plaintiff has filed a motion seeking a new trial based on the alleged discovery of new evidence. In May and October 1997, Florida juries also returned verdicts for defendants in smoking and health cases involving another United States cigarette manufacturer (CONNOR V. R.J. REYNOLDS TOBACCO COMPANY; KARBIWNYK V. R.J. REYNOLDS TOBACCO COMPANY). In September 1997, a court in Brazil awarded plaintiffs in a smoking and health case the Brazilian 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 (ALVES V. SOUZA CRUZ). Defendant is appealing the judgment. Neither the Company nor its affiliates were parties to that action. THE PROPOSED RESOLUTION AND RECENT SETTLEMENTS In June 1997, PM Inc. and other companies in the United States tobacco industry agreed to a proposed Resolution to support federal legislation and ancillary undertakings that would resolve many of the regulatory and litigation issues affecting the industry. (See "PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES" in Item 1 above.) In furtherance of the proposed Resolution, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida and Texas, and a smoking and health class action brought on behalf of airline flight attendants, all on terms consistent with the proposed Resolution. These settlements are discussed below. CURRENTLY PENDING TRIALS In January 1998, trial began in the health care cost recovery action brought by State of Minnesota and Blue Cross Blue Shield of Minnesota against PM Inc., other domestic tobacco manufacturers, and others, including the Company. Plaintiffs seek $1.7 billion in compensatory damages, disgorgement of profits, restitution, treble damages under Minnesota's antitrust statute, punitive damages, funding of smoking cessation and public education programs, civil penalties of $25,000 for each separate violation of various consumer protection statutes, civil penalties of $50,000 for each separate violation of Minnesota's antitrust statute, attorneys' fees and costs, various forms of non-monetary relief and such other legal or equitable relief as the court deems just and equitable. Under Minnesota law, joint and several liability applies. There have been a number of significant rulings and developments in this case, many of which have been adverse to defendants. Certain of these rulings and developments are discussed below under the heading "Health Care Cost Recovery Litigation--MINNESOTA TRIAL." Trial in an individual ETS case began in February 1998 (DUNN V. RJR NABISCO HOLDINGS CORP., ET AL.). FUTURE TRIAL DATES The following health care cost recovery actions are currently scheduled for trial later in 1998: Washington (September), Arizona (October) and Oklahoma (November). Approximately 25 individual smoking and health cases are currently scheduled for trial in 1998 against PM Inc. and, in some cases, the Company, one of which is scheduled to begin in Florida in May 1998, and approximately 15 of which are scheduled to commence in Florida in June 1998. Trial in a New York smoking and health class action, previously scheduled to begin in February, has been delayed and may begin in the spring or summer of 1998 (FROSINA, ET AL. V. PHILIP MORRIS, INC.). A Florida smoking and health class action, previously scheduled 18 for trial in February 1998, has also been delayed (ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL.). No new trial date has been set. 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. Plaintiffs in these 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 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 February 27, 1998, 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, South Dakota, Tennessee, Texas, Utah, West Virginia and Wisconsin, as well as in Canada, Brazil and Nigeria. As of February 27, 1998, classes had been certified in five of these smoking and health class actions, in Florida, Louisiana, Maryland and New York (2), and class certification had been denied or reversed in three cases involving PM Inc., in Louisiana, the District of Columbia and Pennsylvania. A number of these class certification decisions are under appeal. One smoking and health class action was settled in 1997 as discussed below. THE Broin SETTLEMENT The BROIN, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL. class action was settled in October 1997 by PM Inc. and other companies in the domestic tobacco industry. 19 The BROIN class consisted of "all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from various diseases and disorders caused by their exposure to second-hand smoke in airline cabins." Under the settlement, the settling defendants will pay $300 million to establish a foundation to sponsor scientific research with respect to diseases associated with cigarette smoking. These funds will be paid in three equal annual installments, with interest. Settling defendants also agreed to pay attorneys' fees of up to $46 million and costs of $3 million, subject to court approval. PM Inc.'s share of all the foregoing payments (exclusive of interest) is approximately $175 million and was charged to expense in the third quarter of 1997. Under the settlement, all defendants (and certain other entities and persons) are released from liability for the claims asserted in the present action. Each individual member of the class, however, may later bring an individual action for diseases and conditions existing on or before January 15, 1997 ("retained claims"), based upon certain legal theories against the settling defendants, but may only seek compensatory, and not punitive, damages. The defendants expressly did not admit liability for injury of any member of the settlement class or that ETS can cause any disease. In any individual lawsuits brought by members of the settlement class for retained claims, the settling defendants would assume the burden of proof as to whether ETS can cause certain conditions, but the plaintiff would retain the burden of proving that his or her condition was caused by exposure to ETS. The settling defendants have also agreed not to raise a statute of limitations defense with respect to any retained claims brought by a member of the settlement class within one year after final court approval of the settlement. The settlement does not apply to, nor does it have any effect on, "future" claims brought by members of the settlement class for any new and unrelated diseases or conditions arising after January 15, 1997. Trial court approval of the BROIN settlement was granted in February 1998, but this approval has been appealed by a number of individuals. No payments with respect to either the research fund or attorneys' fees will be due until final appellate court approval of the settlement. The ultimate outcome of the appeals cannot be predicted. HEALTH CARE COST RECOVERY LITIGATION In certain of the pending proceedings, foreign, state and local government entities, unions, federal and state taxpayers, native American tribes and others seek reimbursement for Medicaid and/or other health care expenditures allegedly caused by tobacco products and, in some cases, for future expenditures and damages as well. 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 one purported class action, Blue Cross/Blue Shield subscribers in the United States are seeking reimbursement of allegedly increased medical insurance premiums caused by tobacco products. In the native American cases, claims are also asserted for alleged lost productivity of tribal government employees. Other relief sought by some but not all plaintiffs includes punitive damages, treble/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. 20 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 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 of February 27, 1998, there were approximately 105 health care cost recovery cases pending against PM Inc. and, in some cases, the Company, including cases filed by states, through their attorneys general and/or other state agencies, in Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, 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. In addition, approximately 45 of the pending health care cost recovery actions were filed by unions, eight by city and county governments, six by federal and state taxpayers and four by native American tribes. Health care cost recovery actions have also been brought by the Republic of the Marshall Islands and the Commonwealth of Puerto Rico. Three health care cost recovery cases were settled recently as discussed below. THE MISSISSIPPI, FLORIDA AND TEXAS SETTLEMENTS In June 1997, PM Inc. and other companies in the United States tobacco industry agreed to a proposed Resolution to support federal legislation and ancillary undertakings that would resolve much of the litigation facing the United States tobacco industry. (See "PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES" in Item 1 above.) In furtherance of the proposed Resolution, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida and Texas on terms consistent with the proposed Resolution. The Mississippi action was settled in July 1997, Florida was settled in September 1997 and Texas was settled in January 1998. Copies of the settlement agreements are filed as Exhibits to this Form 10-K, and the discussion herein is qualified by reference thereto. Under the Mississippi settlement agreement, the settling defendants paid $170 million, representing Mississippi's estimated share of the $10 billion initial payment under the proposed Resolution, and paid an additional $15 million to reimburse Mississippi and its private counsel for out-of-pocket costs. The settling defendants also paid approximately $62 million to support a pilot program aimed at reducing the use of tobacco products by persons under the age of eighteen. PM Inc.'s share of all the foregoing payments, approximately $153 million, was charged to expense in the third quarter of 1997. Beginning December 31, 1998, the settling defendants will pay Mississippi amounts based on its anticipated share of the annual industry payments under the proposed Resolution. These payments, which (except for the payment with respect to 1998) will be adjusted as provided in the proposed Resolution, are estimated to be $68 million with respect to 1998 and will increase annually thereafter to an estimated $136 million by 2003, continuing at that level thereafter, and will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. 21 Under the Florida settlement agreement, the settling defendants paid $550 million, representing Florida's estimated share of the $10 billion initial payment under the proposed Resolution, and also reimbursed Florida's expenses and those of its private counsel. The settling defendants also paid $200 million to support a pilot program by Florida aimed at reducing the use of tobacco products by persons under the age of eighteen. PM Inc.'s share of all the foregoing payments, approximately $484 million, was charged to expense in the third quarter of 1997. On September 15, 1998, and annually thereafter on December 31, the settling defendants will make ongoing payments to Florida in the following estimated amounts--1998: $220 million; 1999: $247.5 million; 2000: $275 million; 2001: $357.5 million; 2002: $357.5 million; and each year thereafter: $440 million. These amounts are projected to approximate that portion of the annual industry payments under the proposed Resolution that is contemplated to be paid to Florida. These payments (except for the payment with respect to 1998) will be adjusted as provided in the proposed Resolution and will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. Under the Texas settlement agreement, the settling defendants agreed to pay Texas an up-front payment of $725 million in 1998, representing Texas's estimated share of the $10 billion initial payment under the proposed Resolution, and agreed to reimburse Texas and its private counsel for expenses in the estimated amount of $45 million. The settling defendants also agreed to pay Texas $264 million to support a pilot program aimed at reducing the use of tobacco by persons under the age of eighteen. PM Inc.'s share of all of the foregoing payments, approximately $645 million, was charged to expense in the fourth quarter of 1997. Beginning in November and December 1998, and on December 31 of each subsequent year, the settling defendants will pay Texas 7.25% of the annual industry payments contemplated to be paid to the states under the proposed Resolution. These payments, which (except for the payments with respect to 1998) will be adjusted as provided in the proposed Resolution, will be in the following estimated amounts--1998: $290 million; 1999: $326 million; 2000: $363 million; 2001: $471 million; 2002: $471 million; and 2003 and each year thereafter: $580 million. These payments will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. Several county hospitals, local governments and others in Texas have filed motions challenging the applicability of the Texas settlement agreement to the health care cost recovery claims of such entities. The effect and the ultimate outcome of these challenges cannot be predicted. The settling defendants have also agreed to pay reasonable attorneys' fees of private contingency fee counsel of Mississippi, Florida and Texas as set by a panel of independent arbitrators. Each of these payments would be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales and will be subject to an aggregate national annual cap of $500 million. Certain of Florida's private contingency fee counsel have challenged the attorneys' fees provision set forth in the Florida settlement agreement, arguing that the settlement agreement has no effect on their rights under their contingency fee agreement with Florida. In November 1997, the court ordered all parties to comply with the provisions for obtaining attorneys' fees, as set forth in the settlement agreement. Certain contingency fee counsel are appealing this ruling. One of these contingency fee counsel has filed suit against PM Inc. and others alleging, among other things, tortious interference with such counsel's contingency fee agreement with the State. If legislation implementing the proposed Resolution or its substantial equivalent is enacted, the settlements will remain in place, but the terms of the federal legislation will supersede the settlement agreements (except for the terms of the pilot programs and payments thereunder, the initial payments and the annual payments with respect to 1998), and the other payments described above will be adjusted so that Mississippi, Florida and Texas will receive the same payments as they would receive under such legislation. 22 If the settling defendants enter into any future pre-verdict settlement agreement with a non-federal governmental plaintiff on more favorable terms (after due consideration of relevant differences in population or other appropriate factors), Mississippi, Florida and Texas will obtain treatment at least as relatively favorable as such governmental plaintiff. If federal legislation implementing the proposed Resolution or its substantial equivalent is enacted, the parties contemplate that Mississippi, Florida and Texas and any other state that has made an exceptional contribution to secure resolution of these matters may apply to a panel of independent arbitrators for reasonable compensation for its efforts in securing the proposed Resolution. The settling defendants have agreed not to oppose applications for $75 million by Mississippi, $250 million by Florida and $329.5 million by Texas, subject to a nationwide annual cap for all such payments of $100 million. Finally, the settlement agreements provide that they are not an admission or concession or evidence of any liability or wrongdoing on the part of any party, and were entered into by the settling defendants solely to avoid the further expense, inconvenience, burden and uncertainty of litigation. MINNESOTA TRIAL Trial in the Minnesota health care cost recovery action began in January 1998. Plaintiffs seek $1.7 billion in compensatory damages, disgorgement of profits, restitution, treble damages under Minnesota's antitrust statute, punitive damages, funding of smoking cessation and public education programs, civil penalties of $25,000 for each separate violation of various consumer protection statutes, civil penalties of $50,000 for each separate violation of Minnesota's antitrust statute, attorneys' fees and costs, various forms of non-monetary relief and such other relief as the court deems just and equitable. Under Minnesota law, joint and several liability applies. Prior to trial, in December 1997, the court imposed sanctions on certain companies, other than PM Inc. and the Company, for alleged failure to produce certain documents and to answer discovery questions properly. Sanctions included fines and revocation of the privileged status of certain documents. The court further stated that it would impose one or more of the following sanctions, or any other sanction, that the court deems just in light of any prejudice to plaintiffs' case as a result of the alleged discovery abuses: plaintiffs will be permitted to present to the jury the failure to provide discovery and the court will instruct the jury that it may draw a negative inference from such failure; the court will order that plaintiffs' allegations against these companies that rest upon the information ordered produced (smoking and health research and marketing/advertising) be deemed established; and the court will enter default judgment against these companies. In January 1998, the court denied defendants' motion to strike the jury panel. Defendants had argued that the process of selecting the jury was unfair and had led to the selection of a jury that is inherently biased against defendants. In January and February 1998, the court issued a number of rulings on summary judgment motions, denying defendants' motion based on statute of limitations and federal preemption and plaintiffs' motion based on non-statutory claims (special duty, unjust enrichment, and performance of a duty of another) and antitrust claims. The court also denied defendants' motion seeking to prohibit plaintiffs from recovering the federal government's share of Medicaid expenses and denied a motion to prevent plaintiffs from seeking disgorgement of profits under certain counts. The court also denied defendants' motion for partial summary judgment based on plaintiffs' inability to prove causation or damages and based on defendants' right to petition (I.E., lobby) the government. In February 1998, the Special Master appointed by the court to review defendants' assertions of privilege found that over 30,000 documents should be produced on the grounds that they were either not privileged or, if privileged, were discoverable under the crime-fraud exception to the privilege. The finding is preliminary and is on appeal to the trial court. In an earlier ruling on the discoverability of certain 23 documents as to which defendants asserted a privilege, the trial court adopted a report of the Special Master recommending release of over 800 documents as either not being privileged or, if privileged, subject to the crime-fraud exception. The court has also issued the following rulings, among others: defendants cannot argue that plaintiff Blue Cross/Blue Shield passed any increased health care costs on to smokers through differential premiums, but defendants can introduce evidence of differential premiums to the extent it is relevant in apportioning fault and establishing the defense of unclean hands; defendants cannot raise affirmative defenses based on conduct of individual smokers, but can introduce evidence relating to individual smokers to the extent that individual conduct is relevant to the causal chain between defendants' conduct and plaintiffs' injury; defendants cannot argue that the State's statistical model is flawed because it does not take into account the reduction in health care costs occasioned by the premature deaths of smokers; defendants cannot introduce certain research results; defendants can present evidence of the State's distribution of cigarettes and failure to enforce youth smoking laws; defendants can present evidence regarding the reasonableness of smoking-related actions taken by the Minnesota legislature; plaintiffs may present evidence of defendants' alleged discovery abuses; and plaintiffs can show the jury the videotaped deposition of a former employee of PM Inc., who asserted his Fifth Amendment right not to testify. ------------------------ 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 billion. In addition, the Italian lira equivalent of $6.0 billion in interest and penalties has been assessed. The Company anticipates that value-added and income tax assessments may also be received in respect of 1996 and 1997. In September 1997, in the first of several appeals filed by affiliates of the Company, the Italian administrative tax court in Milan overturned one of the assessments for value-added taxes. A hearing on a second appeal was held in October 1997, and hearings on additional appeals were held in December 1997 and January 1998. Additional hearings are anticipated over the course of 1998. 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 a public prosecutor in Milan where a preliminary investigations judge will make a new determination 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. ------------------------ On March 5, 1998, Kraft received a "Notice of Violation and Proposed Settlement" from the San Joaquin Valley Unified Air Pollution Control District (the "Pollution Control District") alleging that a subsidiary of Kraft had violated the terms of its air emissions permit. The Pollution Control District is seeking a civil penalty of $281,574 in settlement of this matter. ------------------------ It is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention, including a decision by a federal district court on a motion for summary judgment not to preclude the FDA from asserting jurisdiction over cigarettes as "drugs" or 24 "medical devices," which decision is now under appeal. These developments, as well as the widespread media attention given to the proposed Resolution discussed in Item 1 above and the settlements of the Mississippi, Florida and Texas health care cost recovery actions and the BROIN class action, may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. It is possible that the Company's results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially affected by an unfavorable outcome of certain pending litigation or by the proposed Resolution discussed in Item 1 above or by settlement, if any, of certain pending cases. However, implementation of the proposed Resolution should resolve the most significant tobacco litigation against the Company and its subsidiaries. Furthermore, the Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. Except as described in Item 1 above, under the heading "PROPOSED RESOLUTION OF CERTAIN REGULATORY AND LITIGATION ISSUES--EFFECTS ON LITIGATION," all such cases are, and will continue to be, vigorously defended. Reference is made to Note 15, incorporated herein by reference to the Company's 1997 Annual Report, for a description of certain pending legal proceedings, and Exhibit 99 to this Form 10-K for a list of pending smoking and health class actions, health care cost recovery actions, and certain other actions, and for a description of certain developments in such proceedings. Copies of Note 15 and Exhibit 99 are available upon written request to the Corporate Secretary, Philip Morris Companies Inc., 120 Park Avenue, New York, NY 10017. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 25 EXECUTIVE OFFICERS OF THE COMPANY The following are the executive officers of the Company as of March 1, 1998:
NAME OFFICE AGE - ----------------------------------------------------- ----------------------------------------------------- --- Geoffrey C. Bible.................................... Chairman of the Board and Chief Executive Officer 60 John D. Bowlin....................................... President and Chief Executive Officer of Kraft Foods International, Inc. 47 Murray H. Bring...................................... Vice Chairman, External Affairs, and General Counsel 63 Bruce S. Brown....................................... Vice President, Taxes 58 Louis C. Camilleri................................... Senior Vice President and Chief Financial Officer 43 Siw de Gysser........................................ Vice President, Corporate Planning 54 Nancy J. De Lisi..................................... Vice President and Treasurer 47 Robert A. Eckert..................................... President and Chief Executive Officer of Kraft Foods, Inc. 43 Andreas Gembler...................................... President and Chief Executive Officer, Philip Morris International Inc. 54 Marc S. Goldberg..................................... Senior Vice President, Worldwide Operations and Technology 54 G. Penn Holsenbeck................................... Vice President, Associate General Counsel and Corporate Secretary 51 John N. MacDonough................................... Chairman and Chief Executive Officer of Miller Brewing Company 54 Steven C. Parrish.................................... Senior Vice President, Corporate Affairs 47 Timothy A. Sompolski................................. Senior Vice President, Human Resources and Administration 45 Michael E. Szymanczyk................................ President and Chief Executive Officer of Philip Morris Incorporated 49 Frank T. Toscano..................................... Vice President and Controller 46 William H. Webb...................................... Chief Operating Officer 58
All of the above-mentioned officers, with the exception of Mr. Holsenbeck, have been employed by the Company in various capacities during the past five years. Mr. Holsenbeck was elected to his current position with the Company in January 1995. Previously, Mr. Holsenbeck held various positions with Bethlehem Steel Corporation, including Secretary and Deputy General Counsel from 1992 to January 1995. 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information called for by this Item is hereby incorporated by reference to the paragraph captioned "Quarterly Financial Data (Unaudited)" on page 61 of the Company's 1997 Annual Report and made a part hereof. ITEM 6. SELECTED FINANCIAL DATA. The information called for by this Item is hereby incorporated by reference to the information with respect to 1993-1997 appearing under the caption "Selected Financial Data" on pages 36 and 37 of the Company's 1997 Annual Report and made a part hereof. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information called for by this Item is hereby incorporated by reference to the paragraphs captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 21-35 of the Company's 1997 Annual Report and made a part hereof. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information called for by this Item is hereby incorporated by reference to the paragraphs in the MD&A captioned "Market Risk" and "Value at Risk" on pages 34 and 35 of the Company's 1997 Annual Report and made a part hereof. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information called for by this Item is hereby incorporated by reference to the Company's 1997 Annual Report as set forth under the caption "Quarterly Financial Data (Unaudited)" on page 61 and in the Index to Consolidated Financial Statements and Schedules (see Item 14) and made a part hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ITEM 11. EXECUTIVE COMPENSATION. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Except for the information relating to the executive officers of the Company set forth in Part I of this Report, the information called for by Items 10-13 is hereby incorporated by reference to the Company's definitive proxy statement for use in connection with its annual meeting of stockholders to be held on April 30, 1998, and made a part hereof. 27 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Index to Consolidated Financial Statements and Schedules
REFERENCE -------------------------------- FORM 10-K 1997 ANNUAL ANNUAL REPORT REPORT PAGE PAGE ----------------- ------------- Data incorporated by reference to the Company's 1997 Annual Report: Consolidated Balance Sheets at December 31, 1997 and 1996.... -- 38-39 Consolidated Statements of Earnings for the years ended December 31, 1997, 1996 and 1995........................... -- 40 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995..................... -- 42 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995........................... -- 40-41 Notes to Consolidated Financial Statements................... -- 43-61 Report of Independent Accountants............................ -- 62 Data submitted herewith: Report of Independent Accountants............................ S-1 -- Financial Statement Schedule--Valuation and Qualifying Accounts................................................... S-2 --
Schedules other than those listed above have been omitted either because such schedules are not required or are not applicable. (b) Reports on Form 8-K: No Current Reports on Form 8-K were filed during the last quarter of the period for which this Report is filed. Subsequent to the last quarter of the period for which this Report is filed, the Company filed Current Reports on Form 8-K dated January 16, 1998, and January 28, 1998, and a Form 8-K/A dated February 17, 1998. (c) The following exhibits are filed as part of this Report (Exhibit Nos. 10.1-10.16 are management contracts, compensatory plans or arrangements): 3.1. Restated Articles of Incorporation of the Company. (1) 3.2. By-Laws, as amended, of the Company. 4.1. Indenture dated as of August 1, 1990, between the Company and The Chase Manhattan Bank (formerly known as Chemical Bank), Trustee. (2) 4.2. First Supplemental Indenture dated as of February 1, 1991, to Indenture dated as of August 1, 1990, between the Company and The Chase Manhattan Bank (formerly known as Chemical Bank), Trustee. (3) 4.3. Second Supplemental Indenture dated as of January 21, 1992, to Indenture dated as of August 1, 1990, between the Company and The Chase Manhattan Bank (formerly known as Chemical Bank), Trustee. (4) 4.4. 5-Year Revolving Credit Agreement dated as of October 14, 1997, among the Company, and the Initial Lenders named therein and Citibank, N.A., and The Chase Manhattan Bank, as Administrative Agents, and Credit Suisse First Boston, as Syndication Agent, and Deutsche Bank AG, New York Branch, as Documentation Agent. (5)
28 10.1. Financial Counseling Program. 10.2. Philip Morris Benefit Equalization Plan, as amended. (6) 10.3. Form of Employee Grantor Trust Enrollment Agreement. (7) 10.4. Automobile Policy. 10.5. Agreement, dated October 12, 1987, between the Company and Murray H. Bring, as amended. (8) 10.6. Agreement, dated November 1, 1989, between the Company and Murray H. Bring. (9) 10.7. Form of Employment Agreement between the Company and its executive officers. (9) 10.8. Supplemental Management Employees' Retirement Plan of the Company, as amended. 10.9. The Philip Morris 1992 Incentive Compensation and Stock Option Plan. 10.10. 1992 Compensation Plan for Non-Employee Directors, as amended. (10) 10.11. Unit Plan for Incumbent Non-Employee Directors, effective January 1, 1996. (7) 10.12. The Philip Morris 1987 Long Term Incentive Plan. 10.13. Form of Executive Master Trust between the Company, The Chase Manhattan Bank (formerly known as Chemical Bank) and Handy Associates. (9) 10.14. 1997 Performance Incentive Plan. (11) 10.15. Philip Morris Long-Term Disability Benefit Equalization Plan, as amended. 10.16. Philip Morris Survivor Income Benefit Equalization Plan, as amended. 10.17. Memorandum of Understanding related to proposed resolution of certain U.S. litigation and regulation issues. (12) 10.18. Comprehensive Settlement Agreement and Release dated October 17, 1997, related to settlement of Mississippi health care cost recovery action. 10.19. Settlement Agreement dated August 25, 1997, related to settlement of Florida health care cost recovery action. (13) 10.20. Comprehensive Settlement Agreement and Release dated January 16, 1998, related to settlement of Texas health care cost recovery action. (14) 12. Statements re computation of ratios. (15) 13. Pages 21-62 of the Company's 1997 Annual Report, but only to the extent set forth in Items 1-3, 5-7, 7A, 8 and 14 hereof. With the exception of the aforementioned information incorporated by reference in this Annual Report on Form 10-K, the Company's 1997 Annual Report is not to be deemed "filed" as part of this Report. 21. Subsidiaries of the Company. 23. Consent of independent accountants. 24. Powers of attorney. 99. Certain Pending Litigation Matters and Recent Developments.
- ------------------------ (1) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997. 29 (2) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-36450) dated August 22, 1990. (3) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-39059) dated February 21, 1991. (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-45210) dated January 22, 1992. (5) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997. (6) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. (7) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. (8) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. (9) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994. (10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1997. (11) Incorporated by reference to the Company's proxy statement dated March 10, 1997. (12) Incorporated by reference to the Company's Current Report on Form 8-K dated June 20, 1997. (13) Incorporated by reference to the Company's Current Report on Form 8-K dated August 25, 1997. (14) Incorporated by reference to the Company's Current Report on Form 8-K dated January 16, 1998. (15) Incorporated by reference to the Company's Current Report on Form 8-K dated January 28, 1998, as amended by Form 8-K/A dated February 17, 1998. 30 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. PHILIP MORRIS COMPANIES INC. By: /s/ GEOFFREY C. BIBLE ----------------------------------------- (Geoffrey C. Bible Chairman of the Board and Chief Executive Officer) Date: March 5, 1998
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED: SIGNATURE TITLE DATE - ------------------------------------- -------------------------- -------------- /s/ GEOFFREY C. BIBLE Director, Chairman of the - ------------------------------------- Board and Chief March 5, 1998 (Geoffrey C. Bible) Executive Officer /s/ LOUIS C. CAMILLERI - ------------------------------------- Senior Vice President and March 5, 1998 (Louis C. Camilleri) Chief Financial Officer /s/ FRANK T. TOSCANO - ------------------------------------- Vice President and March 5, 1998 (Frank T. Toscano) Controller * ELIZABETH E. BAILEY, MURRAY H. BRING, HAROLD BROWN, WILLIAM H. DONALDSON, JANE EVANS, ROBERT E. R. HUNTLEY, RUPERT MURDOCH, JOHN D. NICHOLS, LUCIO A. NOTO, RICHARD D. PARSONS, ROGER S. PENSKE, JOHN S. REED, CARLOS SLIM HELU, STEPHEN M. WOLF, Directors *BY: /S/ LOUIS C. CAMILLERI - ------------------------------------- (Louis C. Camilleri Attorney-in-fact) March 5, 1998 31 REPORT OF INDEPENDENT ACCOUNTANTS Our report on our audits of the consolidated financial statements of Philip Morris Companies Inc. has been incorporated by reference in this Form 10-K from the 1997 annual report to stockholders of Philip Morris Companies Inc. and appears on page 62 therein. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index in Item 14(a) on page 28 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. /S/ COOPERS & LYBRAND L.L.P. New York, New York January 26, 1998 S-1 PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN MILLIONS)
COL. C ---------------------------- COL. B ADDITIONS COL. E ----------- ---------------------------- ------------- COL. A BALANCE AT CHARGED TO CHARGED TO COL. D BALANCE AT - ---------------------------------------------------- BEGINNING COSTS AND OTHER ------------- END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD - ---------------------------------------------------- ----------- ------------- ------------- ------------- ------------- (A) (B) 1997: CONSUMER PRODUCTS: Allowance for discounts........................... $ 5 $ 534 $ -- $ 531 $ 8 Allowance for doubtful accounts................... 167 35 (13) 32 157 Allowance for returned goods...................... 5 66 -- 65 6 ----- ----- --- ----- ----- $ 177 $ 635 $ (13) $ 628 $ 171 ----- ----- --- ----- ----- ----- ----- --- ----- ----- FINANCIAL SERVICES AND REAL ESTATE: Allowance for losses.............................. $ 101 $ -- $ -- $ -- $ 101 ----- ----- --- ----- ----- ----- ----- --- ----- ----- 1996: CONSUMER PRODUCTS: Allowance for discounts........................... $ 12 $ 492 $ -- $ 499 $ 5 Allowance for doubtful accounts................... 163 27 16 39 167 Allowance for returned goods...................... 3 64 -- 62 5 ----- ----- --- ----- ----- $ 178 $ 583 $ 16 $ 600 $ 177 ----- ----- --- ----- ----- ----- ----- --- ----- ----- FINANCIAL SERVICES AND REAL ESTATE: Allowance for losses.............................. $ 101 $ -- $ -- $ -- $ 101 ----- ----- --- ----- ----- ----- ----- --- ----- ----- 1995: CONSUMER PRODUCTS: Allowance for discounts........................... $ 15 $ 551 $ -- $ 554 $ 12 Allowance for doubtful accounts................... 168 35 (12) 28 163 Allowance for returned goods...................... 4 40 -- 41 3 ----- ----- --- ----- ----- $ 187 $ 626 $ (12) $ 623 $ 178 ----- ----- --- ----- ----- ----- ----- --- ----- ----- FINANCIAL SERVICES AND REAL ESTATE: Allowance for losses.............................. $ 104 $ -- $ -- $ 3 $ 101 ----- ----- --- ----- ----- ----- ----- --- ----- -----
- ------------------------ Notes: (a) Related to divestitures, acquisitions and currency translation. (b) Represents charges for which allowances were created. S-2 EX-3.2 2 BY-LAWS AS AMENDED OF PM Exhibit 3.2 BY-LAWS of PHILIP MORRIS COMPANIES INC. ARTICLE I Meetings of Stockholders Section 1. Annual Meetings. - The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting, and any postponement or adjournment thereof, shall be held on such date and at such time as the Board of Directors may in its discretion determine. Section 2. Special Meetings. - Unless otherwise provided by law, special meetings of the stockholders may be called by the chairman of the Board of Directors, or in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, an executive vice president or by order of the Board of Directors, whenever deemed necessary. Section 3. Place of Meetings. - All meetings of the stockholders shall be held at such place in the Commonwealth of Virginia as from time to time may be fixed by the Board of Directors. Section 4. Notice of Meetings. - Notice, stating the place, day and hour and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given not less than ten nor more than sixty days before the date of the meeting (except as a different time is specified herein or by law), to each stockholder of record having voting power in respect of the business to be transacted thereat. Notice of a stockholders' meeting to act on an amendment of the Articles of Incorporation, a plan of merger or share exchange, a proposed sale of all, or substantially all of the Corporation's assets, otherwise than in the usual and regular course of business, or the dissolution of the Corporation shall be given not less than twenty-five nor more than sixty days before the date of the meeting and shall be accompanied, as appropriate, by a copy of the proposed amendment, plan of merger or share exchange or sale agreement. February 25, 1998 -1- Notwithstanding the foregoing, a written waiver of notice signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A stockholder who attends a meeting shall be deemed to have (i) waived objection to lack of notice or defective notice of the meeting, unless at the beginning of the meeting he or she objects to holding the meeting or transacting business at the meeting, and (ii) waived objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless he or she objects to considering the matter when it is presented. Section 5. Quorum. - At all meetings of the stockholders, unless a greater number or voting by classes is required by law, a majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum. If a quorum is present, action on a matter is approved if the votes cast favoring the action exceed the votes cast opposing the action, unless the vote of a greater number or voting by classes is required by law or the Articles of Incorporation, and except that in elections of directors those receiving the greatest number of votes shall be deemed elected even though not receiving a majority. Less than a quorum may adjourn. Section 6. Organization and Order of Business. - At all meetings of the stockholders, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the most senior executive vice president, shall act as chairman. In the absence of all of the foregoing officers or, if present, with their consent, a majority of the shares entitled to vote at such meeting, may appoint any person to act as chairman. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary at all meetings of the stockholders. In the event that neither the secretary nor any assistant secretary is present, the chairman may appoint any person to act as secretary of the meeting. The chairman shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts and things as are necessary or desirable for the proper conduct of the meeting, including, without limitation, the establishment of procedures for the dismissal of business not properly presented, the maintenance of order and safety, limitations on the time allotted to questions or comments on the affairs of the Corporation, restrictions on entry to such meeting after the time prescribed for the commencement thereof and the opening and closing of the voting polls. At each annual meeting of stockholders, only such business shall be conducted as shall have been properly brought before the meeting (a) by or at the direction of the Board of Directors or (b) by any stockholder of the Corporation who shall be entitled to vote at such meeting and who complies with the notice -2- procedures set forth in this Section 6. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation. To be timely, a stockholder's notice must be given, either by personal delivery or by United States certified mail, postage prepaid, and received at the principal executive offices of the Corporation (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of stockholders or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting. A stockholder's notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting, including the complete text of any resolutions to be presented at the annual meeting, and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder proposing such business, (c) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to bring the business before the meeting specified in the notice, (d) the class and number of shares of stock of the Corporation beneficially owned by the stockholder and (e) any material interest of the stockholder in such business. Notwithstanding anything in the By-Laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 6. The chairman of an annual meeting shall, if the facts warrant, determine that the business was not brought before the meeting in accordance with the procedures prescribed by this Section 6. If the chairman should so determine, he or she shall so declare to the meeting and the business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 6, a stockholder seeking to have a proposal included in the Corporation's proxy statement shall comply with the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended (including, but not limited to, Rule 14a-8 or its successor provision). The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. Section 7. Voting. - A stockholder may vote his or her shares in person or by proxy. Any proxy shall be delivered to the secretary of the meeting at or prior to the time designated by the chairman or in the order of business for so delivering such proxies. No proxy shall be valid after eleven months from its date, unless otherwise provided in the proxy. Each holder of record of stock of any class shall, as to all matters in respect of which stock of such class has voting power, be entitled to such vote as is provided in the Articles of Incorporation for each share of stock of -3- such class standing in the holders's name on the books of the Corporation. Unless required by statute or determined by the chairman to be advisable, the vote on any question need not be by ballot. On a vote by ballot, each ballot shall be signed by the stockholder voting or by such stockholder's proxy, if there be such proxy. Section 8. Written Authorization. - A stockholder or a stockholder's duly authorized attorney-in-fact may execute a writing authorizing another person or persons to act for him or her as proxy. Execution may be accomplished by the stockholder or such stockholder's duly authorized attorney-in-fact or authorized officer, director, employee or agent signing such writing or causing such stockholder's signature to be affixed to such writing by any reasonable means including, but not limited to, by facsimile signature. Section 9. Electronic Authorization. - The secretary or any vice president may approve procedures to enable a stockholder or a stockholder's duly authorized attorney-in-fact to authorize another person or persons to act for him or her as proxy by transmitting or authorizing the transmission of a telegram, cablegram, internet transmission, telephone transmission or other means of electronic transmission to the person who will be the holder of the proxy or to a proxy solicitation firm, proxy support service organization or like agent duly authorized by the person who will be the holder of the proxy to receive such transmission, provided that any such transmission must either set forth or be submitted with information from which the inspectors of election can determine that the transmission was authorized by the stockholder or the stockholder's duly authorized attorney-in-fact. If it is determined that such transmissions are valid, the inspectors shall specify the information upon which they relied. Any copy, facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this Section 9 may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. Section 10. Inspectors. - At every meeting of the stockholders for election of directors, the proxies shall be received and taken in charge, all ballots shall be received and counted and all questions concerning the qualifications of voters, the validity of proxies, and the acceptance or rejection of votes shall be decided, by two or more inspectors. Such inspectors shall be appointed by the chairman of the meeting. They shall be sworn faithfully to perform their duties and shall in writing certify to the returns. No candidate for election as director shall be appointed or act as inspector. -4- ARTICLE II Board of Directors Section 1. General Powers. - The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. Section 2. Number. - The number of directors shall be fifteen (15). Section 3. Term of Office and Qualification. - Each director shall serve for the term for which he or she shall have been elected and until a successor shall have been duly elected. Section 4. Nomination and Election of Directors. - At each annual meeting of stockholders, the stockholders entitled to vote shall elect the directors. No person shall be eligible for election as a director unless nominated in accordance with the procedures set forth in this Section 4. Nominations of persons for election to the Board of Directors may be made by the Board of Directors or any committee designated by the Board of Directors or by any stockholder entitled to vote for the election of directors at the applicable meeting of stockholders who complies with the notice procedures set forth in this Section 4. Such nominations, other than those made by the Board of Directors or any committee designated by the Board of Directors, may be made only if written notice of a stockholder's intent to nominate one or more persons for election as directors at the applicable meeting of stockholders has been given, either by personal delivery or by United States certified mail, postage prepaid, to the secretary of the Corporation and received (i) not less than 120 days nor more than 150 days before the first anniversary of the date of the Corporation's proxy statement in connection with the last annual meeting of stockholders, or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date contemplated at the time of the previous year's proxy statement, not less than 60 days before the date of the applicable annual meeting, or (iii) with respect to any special meeting of stockholders called for the election of directors, not later than the close of business on the seventh day following the date on which notice of such meeting is first given to stockholders. Each such stockholder's notice shall set forth (a) as to the stockholder giving the notice, (i) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder, (ii) a representation that such stockholder is a stockholder of record and intends to appear in person or by proxy at such meeting to nominate the person or persons specified in the notice, (iii) the class and number of shares of stock of the Corporation beneficially owned by such stockholder, and (iv) a description of all arrangements or understandings between such stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by such stockholder; and (b) as to each person whom -5- the stockholder proposes to nominate for election as a director, (i) the name, age, business address and, if known, residence address of such person, (ii) the principal occupation or employment of such person, (iii) the class and number of shares of stock of the Corporation which are beneficially owned by such person, (iv) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors or is otherwise required by the rules and regulations of the Securities and Exchange Commission promulgated under the Securities Exchange Act of 1934, as amended, and (v) the written consent of such person to be named in the proxy statement as a nominee and to serve as a director if elected. The secretary of the Corporation shall deliver each such stockholder's notice that has been timely received to the Board of Directors or a committee designated by the Board of Directors for review. Any person nominated for election as director by the Board of Directors or any committee designated by the Board of Directors shall, upon the request of the Board of Directors or such committee, furnish to the secretary of the Corporation all such information pertaining to such person that is required to be set forth in a stockholder's notice of nomination. The chairman of the meeting of stockholders shall, if the facts warrant, determine that a nomination was not made in accordance with the procedures prescribed by this Section 4. If the chairman should so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded. Section 5. Organization. - At all meetings of the Board of Directors, the chairman of the Board of Directors or, in the chairman's absence, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) or, in the absence of all of the foregoing, the senior most executive vice president, shall act as chairman of the meeting. The secretary of the Corporation or, in the secretary's absence, an assistant secretary, shall act as secretary of meetings of the Board of Directors. In the event that neither the secretary nor any assistant secretary shall be present at such meeting, the chairman of the meeting shall appoint any person to act as secretary of the meeting. Section 6. Vacancies. - Any vacancy occurring in the Board of Directors, including a vacancy resulting from amending these By-Laws to increase the number of directors by thirty percent or less, may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors. Section 7. Place of Meeting. - Meetings of the Board of Directors, regular or special, may be held either within or without the Commonwealth of Virginia. Section 8. Organizational Meeting. - The annual organizational meeting of the Board of Directors shall be held immediately following adjournment of the -6- annual meeting of stockholders and at the same place, without the requirement of any notice other than this provision of the By-Laws. Section 9. Regular Meetings: Notice. - Regular meetings of the Board of Directors shall be held at such times and places as it may from time to time determine. Notice of such meetings need not be given if the time and place have been fixed at a previous meeting. Section 10. Special Meetings. - Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the vice chairman of the Board of Directors (if any), the president (if any) or two of the directors. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each director, addressed to his or her residence or usual place of business, at least two days before the day on which the meeting is to be held, or shall be sent to such place by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held. Section 11. Waiver of Notice. - Whenever any notice is required to be given to a director of any meeting for any purpose under the provisions of law, the Articles of Incorporation or these By-Laws, a waiver thereof in writing signed by the person or persons entitled to such notice, either before or after the time stated therein, shall be equivalent to the giving of such notice. A director's attendance at or participation in a meeting waives any required notice to him or her of the meeting unless at the beginning of the meeting or promptly upon the director's arrival, he or she objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. Section 12. Quorum and Manner of Acting. - Except where otherwise provided by law, a majority of the directors fixed by these By-Laws at the time of any regular or special meeting shall constitute a quorum for the transaction of business at such meeting, and the act of a majority of the directors present at any such meeting at which a quorum is present shall be the act of the Board of Directors. In the absence of a quorum, a majority of those present may adjourn the meeting from time to time until a quorum be had. Notice of any such adjourned meeting need not be given. Section 13. Order of Business. - At all meetings of the Board of Directors business may be transacted in such order as from time to time the Board of Directors may determine. Section 14. Committees. - In addition to the executive committee authorized by Article III of these By-Laws, other committees, consisting of two or more directors, may be designated by the Board of Directors by a resolution adopted -7- by the greater number of (i) a majority of all directors in office at the time the action is being taken or (ii) the number of directors required to take action under Article II, Section 12 hereof. Any such committee, to the extent provided in the resolution of the Board of Directors designating the committee, shall have and may exercise the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, except as limited by law. ARTICLE III Executive Committee Section 1. How Constituted and Powers. - The Board of Directors, by resolution adopted pursuant to Article II, Section 14 hereof, may designate, in addition to the chairman of the Board of Directors, one or more directors to constitute an executive committee, who shall serve during the pleasure of the Board of Directors. The executive committee, to the extent provided in such resolution and permitted by law, shall have and may exercise all of the authority of the Board of Directors. Section 2. Organization, Etc. - The executive committee may choose a chairman and secretary. The executive committee shall keep a record of its acts and proceedings and report the same from time to time to the Board of Directors. Section 3. Meetings. - Meetings of the executive committee may be called by any member of the committee. Notice of each such meeting, which need not specify the business to be transacted thereat, shall be mailed to each member of the committee, addressed to his or her residence or usual place of business, at least two days before the day on which the meeting is to be held or shall be sent to such place by telegraph, telex or telecopy or be delivered personally or by telephone, not later than the day before the day on which the meeting is to be held. Section 4. Quorum and Manner of Acting. - A majority of the executive committee shall constitute a quorum for transaction of business, and the act of a majority of those present at a meeting at which a quorum is present shall be the act of the executive committee. The members of the executive committee shall act only as a committee, and the individual members shall have no powers as such. Section 5. Removal. - Any member of the executive committee may be removed, with or without cause, at any time, by the Board of Directors. Section 6. Vacancies. - Any vacancy in the executive committee shall be filled by the Board of Directors. -8- ARTICLE IV Officers Section 1. Number. - The officers of the Corporation shall be a chairman of the Board of Directors, a deputy chairman of the Board of Directors (if elected by the Board of Directors), a president (if elected by the Board of Directors), one or more vice chairmen of the Board of Directors (if elected by the Board of Directors), a chief operating officer (if elected by the Board of Directors), one or more vice presidents (one or more of whom may be designated executive vice president or senior vice president), a treasurer, a controller, a secretary, one or more assistant treasurers, assistant controllers and assistant secretaries and such other officers as may from time to time be chosen by the Board of Directors. Any two or more offices may be held by the same person. Section 2. Election, Term of Office and Qualifications. - All officers of the Corporation shall be chosen annually by the Board of Directors, and each officer shall hold office until a successor shall have been duly chosen and qualified or until the officer resigns or is removed in the manner hereinafter provided. The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) and the vice chairmen of the Board of Directors (if any) shall be chosen from among the directors. Section 3. Vacancies. - If any vacancy shall occur among the officers of the Corporation, such vacancy shall be filled by the Board of Directors. Section 4. Other Officers, Agents and Employees - Their Powers and Duties. - - The Board of Directors may from time to time appoint such other officers as the Board of Directors may deem necessary, to hold office for such time as may be designated by it or during its pleasure, and the Board of Directors or the chairman of the Board of Directors may appoint, from time to time, such agents and employees of the Corporation as may be deemed proper, and may authorize any officers to appoint and remove agents and employees. The Board of Directors or the chairman of the Board of Directors may from time to time prescribe the powers and duties of such other officers, agents and employees of the Corporation. Section 5. Removal. - Any officer, agent or employee of the Corporation may be removed, either with or without cause, by a vote of a majority of the Board of Directors or, in the case of any agent or employee not appointed by the Board of Directors, by a superior officer upon whom such power of removal may be conferred by the Board of Directors or the chairman of the Board of Directors. -9- Section 6. Chairman of the Board of Directors and Chief Executive Officer. - - The chairman of the Board of Directors shall preside at meetings of the stockholders and of the Board of Directors and shall be a member of the executive committee. The chairman shall be the Chief Executive Officer of the Corporation and shall be responsible to the Board of Directors. He or she shall be responsible for the general management and control of the business and affairs of the Corporation and shall see to it that all orders and resolutions of the Board of Directors are implemented. The chairman shall from, time to time, report to the Board of Directors on matters within his or her knowledge which the interests of the Corporation may require be brought to its notice. The chairman shall do and perform such other duties as from time to time the Board of Directors may prescribe. Section 7. Deputy Chairman of the Board of Directors. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The deputy chairman shall be responsible to the chairman of the Board of Directors and shall perform such duties as shall be assigned to him or her by the chairman of the Board of Directors. The deputy chairman shall from time to time report to the chairman of the Board of Directors on matters within the deputy chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. Section 8. President. - In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if one shall have been elected by the Board of Directors) shall preside at meetings of the stockholders and of the Board of Directors. The president shall be responsible to the chairman of the Board of Directors. Subject to the authority of the chairman of the Board of Directors, the president shall be devoted to the Corporation's business and affairs under the basic policies set by the Board of Directors and the chairman of the Board of Directors. He or she shall from, time to time, report to the chairman of the Board of Directors on matters within the president's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence of the chairman of the Board of Directors and the deputy chairman of the Board of Directors (if any), the president (if any) shall, except as otherwise directed by the Board of Directors, have all of the powers and the duties of the chairman of the Board of Directors. The president (if any) shall do and perform such other duties as from time to time the Board of Directors or the chairman of the Board of Directors may prescribe. Section 9. Vice Chairmen of the Board of Directors. - In the absence of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), the vice chairman of the Board of Directors designated for such purpose by the chairman of the Board of Directors (if any) shall preside at meetings of the stockholders and of the Board of Directors. Each vice -10- chairman of the Board of Directors shall be responsible to the chairman of the Board of Directors. Each vice chairman of the Board of Directors shall from time to time report to the chairman of the Board of Directors on matters within the vice chairman's knowledge which the interests of the Corporation may require be brought to the chairman's notice. In the absence or inability to act of the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any) and the president (if any), such vice chairman of the Board of Directors as the chairman of the Board of Directors may designate for the purpose shall have the powers and discharge the duties of the chairman of the Board of Directors. In the event of the failure or inability of the chairman of the Board of Directors to so designate a vice chairman of the Board of Directors, the Board of Directors may designate a vice chairman of the Board of Directors who shall have the powers and discharge the duties of the chairman of the Board of Directors. Section 10. Chief Operating Officer. - The chief operating officer (if any) shall be responsible to the Chairman of the Board of Directors for the principal operating businesses of the Corporation and shall perform those duties which may from time to time be assigned. Section 11. Vice Presidents. - The vice presidents of the Corporation shall assist the chairman of the Board of Directors, the deputy chairman of the Board of Directors, the president (if any) and the vice chairmen (if any) of the Board of Directors in carrying out their respective duties and shall perform those duties which may from time to time be assigned to them. The chief financial officer shall be a vice president of the Corporation (or more senior) and shall be responsible for the management and supervision of the financial affairs of the Corporation. Section 12. Treasurer. - The treasurer shall have charge of the funds, securities, receipts and disbursements of the Corporation. He or she shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such banks or trust companies or with such bankers or other depositaries as the Board of Directors may from time to time designate. The treasurer shall render to the Board of Directors, the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), the vice chairmen of the Board of Directors (if any), and the chief financial officer, whenever required by any of them, an account of all of his transactions as treasurer. If required, the treasurer shall give a bond in such sum as the Board of Directors may designate, conditioned upon the faithful performance of the duties of the treasurer's office and the restoration to the Corporation at the expiration of his or her term of office or in case of death, resignation or removal from office, of all books, papers, vouchers, money or other property of whatever kind in his or her possession or under his or her control belonging to the Corporation. The treasurer shall perform such other duties as from time to time may be assigned to him or her. -11- Section 13. Assistant Treasurers. - In the absence or disability of the treasurer, one or more assistant treasurers shall perform all the duties of the treasurer and, when so acting, shall have all the powers of, and be subject to all restrictions upon, the treasurer. Assistant treasurers shall also perform such other duties as from time to time may be assigned to them. Section 14. Secretary. - The secretary shall keep the minutes of all meetings of the stockholders and of the Board of Directors in a book or books kept for that purpose. He or she shall keep in safe custody the seal of the Corporation, and shall affix such seal to any instrument requiring it. The secretary shall have charge of such books and papers as the Board of Directors may direct. He or she shall attend to the giving and serving of all notices of the Corporation and shall also have such other powers and perform such other duties as pertain to the secretary's office, or as the Board of Directors, the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any) or any vice chairman of the Board of Directors may from time to time prescribe. Section 15. Assistant Secretaries. - In the absence or disability of the secretary, one or more assistant secretaries shall perform all of the duties of the secretary and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the secretary. Assistant secretaries shall also perform such other duties as from time to time may be assigned to them. Section 16. Controller. - The controller shall be administrative head of the controller's department. He or she shall be in charge of all functions relating to accounting and the preparation and analysis of budgets and statistical reports and shall establish, through appropriate channels, recording and reporting procedures and standards pertaining to such matters. The controller shall report to the chief financial officer and shall aid in developing internal corporate policies whereby the business of the Corporation shall be conducted with the maximum safety, efficiency and economy. The controller shall be available to all departments of the Corporation for advice and guidance in the interpretation and application of policies which are within the scope of his or her authority. The controller shall perform such other duties as from time to time may be assigned to him or her. Section 17. Assistant Controllers. - In the absence or disability of the controller, one or more assistant controllers shall perform all of the duties of the controller and, when so acting, shall have all of the powers of, and be subject to all the restrictions upon, the controller. Assistant controllers shall also perform such other duties as from time to time may be assigned to them. -12- ARTICLE V Contracts, Checks, Drafts, Bank Accounts, Etc. Section 1. Contracts. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the chairman of the Board of Directors may authorize shall have the power to execute any contract or other instrument on behalf of the Corporation; no other officer, agent or employee shall, unless otherwise in these By-Laws provided, have any power or authority to bind the Corporation by any contract or acknowledgement, or pledge its credit or render it liable pecuniarily for any purpose or to any amount. Section 2. Loans. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president, the treasurer and such other persons as the Board of Directors may authorize shall have the power to effect loans and advances at any time for the Corporation from any bank, trust company or other institution, or from any corporation, firm or individual, and for such loans and advances may make, execute and deliver promissory notes or other evidences of indebtedness of the Corporation, and, as security for the payment of any and all loans, advances, indebtedness and liability of the Corporation, may pledge, hypothecate or transfer any and all stocks, securities and other personal property at any time held by the Corporation, and to that end endorse, assign and deliver the same. Section 3. Voting of Stock Held. - The chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president or the secretary may from time to time appoint an attorney or attorneys or agent or agents of the Corporation to cast the votes that the Corporation may be entitled to cast as a stockholder or otherwise in any other corporation, any of whose stock or securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other corporation, or to consent in writing to any action by any other such corporation, and may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent, and may execute or cause to be executed on behalf of the Corporation such written proxies, consents, waivers or other instruments as such officer may deem necessary or proper in the premises; or the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), the president (if any), any vice chairman of the Board of Directors (if any), any vice president or the secretary may attend in person any meeting of the holders of stock or other securities of such other corporation and thereat vote or -13- exercise any and all powers of the Corporation as the holder of such stock or other securities of such other corporation. ARTICLE VI Certificates Representing Shares Certificates representing shares of the Corporation shall be signed by the chairman of the Board of Directors, the deputy chairman of the Board of Directors (if any), or the vice chairman of the Board of Directors (if any), or the president of the Corporation (if any) and the secretary or an assistant secretary. Any and all signatures on such certificates, including signatures of officers, transfer agents and registrars, may be facsimile. ARTICLE VII Dividends The Board of Directors may declare dividends from funds of the Corporation legally available therefor. ARTICLE VIII Seal The Board of Directors shall provide a suitable seal or seals, which shall be in the form of a circle, and shall bear around the circumference the words "Philip Morris Companies Inc." and in the center the word and figures "Virginia, 1985." ARTICLE IX Fiscal Year The fiscal year of the Corporation shall be the calendar year. -14- ARTICLE X Amendment The power to alter, amend or repeal the By-Laws of the Corporation or to adopt new By-Laws shall be vested in the Board of Directors, but By-Laws made by the Board of Directors may be repealed or changed by the stockholders, or new By-Laws may be adopted by the stockholders, and the stockholders may prescribe that any By-Laws made by them shall not be altered, amended or repealed by the directors. ARTICLE XI Emergency By-Laws If a quorum of the Board of Directors cannot be readily assembled because of some catastrophic event, and only in such event, these By-Laws shall, without further action by the Board of Directors, be deemed to have been amended for the duration of such emergency, as follows: Section 1. Section 6 of Article II shall read as follows: Any vacancy occurring in the Board of Directors may be filled by the affirmative vote of a majority of the directors present at a meeting of the Board of Directors called in accordance with these By-Laws. Section 2. The first sentence of Section 10 of Article II shall read as follows: Special meetings of the Board of Directors shall be held whenever called by order of the chairman of the Board of Directors or a deputy chairman (if any), or of the president (if any) or any vice chairman of the Board of Directors (if any) or any director or of any person having the powers and duties of the chairman of the Board of Directors, the deputy chairman, the president or any vice chairman of the Board of Directors. Section 3. Section 12 of Article II shall read as follows: The directors present at any regular or special meeting called in accordance with these By-Laws shall constitute a quorum for the transaction of business at such meeting, and the action of a majority of such directors shall be the act of the Board of Directors, provided, however, that in the event that only one director is present at any such meeting no action except the election of directors shall be taken until at least two additional directors have been elected and are in attendance. -15- EX-10.1 3 FINANCIAL COUNSELING PRGRM EXHIBIT 10.1 PHILIP MORRIS COMPANIES INC. Financial Counseling Program Philip Morris has a program that has existed since January 1, 1980 to provide for financial counseling for key executives. This program currently provides for reimbursement to senior management for expenditures they incur in connection with their personal financial and estate planning and preparation of their tax returns, subject to the following annual limits: 1. $15,000 for the Chairman and Chief Executive Officer; 2. $10,000 for each member of the Corporate Management Committee; 3. $5,000 for Senior Vice Presidents and those Vice Presidents in salary bands "E" and above. Rather than limit individuals to specific advisors, each eligible executive may seek his own reputable advisor to perform such services. Reimbursement shall be limited to the services set forth above and will not include for example, fees of brokers or investment managers. Also, it shall be necessary for invoices to reflect in reasonable detail the nature and extent of the services performed. Payments by Philip Morris in this program will be included in the compensation of the individuals for whom they are paid; however, the individual is normally entitled to a deduction in his or her income tax return for any expenses related to financial advice, estate and tax planning, and income tax preparation. EX-10.4 4 AUTOMOBILE POLICY EXHIBIT 10.4 PHILIP MORRIS COMPANIES INC. AUTOMOBILE POLICY Since May 16, 1970, the Registrant has maintained a policy under which Company owned or leased automobiles are provided to key executives for business use when required and for personal use at other times. Such executives are required to include the value of any personal use of the automobiles in their annual tax returns. EX-10.8 5 SUPPLEMENT MANAGEMENT PLAN EXHIBIT 10.8 SUPPLEMENTAL MANAGEMENT EMPLOYEES' RETIREMENT PLAN OF PHILIP MORRIS COMPANIES INC. Effective October 1, 1987 (As amended and in effect as of January 1, 1997) SUPPLEMENTAL MANAGEMENT EMPLOYEES' RETIREMENT PLAN OF PHILIP MORRIS COMPANIES INC. The Supplemental Management Employees' Retirement Plan of Philip Morris Companies Inc., as hereinafter set forth shall be effective with respect to an Employee designated as a Participant (as defined herein) whose date of retirement (as specified in an application for retirement in Article II, B of the PM Retirement Plan) is on or after April 1, 1993, or who has filed an application for an Optional Payment pursuant to Article II D(3) of the Plan after March 1, 1992 and with respect to former Employees designated as Participants on or after April 1, 1993. The rights of an Employee or former Employee designated as a Participant who retired before such dates shall be governed by the provisions of the Plan as in effect on the date of retirement or, if later, the date of designation as a Participant, unless an application for an Optional Payment was filed after March 1, 1992. -2- ARTICLE I DEFINITIONS The following terms as used herein shall have the meanings set forth below. Capitalized terms used herein and not defined below shall have the meanings set forth in the PM Retirement Plan or the Profit-Sharing Plan, as the context may require. (a) "Accredited Service" shall have the same meaning as in the PM Retirement Plan, provided, however, that Accredited Service shall also include the additional periods of Accredited Service which may be credited to a Participant under the provisions of Article II, A(1)(a) of the Plan. (b) "Actuarial Equivalent" shall mean a benefit which is equivalent in value to the benefit otherwise payable pursuant to the terms of the Plan, based on the actuarial principles and assumptions set forth in Exhibit "I" to the PM Retirement Plan; provided, however, that a Single Sum Payment shall be the Actuarial Equivalent of the Supplemental Retirement Allowance payable in equal monthly payments during a twelve (12) month period for the life of the Retired Participant, using the actuarial principles and assumptions set forth in Exhibit "A" to the Plan. (c) "Administrator" shall mean the Senior Vice President, Human Resources and Administration of Philip Morris Companies Inc. (or his delegatee) designated by the Committee to carry out certain responsibilities in connection with the administration of the Plan. (d) "Allowances" shall mean a Supplemental Retirement Allowance and a Supplemental Profit-Sharing Allowance. (e) "Appointee" shall mean the person or entity who, pursuant to the provisions of the Plan, is empowered, in his, her or its sole discretion, to designate an Employee as a Participant and grant one or more Allowances under the Plan. The Appointee for an Employee who is not a chief executive officer of a Participating Company shall be the chief executive officer of his Participating Company. The Appointee for a Retired Employee and an Employee who is a chief executive officer of a Participating Company other than the Company shall be the Chief Executive Officer. The Appointee of the Chief Executive Officer shall be the Committee. (f) "Benefit Equalization Plan" shall mean the Philip Morris Benefit Equalization Plan, effective as of September 2, 1974 and as amended from time to time, but only to the extent that benefits are payable pursuant to Article II, A thereof. (g) "Change in Circumstance" shall mean (1) the marriage of the Participant or Retired Participant, (2) the divorce of the Participant or Retired Participant from his Spouse, provided such Spouse was designated as the beneficiary in the currently effective application to receive an Optional Payment, or the Participant or Retired Participant elected to receive an Optional Payment pursuant to clause (1) of Paragraph (u) hereof, (3) the death of the beneficiary designated in the application to receive an Optional Payment, or (4) a medical condition, based on medical evidence satisfactory to the Administrator, which is expected to result in the death of the beneficiary (including the Spouse) who is designated to receive a benefit after the death of the Retired Employee in accordance with the application to receive an Optional Payment originally filed with the Administrator, within five (5) years of the filing of an application for change in Optional Payment method pursuant to Article II, D(3) hereof. (h) "Change of Control" shall mean the happening of any of the following events: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction described in clauses (i), (ii) and (iii) of paragraph 3 of this subsection (h); or (2) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Approval by the shareholders of the Company of a reorganization, merger, share exchange or consolidation (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial -2- owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 80% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of the Company of (i) a complete liquidation or dissolution of the Company or (ii) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation, with respect to which following such sale or other disposition, (A) more than 80% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) less than 20% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by any Person (excluding any employee benefit plan (or related trust) of the Company or such corporation), except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting -3- Securities prior to the sale or disposition and (C) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such sale or other disposition of assets of the Company or were elected, appointed or nominated by the Board. (i) "Chief Executive Officer" shall mean the chief executive officer of the Company. (j) "Committee" shall mean the Corporate Employee Benefit Committee of the Company charged with the administration of the Plan as from time to time constituted. (k) "Company" shall mean Philip Morris Companies Inc. (l) "Deceased Participant" shall mean any former Participant who died while he was a Participant, provided that no Optional Payment pursuant to clause (3) of Paragraph (u) hereof will be made under the Plan after the death of the Deceased Participant. (m) "Deceased Retired Participant" shall mean a Retired Participant who has elected to receive an Optional Payment but who has died prior to the date his Optional Payment commences to be paid. (n) "Deferred Retirement Allowance" shall mean the Retirement Allowance payable pursuant to Article II, A(2) of the PM Retirement Plan. (o) "Early Retirement Allowance" shall mean the Retirement Allowances payable pursuant to Article II, A(3) of the PM Retirement Plan. (p) "Employee" shall mean any person who (1) is employed on a salaried basis by a Participating Company, (2) is a member of a select group of management or a highly compensated employee of his Participating Company and (3) is eligible to receive a Retirement Allowance under the PM Retirement Plan. An Employee shall cease to be such under the Plan upon termination of his service for any cause whatsoever; provided, however, that he shall be deemed to be an Employee during the periods of service accredited to him pursuant to Article III of the PM Retirement Plan. (q) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended from time to time, and any successor thereto. (r) "Fiduciary" shall mean the Committee, the Management Committee and the Administrator to the extent that such person or body (1) exercises any -4- discretionary authority or control respecting management of the Plan, or (2) has discretionary authority or responsibility in the administration of the Plan. (s) "Full Retirement Allowance" shall mean the Retirement Allowance payable pursuant to Article II, A(1) of the PM Retirement Plan. (t) "Management Committee" shall mean the Philip Morris Management Committee for Employee Benefits designated by the Committee to carry out certain responsibilities in connection with the administration of the Plan. (u) "Optional Payment" shall mean the following forms in which a Supplemental Retirement Allowance of a Participant who has made an election pursuant to Article II, D(3) hereof may be paid: (1) in equal monthly payments for the life of the Retired Participant, (2) as a Supplemental Joint and Survivor Allowance, or (3) as a Supplemental Optional Payment Allowance. Any election to receive an Optional Payment with respect to a Retired Participant's Supplemental Retirement Allowance under the Plan shall be independent of any election with respect to his benefits under any Other Plan. (v) "Other Plan" shall mean (1) the Retirement Plan, (2) the Benefit Equalization Plan, (3) any other plan, except a defined contribution or similar plan, maintained by the Company, or any domestic or foreign subsidiary of the Company, which provides retirement income to one or more employees on or after termination of employment and (4) any employment contract or other agreement between an Employee and the Company or any other member of the Controlled Group providing for retirement benefits or benefits in the event of a termination of employment or a Change in Control of the Company or of any other member of the Controlled Group. (w) "Participant" shall mean an Employee or Retired Employee who is designated as such by his Appointee pursuant to the terms of the Plan. The designation of an Employee or Retired Employee as a Participant by a chief executive officer of a Participating Company shall be communicated in writing to the Committee. An Employee or Retired Employee shall become a Participant as of the date designated in writing by his Appointee. Except as otherwise specifically provided for in the Plan, a Participant shall cease to be such whenever he ceases to be an Employee. (x) "Participating Company" shall mean the Company and any other corporation which is a member of the Controlled Group and which, with the approval of the Committee determines to participate in the Plan for the benefit of its Employees and executes such instruments of participation as the Committee deems necessary. (y) "Plan" shall mean this Supplemental Management Employees' Retirement Plan of Philip Morris Companies Inc., as amended from time to time. -5- (z) "PM Retirement Plan" shall mean the Philip Morris Salaried Employees' Retirement Plan, effective as of September 1, 1978 and as amended from time to time. (aa) "Profit-Sharing Plan" shall mean the Philip Morris Deferred Profit-Sharing Plan, effective as of January 1, 1956 and as amended from time to time. (bb) "Retired Participant" shall mean a Participant who ceases to be such but is eligible for, or who has retired and is receiving a Supplemental Retirement Allowance from the Plan. A former Employee shall cease to be a Retired Participant as of the date he receives a Single Sum Payment. (cc) "Retirement Plan" shall mean the PM Retirement Plan and each other defined benefit plan qualified under Section 401(a) of the Code maintained by a member of the Controlled Group in which a Participant has an accrued benefit. (dd) "Single Sum Payment" shall mean (1) in the case of a Supplemental Retirement Allowance, the normal form of distribution to a Retired Participant who is eligible for a Full, Deferred or Early Retirement Allowance, which distribution shall be made in one payment to the Retired Participant (or his designated beneficiary) at the time set forth in Article II, D(2)(a) hereof and which is the Actuarial Equivalent of the Supplemental Retirement Allowance payable in equal monthly payments during a twelve (12) month period for the life of the Retired Participant and (2) the sole form of distribution of the Retired Participant's Supplemental Profit-Sharing Allowance. (ee) "Supplemental Joint and Survivor Allowance" shall mean the total amount payable during a twelve (12) month period as a reduced Supplemental Retirement Allowance to a Retired Participant for life and after his death the amount payable to his Spouse for life equal to one-half of the reduced Supplemental Retirement Allowance payable to the Retired Participant, which together shall be the Actuarial Equivalent of the Supplemental Retirement Allowance of the Retired Participant. (ff) "Supplemental Optional Payment Allowance" shall mean (1) the total amount payable during a twelve (12) month period in accordance with one of the payment methods described in Article II, A(4)(d) of the PM Retirement Plan designated by the Participant in the application for an Optional Payment under Article II, D(3) hereof pursuant to which the Participant receives for life after his retirement a reduced Supplemental Retirement Allowance and after his death after retirement his beneficiary receives for life a benefit according to the option elected by the Employee, which together shall be the Actuarial Equivalent of the Supplemental Retirement Allowance payable in equal monthly payments for the life of the Participant after his retirement, or (2) the total amount payable during a twelve (12) month period in accordance with one of the payment methods described in Article II, -6- A(4)(d) of the PM Retirement Plan pursuant to an election described in Article II, A(4)(c) of the PM Retirement Plan and designated by the Participant in the application for an Optional Payment under Article II, D(3) hereof pursuant to which the Participant receives for life after his retirement a reduced Supplemental Retirement Allowance and after his death his beneficiary receives for life a benefit according to the option elected by the Participant, which together shall be the Actuarial Equivalent of the Supplemental Retirement Allowance accrued to the date of election. (gg) "Supplemental Profit-Sharing Allowance" shall mean the benefit determined and payable in a Single Sum Payment upon termination of a Participant's service with the Controlled Group pursuant to Article III hereof. (hh) "Supplemental Retirement Allowance" shall mean the benefit determined under Article II, A hereof and payable at the time and in the manner set forth in Article II, D, provided, however, that, except as otherwise required by Article II, A(1) or Article II, D(3) of the Plan, payment to a Retired Participant in any form shall be the Actuarial Equivalent of a Supplemental Retirement Allowance expressed as a benefit payable in equal monthly payments during a twelve (12) month period for the life of the Retired Participant commencing at the Retired Participant's Normal Retirement Age. (ii) "Supplemental Survivor Allowance" shall mean the total amount payable during a twelve (12) month period in equal monthly payments for the life of the Spouse of a Deceased Participant or Deceased Retired Participant who has died after the date of his retirement and prior to the date his Optional Payment under Paragraph (u)(1) or (2) hereof commences to be paid in an amount equal to one-half of the reduced Supplemental Retirement Allowance which would have been payable as a Supplemental Joint and Survivor Allowance to the Deceased Participant or Deceased Retired Participant. Payment of the Supplemental Survivor Allowance to the Spouse of a Deceased Participant or Deceased Retired Participant who is eligible for such benefit under Article II, B hereof shall be payable at the time set forth in Article II, D(4) hereof. (jj) "Supplemental Survivor Income Benefit Allowance" shall mean the total amount payable during a twelve (12) month period to the Spouse of a Deceased Participant or Deceased Retired Participant equal to one-half of the reduced Supplemental Retirement Allowance which would have been payable to the Deceased Participant or Deceased Retired Participant had he elected to receive a Supplemental Joint and Survivor Allowance. Payment of the Supplemental Survivor Income Benefit Allowance to the Spouse of a Deceased Participant or Deceased Retired Participant who is eligible for such benefit under Article II, B hereof shall be payable at the time set forth in Article II, D(4) hereof. -7- (kk) "Supplemental Survivor Income Benefit Plan" shall mean the Philip Morris Survivor Income Benefit Equalization Plan, effective as of January 1, 1985 and as amended from time to time. (ll) "Survivor Income Benefit Plan" shall mean the Philip Morris Survivor Income Benefit Plan, effective as of February 1, 1974 and as amended from time to time. (mm) "Vested Retirement Allowance" shall mean the Retirement Allowance payable pursuant to Article II, A(6) of the PM Retirement Plan, provided, however, that a Participant who is only eligible for a Vested Retirement Allowance may be deemed to be eligible for an Early Retirement Allowance for any and all purposes of this Plan if in accordance with his designation as a Participant in the Plan. As used in this Plan, the masculine pronoun shall include the feminine and the feminine pronoun shall include the masculine unless otherwise specifically indicated. -8- ARTICLE II SUPPLEMENTAL RETIREMENT ALLOWANCES A. Supplemental Retirement Allowances payable under this Plan shall be as follows: (1) A Participant may be granted one or more of the following Supplemental Retirement Allowances under the Plan: (a) A Supplemental Retirement Allowance in an amount determined by using the formula for calculating the Participant's Retirement Allowance under the PM Retirement Plan, but, subject to the limitations of Subparagraph (2) hereof, crediting Accredited Service in addition to that credited to the Participant pursuant to the PM Retirement Plan in recognition of previous service by the Participant deemed to be of special value to the Company or his Participating Company; (b) A Supplemental Retirement Allowance in an amount equal to (i) a stated dollar amount per year, or (ii) a stated percentage of not more than sixty (60) percent of the Participant's Five-Year Average Compensation, or (iii) the Participant's Retirement Allowance under the PM Retirement Plan, which Supplemental Retirement Allowance accrues at a rate as a percentage of the Participant's Five-Year Average Compensation which is greater than the rate of accrual under the PM Retirement Plan, such Supplemental Retirement Allowances to be calculated in individual instances on the basis of specific instructions which may depart only for such purpose from the terms, conditions and requirements of the PM Retirement Plan; or (c) A Supplemental Retirement Allowance in an amount determined by using the formula for calculating the Participant's Retirement Allowance under the PM Retirement Plan, such Supplemental Retirement Allowance to be payable on and after the Participant's retirement in an amount which is greater than the Retirement Allowance otherwise payable to the Participant at such age. (2) If a Supplemental Retirement Allowance under Subparagraph (1) hereof is determined pursuant to a formula in the PM Retirement Plan using the Participant's Compensation (including awards under incentive compensation plans of the Company), the aggregate number of years of Accredited Service used in calculating the amount of the Participant's Supplemental Retirement Allowance under this Plan shall not exceed thirty-five (35) years. (3) The name of each Participant and the Supplemental Retirement Allowance awarded to him pursuant to Subparagraph (1) above shall be set forth in Appendix I to the Plan. -9- B. Supplemental Survivor Allowances, Supplemental Survivor Income Benefit Allowances and Supplemental Optional Payment Allowances payable to the Spouse or beneficiary of certain Deceased Participants and Deceased Retired Participants shall be as follows: (1) (a) If a Deceased Participant has died prior to date he would have attained the age of sixty-five (65) years, his Spouse shall be eligible to receive a Supplemental Survivor Allowance determined in accordance with the applicable provisions of Article II, A(1) of this Plan. (b) If a Deceased Participant who is eligible for a Supplemental Retirement Allowance under Subparagraphs (a), (b)(iii) or (c) of Article II, A(1) has died prior to date he would have attained the age of sixty-five (65) years and has (or is deemed to have) completed five (5) or more years of Accredited Service, his Spouse shall be eligible to receive a Supplemental Survivor Income Benefit Allowance determined in accordance with Subparagraphs (a), (b)(iii) or (c) of Article II, A(1) as applicable to such Deceased Participant, assuming such Deceased Participant had continued in the employ of his Participating Company until the age of sixty-five (65) years, that his compensation (as defined in the Survivor Income Benefit Plan) for all periods of time subsequent to his death and until age sixty-five (65) had been his compensation as in effect immediately prior to his death and that the Deceased Participant died the day after attaining the age of sixty-five (65) years, reduced by the amount of any Supplemental Survivor Allowance payable pursuant to Subparagraph (a) hereof. (2) If a Deceased Participant has died after attaining the age of sixty-five (65) years his Spouse shall be eligible to receive a Supplemental Survivor Allowance determined in accordance with the applicable provisions of Article II, A(1) hereof. (3) (a) The Spouse of a Deceased Retired Participant (other than a Deceased Retired Participant who is only eligible for a Vested Retirement Allowance) whose request for an Optional Payment pursuant to Article I(u)(1) hereof has been granted by the Management Committee, but who has died prior to the date his Optional Payment commences to be paid shall be eligible to receive a Supplemental Survivor Allowance determined in accordance with the applicable provisions of Article II, A(1) of this Plan. (b) The Spouse of a Deceased Retired Participant (other than a Deceased Retired Participant who is only eligible for a Vested Retirement Allowance) who prior to his death commenced to receive an Optional Payment pursuant to Article I(u)(1) hereof shall be eligible to receive a Supplemental Survivor Income Benefit Allowance. (4) The Spouse of a Deceased Retired Participant who is only eligible for a Vested Retirement Allowance under the PM Retirement Plan but who has died prior to his Benefit Commencement Date shall be eligible to receive a Supplemental Survivor Allowance determined in accordance with the applicable provisions of Article II, A(1) of this Plan. -10- (5) The beneficiary of a Retired Participant whose request for a Supplemental Optional Payment Allowance in accordance with Article I(ff)(1) hereof has been granted by the Management Committee but who has died after the date of his retirement and prior to the date his Optional Payment commences to be paid shall be eligible to receive that portion of the Supplemental Optional Payment Allowance elected by the Retired Participant which is payable after the death of the Retired Participant. (6) The beneficiary of a Deceased Participant or Deceased Retired Participant whose request for a Supplemental Optional Payment Allowance described in Article I(ff)(2) hereof has been granted by the Management Committee shall be eligible to receive that portion of the Supplemental Optional Payment Allowance elected by the Deceased Participant or Deceased Retired Participant which is payable after the death of the Deceased Participant or Deceased Retired Participant. C. Reduction of benefits under the Plan (1) (a) The Supplemental Retirement Allowance payable to a Retired Participant pursuant to Article II, A hereof shall be reduced by the greater of (i) the Actuarial Equivalent of the benefits payable pursuant to any Other Plan to the extent that service used to determine the amount of benefits payable from such Other Plan is also used to calculate the amount of a Retired Participant's Supplemental Retirement Allowance under this Plan, or (ii) the amount set forth in, or determined in accordance with, the Participant's designation as such pursuant to Article I(w) hereof, assuming in each case that the Participant elected to receive such benefits in equal monthly payments for his life; provided, however, that (1) in the event the Supplemental Retirement Allowance is paid to the Retired Participant (or his beneficiary) in a Single Sum Payment prior to the Retired Participant's Benefit Commencement Date, such Supplemental Retirement Allowance shall be computed in accordance with the applicable provisions of Paragraph A(1) hereof, as reasonably estimated by the Administrator, reduced by the Actuarial Equivalent of the projected annual amount of benefits payable pursuant to any Other Plan assuming that such benefits are payable to the Retired Participant in equal monthly payments for life and (2) in the event the benefit equalization retirement allowance under the Benefit Equalization Plan is paid to the Retired Participant (or his Spouse or other beneficiary) in a single sum payment (as defined in the Benefit Equalization Plan) prior to the Retired Participant's Benefit Commencement Date, the amount of the reduction to the Participant's Supplemental Retirement Allowance shall be determined in good faith by the Administrator. (b) Any Supplemental Survivor Allowance or Supplemental Survivor Income Benefit Allowance payable to the Spouse of a Deceased Participant or Deceased Retired Participant pursuant to Article II, B hereof shall be reduced by the Actuarial Equivalent of the maximum benefits for which the Spouse was actually eligible under the Retirement Plan, the Benefit Equalization Plan, the Survivor Income Benefit Plan and the Supplemental Survivor Income Benefit Plan assuming that the Participant elected to receive a -11- Retirement Allowance under the Retirement Plan and a benefit equalization retirement allowance under the Benefit Equalization Plan in equal monthly payments for the life of the Retired Participant. (c) Any Supplemental Optional Payment Allowance payable to the beneficiary of a Deceased Participant or Deceased Retired Participant pursuant to Article II, B hereof shall be reduced by the Actuarial Equivalent of the benefits payable pursuant to the Retirement Plan and the Benefit Equalization Plan assuming that the Participant had elected to receive such benefits in equal monthly payments for life. (2) The Supplemental Retirement Allowance of a Participant, who as a result of employment outside of the United States has benefits accrued to him under the social security, or similar laws, of a country other than the United States may, in the discretion of the Administrator, be reduced by the Actuarial Equivalent of such benefits, assuming that such Participant elected to receive such benefits in equal monthly payments for life. (3) No benefits shall be payable to the Spouse or other beneficiary of a Deceased Retired Participant pursuant to Article II, B hereof, if prior to his death the Deceased Retired Participant received a Single Sum Payment from this Plan or the Single Sum Payment is made after his death to his Spouse or a beneficiary. D. Notification for Supplemental Retirement Allowances; Commencement and termination of Supplemental Retirement Allowances (1) An application for a Retirement Allowance, Survivor Allowance or optional form of benefit under the PM Retirement Plan shall be deemed notification to the Administrator that payment of a Supplemental Retirement Allowance or other benefit is to be made or commence to be made to the Retired Participant, Spouse or other beneficiary in accordance with the terms of the Plan. In the event the Participant shall not have elected an Optional Payment method with respect to his Supplemental Retirement Allowance, any such notification shall specify the beneficiary to whom payment of the Single Sum Payment shall be made in the event the Participant dies after the date of retirement and prior to the date the Single Sum Payment is made, provided, that if the Participant shall fail to designate a beneficiary or if the beneficiary shall predecease the Participant, the Administrator shall distribute the Single Sum Payment to the duly authorized representative of the former Participant's estate. (2) (a) A Retired Participant who is eligible for a Full, Deferred or Early Retirement Allowance shall receive his Supplemental Retirement Allowance in a Single Sum Payment no later than sixty (60) days following the Retired Participant's date of retirement (or, if the Retired Participant dies after the date of retirement and before distribution of his Single Sum Payment is made, to his beneficiary as determined pursuant to Subparagraph (1) hereof, in a Single Sum Payment within sixty (60) days following the date of the Retired -12- Participant's death) unless the Participant has elected to have distribution of his Supplemental Retirement Allowance made in accordance with Subparagraph (3) hereof. (b) The Supplemental Retirement Allowance with respect to an Employee who is only eligible for a Vested Retirement Allowance shall be distributed as an Optional Payment under clauses (1) or (2) of Article I(u) hereof (which Optional Payment shall be in the same form which the Retired Participant's benefits are paid from the PM Retirement Plan) and shall commence on the Participant's Benefit Commencement Date. (3) A Participant who is eligible to retire on a Full, Deferred or Early Retirement Allowance and whose Supplemental Retirement Allowance is otherwise payable in a Single Sum Payment pursuant to Paragraph D(1) hereof may make application to the Administrator to receive an Optional Payment. The application may be filed prior to the date the Participant is eligible for an Early Retirement Allowance and shall specify the form of Optional Payment, the beneficiary and the date on which the Optional Payment is to commence to be made, which date shall be on or before the first day of the month coincident with or next preceding the Participant's Required Benefit Commencement Date, but in no event shall the Participant's Optional Payment commence to be paid prior to the later of the first day of the month following the first anniversary of the date of the filing of his application with the Administrator or the Participant's Benefit Commencement Date; provided, however, that in the event the Participant incurs a Change in Circumstance on or after the date of the filing of the application and prior to the date his Optional Payment commences to be paid, the Participant may file an application with the Administrator within ninety (90) days of the Change in Circumstance, but in no event later than the date his Optional Payment is to commence, to change the form of Optional Payment or to change the beneficiary who is designated to receive a benefit after the death of the Retired Participant in accordance with the Optional Payment method originally filed with the Administrator; provided, further, that any election to change the form of Optional Payment filed after the date of his retirement and prior to the date his Optional Payment is to commence may only change the form of Optional Payment to one of the forms specified in Article I(u)(1) or (2) hereof. In the case of a Participant who eighteen (18) months prior to attaining the age of sixty-five (65) years could be compulsorily retired by his Participating Company upon attaining the age of sixty-five (65) years pursuant to Section 12(c) of the Age Discrimination in Employment Act, any application to receive an Optional Payment must be filed with the Administrator more than one (1) year preceding the date the Participant attains the age of sixty-five (65) years. The Administrator shall notify the Management Committee of all applications for an Optional Payment. The Management Committee may grant or deny any such application in its sole and absolute discretion. Any such application shall be of no force and effect if (i) the Participant does not retire on a Full, Deferred or Early Retirement Allowance, (ii) the Participant incurs a disability at any time before the date his Optional Payment commences to be paid which causes him to be eligible for benefits under the Philip Morris Long-Term Disability Plan, or (iii) the Participant is retired for ill health, disability or hardship under Article II, A(3)(a) of the PM Retirement Plan, provided that in the event the application is of no force and effect under clauses (ii) or (iii) hereof, payment of the -13- Participant's Supplemental Retirement Allowance shall be made in a Single Sum Payment pursuant to Paragraph D (2)(a) hereof within sixty (60) days of the date of his retirement, but otherwise such application shall be irrevocable and effective on the Participant's retirement on a Full, Deferred or Early Retirement Allowance and the Participant's benefits shall commence on the date specified in the application; provided, however, that (A) if within the one (1) year period following the date of the filing of the application with the Administrator the Participant's service with any member of the Controlled Group is involuntarily terminated other than by reason of the Participant's death, disability or misconduct (as determined by the Management Committee), such Participant's Optional Payment shall commence to be paid on the Participant's Benefit Commencement Date, or (B) if within the one (1) year period following the date of the filing of the application with the Administrator the Participant voluntarily retires or his employment is terminated for misconduct (as determined by the Management Committee) by any member of the Controlled Group, the Optional Payment shall be reduced as specified in Subparagraph (6) hereof. (4) The Supplemental Survivor Allowance payable to the Spouse of a Deceased Participant pursuant to Paragraphs B(1)(a) or B(2) hereof or to the Spouse of a Deceased Retired Participant pursuant to Paragraphs B(3)(a) and B(4) above shall commence to be paid on the later of (a) the first day of the calendar month coincident with or next following the date the Deceased Participant or Deceased Retired Participant would have attained the age of fifty-five (55) years, or (b) the first day of the calendar month in which the Deceased Participant or Deceased Retired Participant died, provided that the Spouse may elect in accordance with the provisions of Article II, A(5)(c) or (f) of the PM Retirement Plan, as applicable to the Spouse, that the Supplemental Survivor Allowance shall commence on the first day of any month thereafter, but not later than the first day of the calendar month in which the Deceased Participant or Deceased Retired Participant would have attained his Normal Retirement Age and any such Supplemental Survivor Allowance shall terminate on the first day of the month in which the Spouse dies. The Supplemental Survivor Income Benefit Allowance payable to the Spouse of a Deceased Participant pursuant to Paragraph B(1)(b) above or to the Spouse of a Deceased Retired Participant pursuant to Paragraph B(3)(b) above shall commence and terminate simultaneously with the date on which a survivor income benefit allowance would have been payable to the Spouse pursuant to Article II, A(2)(b) or A(4), as applicable, of the Survivor Income Benefit Plan. The Supplemental Optional Payment Allowance payable to the beneficiary of a Deceased Retired Participant pursuant to Paragraph B(5) hereof or to the beneficiary of a Deceased Participant or Deceased Retired Participant pursuant to Paragraph B(6) above shall commence on the first day of the calendar month following the month in which the Deceased Participant or Deceased Retired Participant died. (5) (a) Notwithstanding the previous provisions of this Paragraph, the Committee may cause the distribution of the Supplemental Retirement Allowance or other benefit to any group of similarly situated Retired Participants, or Spouses or beneficiaries in a Single Sum Payment or as an Optional Payment. -14- (b) Notwithstanding the preceding provisions of this Paragraph, the Administrator shall distribute a Participant's Supplemental Retirement Allowance in a Single Sum Payment if the Supplemental Retirement Allowance payable in equal monthly payments is not more than $250. (6) (a) The Supplemental Retirement Allowance payable to a Retired Participant pursuant to clause (B) of Subparagraph (3) hereof shall be further reduced by one percent (1%) for each month (or portion of a month) by which the month in which the Retired Participant's termination of employment precedes the first anniversary of the filing of the application with the Administrator. (b) The Supplemental Survivor Allowance of a Spouse of a Deceased Participant or Deceased Retired Participant commencing at an age other than the Deceased Participant's or Deceased Retired Participant's Normal Retirement Age shall be the Actuarial Equivalent of the Supplemental Retirement Allowance payable as a Joint and Survivor Supplemental Allowance at the Deceased Participant's or Deceased Retired Participant's Normal Retirement Age unless otherwise required by Article II, A(1) of the Plan. The Supplemental Optional Payment Allowance payable to the beneficiary of a Deceased Participant or Deceased Retired Participant commencing at an age other than the Deceased Participant's or Deceased Retired Participant's Normal Retirement Age shall be the Actuarial Equivalent of the Supplemental Retirement Allowance payable as a Supplemental Optional Payment Allowance at the Deceased Participant's or Deceased Retired Participant's Normal Retirement Age unless otherwise required by Article II, A(1) of the Plan. E. Cessation of accruals of Supplemental Retirement Allowance Any right or claim to any Supplemental Retirement Allowance or other benefit under the Plan which any Participant, Spouse or designated beneficiary may have shall terminate if the Committee shall find that such Participant has been guilty of fraud or dishonesty towards a Participating Company, or has willfully damaged the property of a Participating Company, or has wrongfully disclosed any secret process or imparted any confidential information, or has done any other act materially inimical to the interest of a Participating Company. -15- ARTICLE III SUPPLEMENTAL PROFIT-SHARING ALLOWANCES A Participant may be granted a Supplemental Profit-Sharing Allowance equal to the amount, if any, by which the sum of the Contribution which would have been made to the Profit-Sharing Plan and the amount which would have been credited to his account under the Benefit Equalization Plan had such Participant been eligible to participate in such plans for a plan year, exceeds the amount, if any, of employer contributions (excluding any contributions which the Participant has elected to have an employer make on his behalf pursuant to a cash or deferred arrangement) actually made or credited for the plan year on behalf of such Participant under a defined contribution plan qualified under Section 401(a) of the Code, an excess benefit plan (as defined in ERISA) and a plan maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees maintained by any other member of the Controlled Group. Any amounts credited to a Participant's account pursuant to the provisions of this Article III shall be deemed to have been invested in Part C of the Fund under the Profit-Sharing Plan and shall be valued in accordance with the provisions of the Profit-Sharing Plan. A Retired Participant shall receive his Supplemental Profit-Sharing Allowance in a Single Sum Payment no later than sixty (60) days following the Participant's date of retirement or other termination of employment with the Controlled Group. -16- ARTICLE IV FUNDS FROM WHICH ALLOWANCES ARE PAYABLE An individual account shall be established for the benefit of each Participant (and Spouse or designated beneficiary) under the Plan. The Plan shall be unfunded. All benefits intended to be provided under the Plan shall be paid from time to time from the general assets the Participant's Participating Company and paid in accordance with the provisions of the Plan; provided, however, that the Participating Companies reserve the right to meet the obligations created under the Plan through one or more trusts or other arrangements. The contributions by each Participating Company on behalf of its Participants to the individual accounts established under the Plan, whether in trust or otherwise, shall be in an amount which such Participating Company and the Management Committee, with the advice of an actuary, determines to be sufficient to provide for the payment of the benefits under the Plan. No Participant, Spouse or designated beneficiary shall, unless the Plan expressly provides otherwise, have any right or claim whatsoever to any specific assets of a Participating Company or of any trust. Each Participating Company shall maintain such reserves on its books with respect to Participants who are employed by such Participating Company as determined by the actuary for the Plan. -17- ARTICLE V APPLICABILITY OF PROVISIONS OF PM RETIREMENT PLAN AND SURVIVOR INCOME BENEFIT PLAN Except as expressly provided to the contrary, all of the provisions, conditions and requirements set forth in the PM Retirement Plan and where applicable, the Survivor Income Benefit Plan, with respect to eligibility for and payment of benefits thereunder shall be equally applicable to the granting of Supplemental Retirement Allowances and other benefits to Participants and Beneficiaries pursuant to this Plan and the payment thereof pursuant to the provisions of Article III hereof. Whenever a Participant's rights under this Plan are to be determined, appropriate reference shall be made to the PM Retirement Plan. -18- ARTICLE VI ADMINISTRATION The Committee, the Management Committee and the Administrator shall be responsible for the general administration of the Plan. The appropriate Fiduciary shall have full authority to determine all questions arising in connection with the Plan; provided, however, that any Fiduciary who makes a request for payment of a Supplemental Retirement Allowance in accordance with a form of distribution authorized under the Retirement Plan shall excuse himself from any and all deliberations and decisions in connection with such request. Decisions of the appropriate Fiduciary shall be conclusive and binding on all persons. The Fiduciaries may employ and rely on actuaries, legal counsel, accountants and agents as they deem advisable. -19- ARTICLE VII CERTAIN RIGHTS AND LIMITATIONS A. No benefit under the Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to do so shall be void; nor shall any benefit be in any manner liable for or subject to the debts, contracts, liabilities, engagements, or torts of the person entitled to such benefit. In the event that the Administrator shall find that any Participant, Retired Participant or Spouse or other beneficiary under the Plan has become bankrupt or that any attempt has been made to anticipate, alienate, sell, transfer, assign, pledge, encumber, or charge any of his benefits under the Plan, then such benefits shall cease and determine, and in that event, the Administrator shall hold or apply the same to or for the benefit of such Participant, Retired Participant, Spouse or other beneficiary or apply the same to or for the benefit of such Participant, Retired Participant, Spouse or other beneficiary, in such manner as the Administrator may deem proper. B. Except as otherwise expressly provided in the Plan, Supplemental Retirement Allowances and other benefits shall be payable only if the Participant meets all of the requirements for benefits under the Plan. -20- ARTICLE VIII AMENDMENT AND TERMINATION OF THE PLAN A. The Board may, by resolution, from time to time and at any time, amend or modify, in whole or in part, any and all of the provisions of the Plan; provided, however, that authority to amend the Plan is delegated to the following Fiduciaries where approval of the Plan amendment (or amendments) by the shareholders of Philip Morris Companies Inc. is not required: (1) to the Committee, if the amendment (or amendments) will not increase the annual cost of the Plan by $10,000,000, (2) to the Management Committee, if the amendment (or amendments) will not increase the annual cost of the Plan by $4,000,000, and (3) to the Administrator, if the amendment (or amendments) will not increase the annual cost of the Plan by $500,000; provided, further, that no such amendment or modification shall adversely affect the rights of any Participant, Retired Participant, Spouse or beneficiary to benefits accrued at the time such amendment or modification is adopted or becomes effective, whichever is later. B. (1) The Board may terminate the Plan for any reason at any time, provided that such termination shall not adversely affect the rights of any Participant, Retired Participant, Spouse or beneficiary to benefits accrued to the date of termination. (2) In the event the Plan is terminated, each Participant, whether or not such Participant is eligible to receive benefits under this Plan, shall be immediately and fully vested in the benefits set forth in Article II accrued to the date of termination of the Plan. Payment of any such benefits shall be made or commence to be made at the time such Participant (or his Spouse or designated beneficiary) meets, under the terms of the Plan at the time of its termination, the requirement for payment of benefits under the Plan. C. Notwithstanding any other provision of the Plan to the contrary, in the event of a Change of Control of the Company, each Participant shall immediately be fully vested in the benefits set forth in Article II which have accrued through the date of the Change of Control and, upon the Change of Control, each Participant (or his Spouse or designated beneficiary) shall be entitled to a Single Sum Payment in an amount which is the Actuarial Equivalent of such accrued benefits, which amount shall be paid within 30 days of the Change of Control. -21- EXHIBIT A SUPPLEMENTAL MANAGEMENT EMPLOYEES' RETIREMENT PLAN OF PHILIP MORRIS COMPANIES INC. ACTUARIAL ASSUMPTIONS USED TO CALCULATE A SINGLE SUM PAYMENT INTEREST RATE: Average of the interest rates established by the Pension Benefit Guaranty Corporation to value immediate annuities in the case of a plan termination for the 24 months preceding the Participant's date of retirement, less 1/2 of 1%. MORTALITY ASSUMPTION: UP-1984 Unisex Mortality Table -22- EX-10.9 6 PM 1992 INCNTV COMP & STOCK OPT. PLAN EXHIBIT 10.9 THE PHILIP MORRIS 1992 INCENTIVE COMPENSATION AND STOCK OPTION PLAN SECTION 1. Purpose; Definitions. The purpose of the Plan is to give the Company a significant advantage in attracting, retaining and motivating key employees and to provide the Company with the ability to provide incentives more directly linked to the profitability of the Company's businesses and increases in stockholder value. For purposes of the Plan, the following terms are defined as set forth below: a. "Annual Incentive Award" means an award made by the Committee pursuant to Section 4. b. "Annual Incentive Award Reserve" means the reserve established for any fiscal year of the Company pursuant to Section 4. c. "Board" means the Board of Directors of the Company. d. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. e. "Commission" means the Securities and Exchange Commission or any successor agency. f. "Committee" means the Committee referred to in Section 2. g. "Company" means Philip Morris Companies Inc., a corporation organized under the laws of the Commonwealth of Virginia, or any successor corporation. h. "Disability" means permanent and total disability as determined under procedures established by the Committee for purposes of the Plan. i. "Disinterested Person" means a member of the Board who qualifies as a disinterested person as defined in Rule 16b-3. j. "Exercise Period" means the 60-day period from and after a Change in Control (as defined in Section 10(b)). k. "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time, and any successor thereto. l. "Fair Market Value" means, as of any given date, the mean between the highest and lowest reported sales prices of the Stock on the New York Stock Exchange or, if no such sale of Stock occurs on the New York Stock Exchange on such date, the fair market value of the Stock as determined by the Committee in good faith. m. "Incentive Stock Option" means any Stock Option intended to be and designated as an "incentive stock option" within the meaning of Section 422 of the Code. n. "Long Term Performance Award" means an award made by the Committee pursuant to Section 5. o. "Non-Qualified Stock Option" means any Stock Option that is not an Incentive Stock Option. p. "Performance Period" means the two-year or greater period during which a Long Term Performance Award can be earned as determined by the Committee pursuant to Section 5(a). q. "Plan" means The Philip Morris 1992 Incentive Compensation and Stock Option Plan, as set forth herein and as hereinafter amended from time to time. r. "Pretax Earnings" means, for any fiscal year of the Company, the amount reported as earnings from continuing operations before income taxes in the Company's consolidated statements of earnings included in its audited consolidated financial statements for such fiscal year (adjusted to exclude the effects of any unusual or non-recurring items that would not arise in the normal course of business, as determined by the Board). s. "Restricted Stock" means an award made by the Committee pursuant to Section 9. t. "Restriction Period" means the period set by the Committee pursuant to Section 9(c)(i) during which the recipient of a Restricted Stock Award may not sell, assign, transfer, pledge or otherwise encumber shares of Restricted Stock. u. "Retirement" means retirement from active employment under a pension plan of the Company, any subsidiary or affiliate or under an employment contract with any of them or termination of employment at or after age 55 under circumstances which the Committee, in its sole discretion, deems equivalent to retirement. v. "Rule 16b-3" means Rule 16b-3, as promulgated by the Commission under Section 16(b) of the Exchange Act, as amended from time to time. w. "Spread Value" means with respect to a share of Stock subject to a Stock Option an amount equal to the excess of the Fair Market Value over the option price. x. "Stock" means the Common Stock, $1 par value, of the Company. y. "Stock Appreciation Right" means a right granted by the Committee pursuant to Section 8. 2 z. "Stock Option" means an option granted by the Committee pursuant to Section 7. In addition, the terms "Business Combination", "Change in Control", "Change in Control Price", "Incumbent Board", "Outstanding Company Stock", "Outstanding Company Voting Securities", and "Person" have the meanings set forth in Section 10. SECTION 2. Administration. The Plan shall be administered by the Compensation Committee of the Board or such other committee of the Board, composed of not less than two Disinterested Persons, who shall be appointed by the Board and who shall serve at the pleasure of the Board. If at any time no Committee shall be in office, the functions of the Committee specified in the Plan shall be exercised by those members of the Board who qualify as Disinterested Persons. The Committee shall have plenary authority to grant to employees, pursuant to the terms of the Plan, Annual Incentive Awards, Long Term Performance Awards, Stock Options, Stock Appreciation Rights and Restricted Stock. In particular, the Committee shall have the authority, subject to the terms of the Plan: (a) to select the employees to whom Annual Incentive Awards, Long Term Performance Awards, Stock Options, Stock Appreciation Rights and Restricted Stock may from time to time be granted; (b) to determine whether and to what extent Annual Incentive Awards, Long Term Performance Awards, Incentive Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights and Restricted Stock or any combination are to be granted hereunder; (c) to determine and adjust the performance goals and measurements applicable to Long Term Performance Awards granted pursuant to the Plan; (d) to determine the extent to which Long Term Performance Awards have been earned and by whom; (e) to determine to what extent and under what circumstances amounts earned with respect to a Long Term Performance Award shall be deferred; (f) to determine the number of shares to be covered by each award of Stock Options, Stock Appreciation Rights and Restricted Stock; (g) to determine the terms and conditions of any Stock Options granted pursuant to the Plan, including, but not limited to, the option price (subject to Section 7(a)), any restriction or limitation and any vesting acceleration or forfeiture waiver regarding any Stock Option, based on such factors as the Committee shall determine; (h) to determine under what circumstances a Stock Option may be settled in cash pursuant to the first paragraph of Section 7(k); and 3 (i) to determine the terms and conditions of vesting of Restricted Stock awards. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines, practices, and procedures governing the Plan as it shall, from time to time, deem advisable, to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreement relating thereto) and to otherwise supervise the administration of the Plan. The Committee may also adopt sub-plans, consistent with the Plan, to conform to applicable state or foreign securities or tax laws. The Committee may act only by a majority of its members then in office, except that the members thereof may delegate to the Chief Executive Officer of the Company or such other officer as may be designated by the Committee, the authority to make decisions pursuant to Sections 1(u), 7(c), (f), (g), (h) and (i) and 9(c)(i) and (iv), the authority, subject to guidelines prescribed by the Committee and approved by the Board, to grant Stock Options and Stock Appreciation Rights to employees who are not then subject to the provisions of Section 16 of the Exchange Act and to determine the number of shares to be covered by any such Stock Option and the terms and conditions thereof in accordance with the provisions of clause (g) of this Section 2 and may authorize any one or more of their number or any officer of the Company to execute and deliver documents on behalf of the Committee, provided that no such delegation may be made that would cause grants, awards or other transactions under the Plan to cease to be exempt from Section 16(b) of the Exchange Act. Any determination made by the Committee or pursuant to delegated authority in accordance with the provisions of the Plan with respect to any award shall be made in the sole discretion of the Committee or such delegate at the time of the grant of the award or, unless in contravention of any express term of the Plan, at any time thereafter. All decisions made by the Committee or any appropriately designated officer pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company and Plan participants. SECTION 3. Eligibility. Employees of the Company, its subsidiaries and affiliates who are responsible for or contribute to the management, growth and profitability of the business of the Company, its subsidiaries or affiliates are eligible to be granted awards under the Plan. SECTION 4. Annual Incentive Awards. (a) Establishment of Annual Incentive Award Reserve. The Board may at any time and from time to time, in respect of each fiscal year of the Company, establish an Annual Incentive Award Reserve which shall not exceed four percent of Pretax Earnings for such fiscal year; provided, however, that the Annual Incentive Award Reserve established for any fiscal year shall not exceed 16% of the aggregate amount of cash dividends declared on the Stock during said fiscal year; provided, however, that in the event of the acquisition by the Company of a significant subsidiary (as such term is defined in Regulation S-X under the Exchange Act), the foregoing percentage shall be increased with respect to the fiscal year in which such acquisition was consummated and all subsequent years by 4%. Such increase shall apply with respect to each such acquisition. 4 As soon as practicable after the end of each fiscal year of the Company, the independent auditors who audited the Company's books and accounts for such fiscal year shall report to the Board the maximum amount that can be credited to the Annual Incentive Award Reserve for such fiscal year under the provisions of the Plan, after giving effect to any determination made by the Board pursuant to the provisions of the Plan with respect thereto. Such report shall be final, binding and conclusive upon the Company and all other persons. Amounts credited to the Annual Incentive Award Reserve with respect to any fiscal year which are not made the subject of Annual Incentive Awards by the Committee shall not be carried over to any other fiscal year. (b) Selection of Recipients and Amounts of Awards. The Committee shall select the employees to whom Annual Incentive Awards shall be made and the amount thereof; provided, however, that no employee may receive an Annual Incentive Award which would exceed 125% of his or her highest annual base salary rate during the fiscal year for which the Annual Incentive Award is granted. Annual Incentive Awards may be awarded alone or in addition to other awards granted under the Plan. (c) Payment of Awards. All Annual Incentive Awards shall be expressed in U.S. currency and paid in cash by the Company or the subsidiary or affiliate that employs the recipient of the award as soon as practicable after the close of the fiscal year for which awarded or at such earlier time as the Committee shall determine. SECTION 5. Long Term Performance Awards. (a) Awards and Administration. Long Term Performance Awards may be awarded either alone or in addition to other awards granted under the Plan. The Committee shall determine the nature, length, and starting date of the Performance Period for each Long Term Performance Award, which, subject to Section 10, shall be at least two years, and shall determine the performance objectives to be used in valuing Long Term Performance Awards and determining the extent to which such Long Term Performance Awards have been earned. Performance objectives may vary from participant to participant and between groups of participants and shall be based upon such Company, business unit or individual performance factors or criteria as the Committee may deem appropriate, including, but not limited to, earnings per share or return on equity. Performance Periods may overlap and participants may participate simultaneously with respect to Long Term Performance Awards that are subject to different Performance Periods and different performance factors and criteria. Long Term Performance Awards shall be confirmed by, and be subject to the terms of, a Long Term Performance Award Agreement. The terms of such awards need not be the same with respect to each participant. On or before the beginning of each Performance Period, the Committee shall determine for each Long Term Performance Award subject to such Performance Period the range of dollar values to be paid to the participant at the end of the Performance Period if and to the extent that the relevant measures of performance for such Long Term Performance Award are met. Such dollar values may be fixed or may vary in accordance with such performance or other criteria as may be determined by the Committee. (b) Maximum Aggregate Amount Payable for Any Performance Period. The aggregate amount of Long Term Performance Awards payable with respect to any Performance Period (determined without regard to any interest credited with respect to deferred awards) shall not exceed (y) the sum of the maximum aggregate amount 5 that could have been credited to the Annual Incentive Award Reserve in respect of each fiscal year of the applicable Performance Period less (z) the sum of all Annual Incentive Awards earned with respect to each fiscal year of the Performance Period and the amount of Long Term Performance Awards earned with respect to any such fiscal year because of an overlapping Performance Period. (c) Adjustment of Awards. The Committee may adjust the performance goals and measurements applicable to Long Term Performance Awards to take into account changes in law and accounting and tax rules and to make such adjustments as the Committee deems necessary or appropriate to reflect the impact of the inclusion or exclusion of extraordinary or unusual items, events or circumstances in order to avoid windfalls or unintended disadvantages. (d) Termination of Employment. Subject to Section 9 and unless otherwise provided in the applicable Long Term Performance Award Agreement, if a participant terminates employment during a Performance Period because of death, Disability or Retirement, such participant shall be entitled to a payment with respect to each outstanding Long Term Performance Award at the end of the applicable Performance Period: i) based, to the extent relevant under the terms of the Long Term Performance Award, upon the participant's performance for the portion of such Performance Period ending on the date of termination and the performance of the Company or any applicable business unit for the entire Performance Period, and ii) prorated for the portion of the Performance Period during which the participant was employed by the Company, a subsidiary or affiliate, all as determined by the Committee. The Committee may provide for an earlier payment in settlement of such award in such amount and under such terms and conditions as the Committee deems appropriate. Subject to Section 10 and except as otherwise provided in the applicable Long Term Performance Award Agreement, if a participant terminates employment during a Performance Period for any other reason, then such participant shall not be entitled to any payment with respect to a Long Term Performance Award awarded for such Performance Period, unless the Committee shall otherwise determine. (e) Form of Payment. The earned portion of a Long Term Performance Award shall be paid in cash currently or on a deferred basis with such interest as may be determined by the Committee. SECTION 6. Stock Subject to Plan. The total number of shares of Stock reserved and available for distribution pursuant to Stock Options, Stock Appreciation Rights and (subject to Section 9(a)) Restricted Stock awarded under the Plan shall be 37,000,000 shares. 6 Subject to Section 8(b)(iv), if any Stock Option or Stock Appreciation Right terminates without a payment being made to the participant in the form of Stock, the shares subject to such Stock Option or Stock Appreciation Right shall again be available for distribution in connection with awards under the Plan. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, stock split or other change in corporate structure affecting the Stock, such substitution or adjustments shall be made in the aggregate number and kind of shares reserved for issuance under the Plan, in the number, kind and option price of shares subject to outstanding Stock Options and any related Stock Appreciation Rights and in the number and kind of shares of Restricted Stock outstanding or available for awards as may be determined to be appropriate by the Board, in its sole discretion; provided, however, that the number of shares subject to any award shall always be a whole number. SECTION 7. Stock Options. Stock Options may be granted alone or in addition to other awards granted under the Plan and may be of two types: Incentive Stock Options and Non-Qualified Stock Options (in each case with or without Stock Appreciation Rights). Any Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve. The Committee shall have the authority to grant any optionee Incentive Stock Options, Non-Qualified Stock Options or both types of Stock Options. Incentive Stock Options may be granted only to employees of the Company and its subsidiaries (within the meaning of Section 424(f) of the Code). To the extent that any Stock Option does not qualify as an Incentive Stock Option, it shall constitute a separate Non-Qualified Stock Option. Stock Options shall be evidenced by option agreements, the terms and provisions of which may differ. An option agreement shall indicate on its face whether it is an Incentive Stock Option or a Non-Qualified Stock Option. The grant of a Stock Option shall occur on the date the Committee by resolution, or a duly authorized officer, selects an employee as a participant in any grant of Stock Options, determines the number of shares to be subject to the Stock Option granted to such employee and specifies the terms and provisions of the Stock Option. The Company shall notify a participant of a grant of a Stock Option, and a written option certificate shall be duly executed and delivered by the Company. Anything in the Plan to the contrary notwithstanding, no term of the Plan relating to Incentive Stock Options shall be interpreted, amended or altered nor shall any discretion or authority granted under the Plan be exercised so as to disqualify the Plan under Section 422 of the Code or, without the consent of the optionee affected, to disqualify any Incentive Stock Option under such Section 422. Stock Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions as the Committee shall deem desirable: (a) Option Price. The option price per share of Stock purchasable under a Stock Option shall be equal to the Fair Market Value of the Stock at the date of grant or such higher price as shall be determined by the 7 Committee at grant; provided, however, that, in connection with the issuance of a Stock Option in a transaction to which Section 424(a) of the Code applies, the option price may be determined pursuant to said Section 424(a). (b) Option Term. The term of each Stock Option shall be fixed by the Committee, but no Stock Option shall be exercisable more than ten years after the date the Stock Option is granted. (c) Exercisability. Stock Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee; provided, however, that, except as provided in Sections 7(f), (g), (h) and (i) and 10 or, unless otherwise determined by the Committee, no Stock Option shall be exercisable prior to the first anniversary date of the granting of the Stock Option. The Committee may waive, reduce or eliminate provisions that Stock Options are exercisable only in installments and provisions that Stock Options are not exercisable for a specified period of time, in whole or in part, based on such factors as the Committee may determine. (d) Method of Exercise. Subject to the provisions of this Section 7, Stock Options may be exercised, in whole or in part, at any time during the option term by giving written notice of exercise to the Company specifying the number of shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price by certified or bank check or such other instrument as the Company may accept. As determined by the Committee, payment in full or in part may also be made in the form of unrestricted Stock already owned by the optionee based on the Fair Market Value on the date the Stock Option is exercised; provided, however, that such unrestricted Stock shall not have been acquired within the preceding six months upon the exercise of a Stock Option or any stock option or stock unit or similar award granted under the Plan or any other plan maintained at any time by the Company or any subsidiary. No shares of Stock shall be issued until full payment therefor has been made. An optionee shall have all of the rights of a stockholder of the Company, including the right to vote the shares and the right to receive dividends, with respect to shares subject to the Stock Option when the optionee has given written notice of exercise, has paid in full for such shares and, if requested, has given the representation described in Section 12(a). (e) Non-transferability of Options. No Stock Option shall be transferable by the optionee other than by will or by the laws of descent and distribution or (in the case of a Non-Qualified Stock Option) pursuant to a "qualified domestic relations order" (as defined by the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended, or the rules thereunder), and all Stock Options shall be exercisable, during the optionee's lifetime, only by the optionee, by the guardian or legal representative of the optionee or (in the case of a NonQualified Stock Option) its alternate payee pursuant to such qualified domestic relations order, it being understood that the terms "holder" and "optionee" include the guardian and legal representative of the optionee named in the option agreement and any person to whom an option is transferred by will, the laws of descent and distribution or (in the case of a Non-Qualified Stock Option) such qualified domestic relations order. (f) Termination by Death. If an optionee's employment terminates by reason of death, any Stock Option held by such optionee may thereafter be exercised, to the extent then exercisable or on such accelerated basis 8 as the Committee may determine, for such period as the Committee may specify at grant from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (g) Termination by Reason of Disability. If an optionee's employment terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of termination or on such accelerated basis as the Committee may determine, for such period as the Committee may specify at grant from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that, if the optionee dies within such period, any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such period, continue to be exercisable to the extent to which it was exercisable at the time of death for a period of twelve months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. (h) Termination by Reason of Retirement. If an optionee's employment terminates by reason of Retirement, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of such Retirement or on such accelerated basis as the Committee may determine, for such period as the Committee may specify at grant from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that, if the optionee dies within such period, any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such period, continue to be exercisable to the extent to which it was exercisable at the time of death for a period of twelve months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of termination of employment by reason of Retirement, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. (i) Other Termination. Unless otherwise determined by the Committee, if an optionee's employment terminates for any reason other than death, Disability or Retirement, the Stock Option shall thereupon terminate, except that such Stock Option, to the extent then exercisable or on such accelerated basis as the Committee may determine, may be exercised for the lesser of one year from termination of employment or the balance of such Stock Option's term; provided, however, that if the optionee dies within such one-year period, any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such one-year period, continue to be exercisable to the extent to which it was exercisable at the time of death for a period of twelve months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of termination of employment, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a NonQualified Stock Option. (j) Incentive Stock Options. The Committee is authorized to provide at the time of grant, that, to the extent permitted under Section 422 of the Code, if a participant's employment with the Company and its subsidiaries is terminated and the portion of any Incentive Stock Option that is otherwise exercisable during the post-termination 9 period specified under Sections 7(f), (g), (h) or (i), applied without regard to this Section 7(j), is greater than the portion of such option that is exercisable as an "incentive stock option" during such post-termination period under Section 422, such post-termination period shall automatically be extended (but not beyond the original option term) to the extent necessary to permit the optionee to exercise such Incentive Stock Option (either as an Incentive Stock Option or, if exercised after the expiration periods that apply for the purposes of Section 422, as a Non-Qualified Stock Option). (k) Cashing Out of Option; Settlement of Spread Value in Stock. On receipt of written notice of exercise, the Committee may elect to cash out all or a portion of the shares of Stock for which a Stock Option is being exercised by paying the optionee an amount, in cash or Stock, equal to the Spread Value of such shares on the effective date of such cash out. Notwithstanding any other provision of this Plan, upon a Change in Control, unless the Committee shall determine otherwise at grant, an optionee shall have the right, by giving notice to the Company within the Exercise Period, to elect to surrender all or part of the Stock Option to the Company and to receive in cash, within 30 days of such notice, an amount equal to the amount by which the "Change in Control Price" on the date of such notice shall exceed the exercise price under the Stock Option multiplied by the number of shares of Stock as to which the right granted under this Section 7(k) shall have been exercised. SECTION 8. Stock Appreciation Rights. (a) Grant and Exercise. Stock Appreciation Rights may be granted only in conjunction with all or part of any Stock Option granted under the Plan. In the case of a Non-Qualified Stock Option, such rights may be granted either at or after the time of grant. In the case of an Incentive Stock Option, such rights may be granted only at the time of grant. A Stock Appreciation Right or applicable portion thereof granted with respect to a given Stock Option shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option, except that, unless otherwise determined by the Committee at the time of grant, a Stock Appreciation Right granted with respect to less than the full number of shares, covered by a related Stock Option shall not be reduced until the number of shares covered by an exercise or termination of the related Stock Option exceeds the number of shares not covered by the Stock Appreciation Right. A Stock Appreciation Right may be exercised by an optionee in accordance with Section 8(b) by surrendering the applicable portion of the related Stock Option in accordance with procedures established by the Committee. Upon such exercise and surrender, the optionee shall be entitled to receive an amount determined in the manner prescribed in Section 8(b). Stock Options which have been so surrendered shall no longer be exercisable to the extent the related Stock Appreciation Rights have been exercised. (b) Terms and Conditions. Stock Appreciation Rights shall be subject to such terms and conditions as shall be determined by the Committee, including the following: 10 i) Stock Appreciation Rights shall be exercisable only at such time or times and to the extent that the Stock Options to which they relate are exercisable in accordance with the provisions of Section 7 and this Section 8. ii) Upon the exercise of a Stock Appreciation Right, an optionee shall be entitled to receive an amount in cash, shares of Stock or both equal in value to the excess of the Fair Market Value of one share of Stock over the option price per share specified in the related Stock Option multiplied by the number of shares in respect of which the Stock Appreciation Right shall have been exercised, with the Committee having the right to determine the form of payment. iii) Stock Appreciation Rights shall be transferable only when and to the extent that the underlying Stock Option would be transferable under Section 7(e) and only to the transferee of the underlying Stock Option. iv) Upon the exercise of a Stock Appreciation Right, the Stock Option or part thereof to which such Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 6 on the number of shares of Stock to be issued under the Plan but only to the extent of the number of shares issued under the Stock Appreciation Right at the time of exercise. v) The Committee may provide, at the time of grant, that a Stock Appreciation Right can be exercised only in the event of a Change in Control, subject to such terms and conditions as the Committee may specify at grant. SECTION 9. Restricted Stock. (a) Administration. Not in excess of 9,000,000 shares (subject to adjustment pursuant to Section 6) of Restricted Stock may be issued either alone or in addition to other awards granted under the Plan. The Committee shall determine the employees to whom and the time or times at which grants of Restricted Stock will be made, the number of shares to be awarded, the time or times within which such awards may be subject to forfeiture and any other terms and conditions of the awards, in addition to those contained in Section 9(c). The Committee may condition the grant of Restricted Stock upon the attainment of specified performance goals or such other factors or criteria as the Committee shall determine. The provisions of Restricted Stock awards need not be the same with respect to each recipient. (b) Awards and Certificates. Shares of Restricted Stock may be evidenced in such manner as the Committee may deem appropriate, including book-entry registration or issuance of a stock certificate or certificates. Any certificate issued in respect of shares of Restricted Stock shall be registered in the name of the participant and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such award, substantially in the following form: 11 The transferability of this certificate and the shares of stock represented hereby are subject to the terms and conditions (including forfeiture) of The Philip Morris 1992 Incentive Compensation and Stock Option Plan and a Restricted Stock Agreement. Copies of such Plan and Agreement are on file at the offices of Philip Morris Companies Inc., 120 Park Avenue, New York, New York 10017. The Committee may require that the certificates evidencing such shares be held in custody by the Company until the restrictions thereon shall have lapsed and that, as a condition of any Restricted Stock award, the participant shall have delivered a stock power, endorsed in blank, relating to the Stock covered by such award. (c) Terms and Conditions. Shares of Restricted Stock shall be subject to the following terms and conditions: i) During a period set by the Committee (the "Restriction Period"), commencing with the date of such award, the participant shall not be permitted to sell, assign, transfer, pledge or otherwise encumber shares of Restricted Stock. The Committee may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions, in whole or in part, based on service, performance and such other factors or criteria as the Committee may determine. ii) Except as otherwise provided in the applicable Restricted Stock Agreement and Section 9(c)(i), the participant shall have, with respect to the shares of Restricted Stock, all of the rights of a stockholder of the Company, including the right to vote the shares and the right to receive any cash dividends. Dividends payable in Stock shall be paid in the form of Restricted Stock. iii) Except as otherwise provided in the applicable Restricted Stock Agreement and Sections 9(c)(i) and (iv), upon termination of a participant's employment for any reason during the Restriction Period, all shares still subject to restriction shall be forfeited by the participant. iv) In the event of hardship or other special circumstances of a participant whose employment is terminated for any reason, the Committee may waive in whole or in part any or all remaining restrictions with respect to such participant's shares of Restricted Stock. v) If and when the Restriction Period expires without a prior forfeiture of the Restricted Stock subject to such Restriction Period, unlegended certificates for such shares shall be delivered to the participant. vi) Each award shall be confirmed by, and be subject to the terms of, a Restricted Stock Agreement. 12 SECTION 10. Change in Control Provisions. (a) Impact of Event. Notwithstanding any other provision of the Plan to the contrary, in the event of a Change in Control: i) Any Stock Options and Stock Appreciation Rights outstanding as of the date such Change in Control occurs and not then exercisable shall become fully exercisable. ii) The restrictions applicable to any Restricted Stock shall lapse, and such Restricted Stock shall become free of all restrictions and fully vested to the full extent of the original grant. iii) Subject to the provisions of Section 7(k), the value of all outstanding Stock Options, Stock Appreciation Rights and Restricted Stock which, in the case of holders who are then subject to the provisions of Section 16 of the Exchange Act, shall have been granted at least six months before the date of cash-out occurring pursuant to this Section 10(a)(iii), shall, unless otherwise determined by the Committee at or after grant, be cashed out on the basis of the "Change in Control Price", as defined in Section 10(c), as of the date such Change in Control occurs or such other date as the Committee may determine prior to the Change in Control. iv) Any Long Term Performance Awards relating to Performance Periods prior to the Performance Period in which the Change in Control occurs which have been earned but not paid shall become immediately payable in cash. In addition, subject to the provisions of Section 5(b), each participant who has been awarded a Long Term Performance Award, shall be deemed to have earned a pro rata Long Term Performance Award equal to the product of (y) such participant's maximum award opportunity for such Performance Period, and (z) a fraction, the numerator of which is the number of full or partial months which have elapsed since the beginning of such Performance Period to the date on which the Change in Control occurs, and the denominator of which is the total number of months in such Period or, in the case of a completed Performance Period, equal to the maximum award opportunity. (b) Definition of Change in Control. A "Change in Control" means the happening of any of the following events: i) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a "Person")) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (A) the then outstanding shares of Stock (the "Outstanding Company Common Stock") or (B) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that the following acquisitions shall not constitute a Change in Control: (1) any acquisition directly from the Company, (2) any acquisition by the Company, (3) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (4) any acquisition by any corporation pursuant to a transaction described in clauses (A), (B) and (C) of paragraph (iii) of this Section 10(b); or 13 ii) Individuals who, as of the effective date of the Plan, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to such effective date whose election, or nomination for election by the stockholders of the Company, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or iii) Approval by the stockholders of the Company of a reorganization, merger, share exchange or consolidation (a "Business Combination"), unless, in each case following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 80% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities prior to the Business Combination and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or iv) Approval by the stockholders of the Company of (A) a complete liquidation or dissolution of the Company or (B) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation with respect to which following such sale or other disposition (1) more than 80% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (2) less than 20% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation 14 entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by any Person (excluding any employee benefit plan (or related trust) of the Company or such corporation), except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities prior to the sale or disposition and (3) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such sale or other disposition of assets of the Company or were elected, appointed or nominated by the Board. (c) Change in Control Price. "Change in Control Price" means the highest price per share paid in any transaction reported on the New York Stock Exchange Composite Index or paid or offered in any bona fide transaction related to a potential or actual change in control of the Company at any time during the preceding 60-day period as determined by the Committee, except that, in the case of Incentive Stock Options, such price shall be based only on transactions reported for the date on which such Incentive Stock Options are cashed out. SECTION 11. Amendments and Termination. The Board may amend, alter, or discontinue the Plan, but no amendment, alteration or discontinuation shall be made which would impair the rights of an optionee under a Stock Option or a recipient of a Long Term Performance Award, Stock Appreciation Right or Restricted Stock Award theretofore granted without the optionee's or recipient's consent or which, without the approval of the Company's stockholders, would: (a) materially increase the benefits accruing to participants under the Plan; (b) except as expressly provided in the Plan, increase the total number of shares of Stock which may be issued under the Plan; (c) modify the requirements as to eligibility for participation in the Plan; (d) except as expressly provided in the Plan, decrease the option price of any Stock Option to less than the Fair Market Value on the date of grant; (e) extend the maximum option period under Section 7(b). The Committee may amend the terms of any Stock Option, Stock Appreciation Right, Restricted Stock Agreement or other award theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any holder without the holder's consent. Subject to the above provisions, the Board shall have authority to amend the Plan to take into account changes in law and tax and accounting rules, as well as other developments. 15 SECTION 12. Unfunded Status of Plan. It is presently intended that the Plan constitute an "unfunded" plan for incentive and deferred compensation, including specifically the Annual Incentive Award Reserve. The Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or make payments; provided, however, that, unless the Committee otherwise determines, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. SECTION 13. General Provisions. (a) The Committee may require each person purchasing shares pursuant to a Stock Option to represent to and agree with the Company in writing that the optionee or participant is acquiring the shares without a view to the distribution thereof. The certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer. All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Stock is then listed and any applicable Federal, state or foreign securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (b) Nothing contained in this Plan shall prevent the Company, a subsidiary or affiliate from adopting other or additional compensation arrangements for its employees. (c) The adoption of the Plan shall not confer upon any employee any right to continued employment nor shall it interfere in any way with the right of the Company, a subsidiary or affiliate to terminate the employment of any employee at any time. (d) No later than the date as of which an amount first becomes includible in the gross income of the participant for Federal income tax purposes with respect to any award under the Plan, the participant shall pay to the Company, or make arrangements satisfactory to the Company regarding the payment of, any Federal, state, local or foreign taxes of any kind required by law to be withheld with respect to such amount. Unless otherwise determined by the Committee, withholding obligations arising from the award or vesting of Restricted Stock or the exercise of Stock Options may be settled with unrestricted Stock, including Stock that is part of, or is received upon exercise of, the award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements, and the Company, its subsidiaries and affiliates shall, to the extent permitted by law, have the right to deduct any such taxes from any payment otherwise due to the participant. The Committee may establish such procedures as it deems appropriate, including the making of irrevocable elections, for the settling of withholding obligations with Stock. (e) At the time of grant, the Committee may provide in connection with any grant made under this Plan that the shares of Stock received as a result of such grant shall be subject to a right of first refusal pursuant to which the participant shall be required to offer to the Company any shares that the participant wishes to sell at the then 16 Fair Market Value of the Stock, subject to such other terms and conditions as the Committee may specify at the time of grant. (f) The reinvestment of dividends in additional Restricted Stock at the time of any dividend payment shall only be permissible if sufficient shares of Stock are available under Section 6 for such reinvestment (taking into account then outstanding Stock Options, Stock Appreciation Rights and other Plan awards). (g) The Committee may establish such procedures as it deems appropriate for a participant to designate a beneficiary to whom any amounts payable in the event of the participant's death are to be paid. (h) The Plan and all awards made and actions taken thereunder shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia. SECTION 14. Effective Date of Plan. The Plan shall be effective on May 1, 1992. SECTION 15. Term of Plan. No Stock Option or Stock Appreciation Right shall be granted or award of Restricted Stock made on or after the fifth anniversary of the effective date of the Plan, but any such awards granted prior to such fifth anniversary may extend beyond that date. There shall be no time limitation with respect to the granting of Annual Incentive Awards or Long Term Performance Awards. 17 EX-10.12 7 PM 1987 LONG TERM INCENTIVE PLAN Exhibit 10.12 THE PHILIP MORRIS 1987 LONG TERM INCENTIVE PLAN SECTION 1. Purpose; Definitions. The purpose of the Plan is to enable key employees of the Company, its subsidiaries and affiliates to participate in the Company's future by offering them long term performance-based incentives and proprietary interests in the Company. The Plan also provides a means through which the Company can attract and retain key employees of merit. For purposes of the Plan, the following are defined as set forth below: a. "Board" means the Board of Directors of the Company. b. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. c. "Commission" means the Securities and Exchange Commission or any successor agency. d. "Committee" means the Committee referred to in Section 2. e. "Company" means Philip Morris Companies Inc., a corporation organized under the laws of the Commonwealth of Virginia, or any successor corporation. f. "Deferred Stock" means an award made pursuant to Section 8. g. "Disability" means permanent and total disability as determined under procedures established by the Committee for purposes of the Plan. h. "Disinterested Person" shall have the meaning set forth in Rule 16b-3(d)(3), as promulgated by the Commission under the Exchange Act, or any successor definition adopted by the Commission. i. "Early Retirement" means retirement, with the consent for purposes of the Plan of the Vice President-Administration and Human Resources of the Company or such other officer as may be designated by the Committee, from active employment with the Company, a subsidiary or affiliate pursuant to the early retirement provisions of the applicable pension plan of such employer. 1 j. "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time, and any successor thereto. k. "Fair Market Value" means, except as provided in Section 5(k) and 6(b)(ii), the mean, as of any given date, between the highest and lowest reported sales prices of the Stock on the New York Stock Exchange or, if no such sale of Stock occurs on the New York Stock Exchange on such date, the fair market value of the Stock as determined by the Committee in good faith. l. "Incentive Stock Option" means any Stock Option intended to be and designated as an "incentive stock option" within the meaning of Section 422A of the Code. m. "Long Term Performance Award" or "Long Term Award" means an award under Section 10. n. "Non-Qualified Stock Option" means any Stock Option that is not an Incentive Stock Option. o. "Normal Retirement" means retirement from active employment with the Company, a subsidiary or affiliate at or after age 65. p. "Plan" means The Philip Morris 1987 Long Term Incentive Plan, as set forth herein and as hereinafter amended from time to time. q. "Restricted Stock" means an award under Section 7. r. "Retirement" means Normal or Early Retirement. s. "Rule 16b-3" means Rule 16b-3, as promulgated by the Commission under Section 16(b) of the Exchange Act, as amended from time to time. t. "Stock" means the Common Stock, $1 par value, of the Company. u. "Stock Appreciation Right" means a right granted under Section 6. v. "Stock Option" or "Option" means an option granted under Section 5. w. "Stock Purchase Right" means a purchase right granted under Section 9. In addition, the terms "Change in Control", "Potential Change in Control" and "Change in Control Price" have the meanings set forth in Sections 11(b), (c) and (d), respectively. 2 SECTION 2. Administration. The Plan shall be administered by the Compensation Committee of the Board or such other committee of the Board, composed of not less than three Disinterested Persons, who shall be appointed by the Board and who shall serve at the pleasure of the Board. If at any time no Committee shall be in office, the functions of the Committee specified in the Plan shall be exercised by the Board. The Committee shall have plenary authority to grant to eligible employees, pursuant to the terms of the Plan, Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, Stock Purchase Rights and Long Term Performance Awards. In particular, the Committee shall have the authority, subject to the terms of the Plan: (a) to select the officers and other key employees to whom Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, Stock Purchase Rights and Long Term Performance Awards may from time to time be granted; (b) to determine whether and to what extent Incentive Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, Stock Purchase Rights, Long Term Performance Awards or any combination thereof are to be granted hereunder; (c) to determine the number of shares to be covered by each award granted hereunder; (d) to determine the terms and conditions of any award granted hereunder (including, but not limited to, the share price, any restriction or limitation and any vesting acceleration or forfeiture waiver regarding any Stock Option or other award and the shares of Stock relating thereto, based on such factors as the Committee shall determine); (e) to adjust the performance goals and measurements applicable to performance-based awards pursuant to the terms of the Plan; (f) to determine under what circumstances a Stock Option may be settled in cash, Deferred Stock or Restricted Stock under Section 5(k); (g) to determine to what extent and under what circumstances Stock and other amounts payable with respect to an award shall be deferred; and (h) to determine the terms and conditions of Stock Purchase Rights, the Stock purchased by exercising such Rights and any loans to be made by the Company with respect thereto. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall, from time to time, deem advisable, to 3 interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreement relating thereto) and to otherwise supervise the administration of the Plan. The Committee may act only by a majority of its members then in office, except that the members thereof may authorize any one or more of their number or any officer of the Company to execute and deliver documents on behalf of the Committee. Any determination made by the Committee pursuant to the provisions of the Plan with respect to any award shall be made in its sole discretion at the time of the grant of the award or, unless in contravention of any express term of the Plan, at any time thereafter. All decisions made by the Committee pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company and Plan participants. SECTION 3. Stock Subject to Plan. The total number of shares of Stock reserved and available for distribution pursuant to Stock Options or other awards under the Plan shall be 8,000,000 shares. Such shares may consist, in whole or in part, of authorized and unissued shares or treasury shares. Subject to Section 6(b)(iv), if any shares of Stock that have been optioned cease to be subject to a Stock Option, if any shares of Stock that are subject to any Restricted or Deferred Stock award, Stock Purchase Right or Long Term Performance Award are forfeited or if any Stock Option or other award otherwise terminates without a payment being made to the participant in the form of Stock, such shares shall again be available for distribution in connection with awards under the Plan. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, stock split or other change in corporate structure affecting the Stock, such substitution or adjustments shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Stock Options, in the number and purchase price of shares subject to outstanding Stock Purchase Rights and in the number of shares subject to other outstanding awards granted under the Plan as may be determined to be appropriately by the Board, in its sole discretion; provided, however, that the number of shares subject to any award shall always be a whole number. Such adjusted option price shall also be used to determine the amount payable by the Company upon the exercise of any Stock Appreciation Right associated with any Stock Option. SECTION 4. Eligibility. Officers and other key employees of the Company, its subsidiaries and affiliates (but excluding members of the Committee and any person who serves only as a director) who are responsible for or contribute to the management, growth and profitability of the business of the Company, its subsidiaries or affiliates are eligible to be granted awards under the Plan. 4 SECTION 5. Stock Options. Stock Options may be granted alone or in addition to other awards granted under the Plan and may be of two types: Incentive Stock Options and Non-Qualified Stock Options. Any Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve. The Committee shall have the authority to grant any optionee Incentive Stock Options, Non-Qualified Stock Options or both types of Stock Options (in each case with or without Stock Appreciation Rights). Incentive Stock Options may be granted only to employees of the Company and its subsidiaries (within the meaning of Section 425(f) of the Code). To the extent that any Stock Option does not qualify as an Incentive Stock Option, it shall constitute a separate Non-Qualified Stock Option. Stock Options shall be evidenced by option agreements, the terms and provisions of which may differ. An option agreement shall indicate on its face whether it is an agreement for Incentive Stock Options or Non-Qualified Stock Options. The grant of a Stock Option shall occur on the date the Committee by resolution selects an employee as a participant in any grant of Stock Options, determines the number of Stock Options to be granted to such employee and specifies the terms and provisions of the option agreement. The Company shall notify a participant of any grant of Stock Options, and a written option agreement or agreements shall be duly executed and delivered by the Company. Anything in the Plan to the contrary notwithstanding, no term of the Plan relating to Incentive Stock Options shall be interpreted, amended or altered nor shall any discretion or authority granted under the Plan be exercised so as to disqualify the Plan under Section 422A of the Code or, without the consent of the optionee affected, to disqualify any Incentive Stock Option under such Section 422A. Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions as the Committee shall deem desirable: (a) Option Price. The option price per share of Stock purchasable under a Stock Option shall be equal to the Fair Market Value of the Stock at time of grant or such higher price as shall be determined by the Committee at grant. (b) Option Term. The term of each Stock Option shall be fixed by the Committee, but no Incentive Stock Option shall be exercisable more than 10 years after the date the Option is granted, and no Non-Qualified Stock Option shall be exercisable more than 10 years and one day after the date the Option is granted. (c) Exercisability. Stock Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee; provided, however, that, except as provided in Sections 5(f), (g), (h) and 11, unless otherwise determined by the 5 Committee, no Stock Option shall be exercisable prior to the first anniversary date of the granting of the Stock Option. If the Committee provides that any Stock Option is exercisable only in installments, the Committee may at any time waive such installment exercise provisions, in whole or in part, based on such factors as the Committee may determine. (d) Method of Exercise. Subject to the provisions of this Section 5, Stock Options may be exercised, in whole or in part, at any time during the option period by giving written notice of exercise to the Company specifying the number of shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price by certified or bank check or such other instrument as the Company may accept. As determined by the Committee, payment in full or in part may also be made in the form of unrestricted Stock already owned by the optionee or, in the case of the exercise of a Non-Qualified Stock Option, Restricted Stock or Deferred Stock subject to an award hereunder (based, in each case, on the Fair Market Value of the Stock on the date the Stock Option is exercised); provided, however, that, in the case of an Incentive Stock Option, the right to make a payment in the form of already owned shares may be authorized only at the time the Stock Option is granted. If payment of the option exercised price of a Non-Qualified Stock Option is made in whole or in part in the form of Restricted Stock or Deferred Stock, such Restricted Stock or Deferred Stock (and any replacement shares relating thereto) shall remain (or be) restricted or deferred, as the case may be, in accordance with the original terms of the Restricted Stock award or Deferred Stock award in question, and any additional Stock received upon the exercise shall be subject to the same forfeiture restrictions or deferral limitations, unless otherwise determined by the Committee. No shares of Stock shall be issued until full payment therefor has been made. Subject to any forfeiture restrictions or deferral limitations that may apply if a Stock Option is exercised using Restricted Stock or Deferred Stock, an optionee shall have all of the rights of a stockholder of the Company, including the right to vote the shares and the right to receive dividends, with respect to shares subject to the Stock Option when the optionee has given written notice of exercise, has paid in full for such shares and, if requested, has given the representation described in Section 14(a). (e) Non-transferability of Options. No Stock Option shall be transferable by the optionee other than by will or by the laws of descent and distribution, and all Stock Options shall be exercisable, during the optionee's lifetime, only by the optionee or by the guardian or legal representative of the optionee, it being understood that the terms "holder" and "optionee" include the guardian and legal representative of the optionee named in the option agreement and any person to whom an option is transferred by will or the laws of descent and distribution. (f) Termination by Death. Subject to Section 5(j), if any optionee's employment terminates by reason of death, any Stock Option held by such optionee may thereafter be exercised, to the extent then exercisable or on such accelerated basis as the Committee may 6 determine, for a period of one year (or such other period as the Committee may specify) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (g) Termination by Reason of Disability. Subject to Section 5(j), if an optionee's employment terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of termination or on such accelerated basis as the Committee may determine, for a period of three years (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that, if the optionee dies within such three-year period (or such shorter period), any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such three-year (or such shorter) period, continue to be exercisable to the extent to which it was exercisable at the time of death for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422A of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. (h) Termination by Reason of Retirement. Subject to Section 5(j), if an optionee's employment terminates by reason of Retirement, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of such Retirement or on such accelerated basis as the Committee may determine, for a period of three years (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that, if the optionee dies within such three-year (or such shorter) period any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such three-year (or such shorter) period, continue to be exercisable to the extent to which it was exercisable at the time of death for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of termination of employment by reason of Retirement, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422A of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. (i) Other Termination. Unless otherwise determined by the Committee, if an optionee's employment terminates for any reason other than death, Disability or Retirement, the Stock Option shall thereupon terminate, except that such Stock Option, to the extent then exercisable, may be exercised for the lesser of three months or the balance of such Stock Option's term if the optionee is involuntarily terminated by the Company, a subsidiary or affiliate without cause. (j) Incentive Stock Option Limitations. To the extent required for "incentive stock option" status under Section 422A of the Code, the aggregate Fair Market Value (determined as of the time of grant) of the Stock with respect to which Incentive Stock Options granted after 7 1986 are exercisable for the first time by the optionee during any calendar year under the Plan and any other stock option plan of any subsidiary or parent corporation (within the meaning of Section 425 of the Code) after 1986 shall not exceed $100,000. The Committee is authorized to provide at grant that, to the extent permitted under Section 422A of the Code, if a participant's employment with the Company and its subsidiaries is terminated by reason of death, Disability or Retirement and the portion of any Incentive Stock Option that is otherwise exercisable during the post-termination period specified under Sections 5(f), (g) or (h), applied without regard to this Section 5(j), is greater than the portion of such option that is exercisable as an "incentive stock option" during such post-termination period under Section 422A, such post-termination period shall automatically be extended (but not beyond the original option term) to the extent necessary to permit the optionee to exercise such Incentive Stock Option (either as an Incentive Stock Option or, if exercised after the expiration periods that apply for the purposes of Section 422A, as a Non-Qualified Stock Option). The Committee is also authorized to provide at grant for a similar extension of the post-termination exercise period in the event of a Change in Control or a Potential Change in Control. Notwithstanding the foregoing, except with respect to Incentive Stock Options granted prior to October 25, 1989, if an optionee's employment terminates at or after a Change in Control (as defined in Section 11(b)), other than by reason of death, Disability or Retirement, any Stock Option held by such optionee shall be exercisable for the lesser of (x) six months and one day, and (y) the balance of such Stock Option's term pursuant to Section 5(b). (k) Cashing Out of Option; Settlement of Spread Value in Deferred or Restricted Stock. On receipt of written notice to exercise, the Committee may elect to cash out all or part of the portion of any Stock Option to be exercised by paying the optionee an amount, in cash or Stock, equal to the excess of the Fair Market Value of the Stock over the option price (the "Spread Value") on the effective date of such cash out. Cash outs relating to options held by the optionees who are actually or potentially subject to Section 16(b) of the Exchange Act shall comply with the "window period" provisions of Rule 16b-3, to the extent applicable, and, in the case of cash outs, of Non-Qualified Stock Options held by such optionees, the Committee may determine Fair Market Value under the pricing rule set forth in Section 6(b)(ii)(B). In addition, if the option agreement so provides at grant or is amended after grant and prior to exercise to so provide (with the optionee's consent), the Committee may require that all or part of the shares to be issued with respect to the Spread Value payable in the event of a cash out of an unexercised Stock Option or the Spread Value portion of an exercised Stock Option take the form of Deferred or Restricted Stock, which shall be valued on the date of exercise on the basis of the Fair Market Value of such Deferred or Restricted Stock, determined without regard to the deferral limitations or forfeiture restrictions involved. 8 Notwithstanding any other provision of this Plan, upon a Change in Control (as defined in Section 11(b)) other than a Change in Control specified in clause (i) of Section 11(b) arising as a result of beneficial ownership (as defined therein) by the Participant of Outstanding Company Common Stock or Outstanding Company Voting Securities (as such terms are defined below), in the case of Stock Options other than (x) Stock Options held by an officer or director of the Company (within the meaning of Section 16 of the Exchange Act) which were granted less than six months prior to the Change in Control and (y) Incentive Stock Options granted prior to October 25, 1989, during the 60-day period from and after a Change in Control (the "Exercise Period"), unless the Committee shall determine otherwise at the time of grant, an optionee shall have the right, in lieu of the payment of the exercise price of the shares of Stock being purchased under the Stock Option and by giving notice to the Company, to elect (within the Exercise Period) to surrender all or part of the Stock Option to the Company and to receive in cash, within 30 days of such notice, an amount equal to the amount by which the "Change in Control Price" (as defined in Section 11(c)) per share of common stock on the date of such election shall exceed the exercise price per share of Stock under the Stock Option multiplied by the number of shares of common stock granted under the Stock Option as to which the right granted under this Section 5(k) shall have been exercised. SECTION 6. Stock Appreciation Rights. (a) Grant and Exercise. Stock Appreciation Rights may be granted in conjunction with all or part of any Stock Option granted under the Plan. In the case of a Non-Qualified Stock Option, such rights may be granted either at or after the time of grant of such Stock Option. In the case of an Incentive Stock Option, such rights may be granted only at the time of grant of such Stock Option. A Stock Appreciation Right or applicable portion thereof granted with respect to a given Stock Option shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option, except that, unless otherwise determined by the Committee at the time of grant, a Stock Appreciation Right granted with respect to less than the full number of shares covered by a related Stock Option shall not be reduced until the number of shares covered by an exercise or termination of the related Stock Option exceeds the number of shares not covered by the Stock Appreciation Right. A Stock Appreciation Right may be exercised by an optionee in accordance with Section 6(b) by surrendering the applicable portion of the related Stock Option in accordance with procedures established by the Committee. Upon such exercise and surrender, the optionee shall be entitled to receive an amount determined in the manner prescribed in Section 6(b). Stock Options which have been so surrendered shall no longer be exercisable to the extent the related Stock Appreciation Rights have been exercised. (b) Terms and Conditions. Stock Appreciation Rights shall be subject to such terms and conditions as shall be determined by the Committee, including the following: 9 (i) Stock Appreciation Rights shall be exercisable only at such time or times and to the extent that the Stock Options to which they relate are exercisable in accordance with the provisions of Section 5 and this Section 6; provided, however, that a Stock Appreciation Right shall not be exercisable during the first six months of its terms by an optionee who is actually or potentially subject to Section 16(b) of the Exchange Act, except that this limitation shall not apply in the event of death or Disability of the optionee prior to the expiration of the six-month period. (ii) Upon the exercise of a Stock Appreciation Right, an optionee shall be entitled to receive an amount in cash, shares of Stock or both equal in value to the excess of the Fair Market Value of one share of Stock over the option price per share specified in the related Stock Option multiplied by the number of shares in respect of which the Stock Appreciation Right shall have been exercised, with the Committee having the right to determine the form of payment. In the case of Stock Appreciation Rights relating to Stock Options held by optionees who are actually or potentially subject to Section 16(b) of the Exchange Act, the Committee: (A) may require that such Stock Appreciation Rights be exercised only in accordance with the applicable "window period" provisions of Rule 16b-3; and (B) in the case of Stock Appreciation Rights relating to Non-Qualified Stock Options, may provide that the amount to be paid upon exercise of such Stock Appreciation Rights during a Rule 16b-3 "window period" shall be based on the highest mean sales price of the Stock on the New York Stock Exchange on any day during such "window period". (iii) Stock Appreciation Rights shall be transferable only when and to the extent that the underlying Stock Option would be transferable under Section 5(e). (iv) Upon the exercise of a Stock Appreciation Right, the Stock Option or part thereof to which such Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 on the number of shares of Stock to be issued under the Plan, but only to the extent of the number of shares issued under the Stock Appreciation Right at the time of exercise based on the value of the Stock Appreciation Right at such time. (v) The Committee may provide, at the time of grant, that a Stock Appreciation Right can be exercised only in the event of a Change in Control or a Potential Change in Control, subject to such terms and conditions as the Committee may specify at grant. (vi) The Committee may also provide that, in the event of a Change in Control or a Potential Change in Control, the amount to be paid upon the exercise of a Stock 10 Appreciation Right shall be based on the Change in Control Price, subject to such terms and conditions as the Committee may specify at grant. SECTION 7. Restricted Stock. (a) Administration. Shares of Restricted Stock may be issued either alone or in addition to other awards granted under the Plan. The Committee shall determine the officers and key employees to whom and the time or times at which grants of Restricted Stock will be made, the number of shares to be awarded, the time or times within which such awards may be subject to forfeiture and any other terms and conditions of the awards, in addition to those contained in Section 7(c). The Committee may condition the grant of Restricted Stock upon the attainment of specified performance goals or such other factors or criteria as the Committee shall determine. The provisions of Restricted Stock awards need not be the same with respect to each recipient. (b) Awards and Certificates. Each participant receiving a Restricted Stock award shall be issued a certificate in respect of such shares of Restricted Stock. Such certificate shall be registered in the name of such participant and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such award, substantially in the following form: "The transferability of this certificate and the shares of stock represented hereby are subject to the terms and conditions (including forfeiture) of The Philip Morris 1987 Long Term Incentive Plan and a Restricted Stock Agreement. Copies of such Plan and Agreement are on file at the offices of Philip Morris Companies Inc., 120 Park Avenue, New York, New York 10017." The Committee may require that the certificates evidencing such shares be held in custody by the Company until the restrictions thereon shall have lapsed and that, as a condition of any Restricted Stock award, the participant shall have delivered a stock power, endorsed in blank, relating to the Stock covered by such award. (c) Terms and Conditions. Shares of Restricted Stock shall be subject to the following terms and conditions: (i) Subject to the provisions of the Plan and the Restricted Stock Agreement referred to in Section 7(c)(vi), during a period set by the Committee, commencing with the date of such award (the "Restriction Period"), the participant shall not be permitted to sell, assign, transfer, pledge or otherwise encumber shares of Restricted Stock. Within these limits, the Committee may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions, in whole or in part, based on service, performance and such other factors or criteria as the Committee may determine. 11 (ii) Except as provided in this paragraph (ii) and Section 7(c)(i), the participant shall have, with respect to the shares of Restricted Stock, all of the rights of a stockholder of the Company, including the right to vote the shares and the right to receive any cash dividends. Unless otherwise determined by the Committee, cash dividends shall be automatically deferred and reinvested in additional Restricted Stock and dividends payable in Stock shall be paid in the form of Restricted Stock. (iii) Except to the extent otherwise provided in the applicable Restricted Stock Agreement and Sections 7(c)(i) and (iv), upon termination of a participant's employment for any reason during the Restriction Period, all shares still subject to restriction shall be forfeited by the participant. (iv) In the event of hardship or other special circumstances of a participant whose employment is involuntarily terminated (other than for cause), the Committee may waive in whole or in part any or all remaining restrictions with respect to such participant's shares of Restricted Stock. (v) If and when the Restriction Period expires without a prior forfeiture of the Restricted Stock subject to such Restriction Period, unlegended certificates for such shares shall be delivered to the participant. (vi) Each award shall be confirmed by, and be subject to the terms of, a Restricted Stock Agreement. SECTION 8. Deferred Stock. (a) Administration. Deferred Stock may be awarded either alone or in addition to other awards granted under the Plan. The Committee shall determine the officers and key employees to whom and the time or times at which Deferred Stock shall be awarded, the number of shares of Deferred Stock to be awarded to any participant, the duration of the period (the "Deferral Period") during which, and the conditions under which, receipt of the Stock will be deferred and any other terms and conditions of the award, in addition to those contained in Section 8(b). The Committee may condition the grant of Deferred Stock upon the attainment of specified performance goals or such other factors or criteria as the Committee shall determine. The provisions of Deferred Stock awards need not be the same with respect to each recipient. (b) Terms and Conditions. Deferred Stock awards shall be subject to the following terms and conditions: (i) Subject to the provisions of the Plan and the Deferred Stock Agreement referred to in Section 8(b)(vii), Deferred Stock awards may not be sold, assigned, transferred, pledged or otherwise encumbered during the Deferral Period. At the 12 expiration of the Deferral Period (or Elective Deferral Period as defined in Section 8(b)(vi), where applicable), share certificates shall be delivered to the participant for the shares covered by the Deferred Stock award. (ii) Unless otherwise determined by the Committee, amounts equal to any dividends declared during the Deferral Period with respect to the number of shares covered by a Deferred Stock award will be awarded, automatically deferred and deemed to be reinvested in additional Deferred Stock. (iii) Except to the extent otherwise provided in the applicable Deferred Stock Agreement and Sections 8(b)(iv) and (v), upon termination of a participant's employment for any reason during the Deferral Period, the rights to the shares still covered by the Deferred Stock award shall be forfeited. (iv) Based on service, performance and such other factors or criteria as the Committee may determine, the Committee may provide for the lapse of deferral limitations in installments and may accelerate the vesting of all or any part of any Deferred Stock award and waive the deferral limitations for all or any part of such award. (v) In the event of hardship or other special circumstances of a participant whose employment is involuntarily terminated (other than for cause), the Committee may waive in whole or in part any or all remaining deferral limitations with respect to any or all of such participant's Deferred Stock. (vi) A participant may elect to further defer receipt of the Deferred Stock payable under an award (or an installment of an award) for a specified period or until a specified event (the "Elective Deferral Period"), subject in each case to the Committee's approval and to such terms as are determined by the Committee. Subject to any exceptions adopted by the Committee, such election must generally be made at least 12 months prior to completion of the Deferral Period for the award (or for such installment of an award). (vii) Each award shall be confirmed by, and be subject to the terms of, a Deferred Stock Agreement. SECTION 9. Stock Purchase Rights. (a) Awards and Administration. The Committee may grant Stock Purchase Rights which shall enable the recipients to purchase Stock: (i) at its Fair Market Value on the date of grant; (ii) at 50% of such Fair Market Value on such date; or 13 (iii) at an amount equal to the par value of such Stock on such date. The Committee may impose such terms and conditions as it shall determine on such Stock Purchase Rights or the exercise thereof and may also provide for deferral limitations or forfeiture restrictions with respect to the Stock purchased. Each Stock Purchase Right award shall be confirmed by, and be subject to the terms of, a Stock Purchase Rights Agreement. The terms of such awards need not be the same with respect to each participant. (b) Stock Exercisability. Stock Purchase Rights shall be exercisable for such period after grant as is determined by the Committee, not to exceed 30 days. However, the Committee may provide that Stock Purchase Rights granted to persons who are actually or potentially subject to Section 16(b) of the Exchange Act shall not become exercisable until six months and one day after the grant date and shall then be exercisable for 10 trading days at the purchase price specified by the Committee in accordance with Section 9(a). (c) Loans. If the Committee so determines, the Company shall make or arrange for a loan to an employee with respect to the exercise of Stock Purchase Rights. The Committee shall have full authority to decide whether such a loan should be made and to determine the amount, term and other provisions of any such loan, including the interest rate to be charged, whether the loan is to be with or without recourse against the borrower, the security, if any, therefor, the terms on which the loan is to be repaid and the conditions, if any, under which it may be forgiven. However, no loan hereunder shall have a term (including extensions) exceeding 10 years in duration or be in an amount exceeding 90% of the total purchase price paid by the borrower. SECTION 10. Long Term Performance Awards. (a) Awards and Administration. Long Term Performance Awards may be awarded either alone or in addition to other awards granted under the Plan. The Committee shall determine the nature, length and starting date of the performance period (the "Performance Period") for each Long Term Performance Award, which shall be at least two years (subject to Section 11), and shall determine the performance objectives to be used in valuing Long Term Performance Awards and determining the extent to which such Long Term Performance Awards have been earned. Performance objectives may vary from participant to participant and between groups of participants and shall be based upon such Company, business unit or individual performance factors or criteria as the Committee may deem appropriate, including, but not limited to, earnings per share or return on equity. Performance Periods may overlap and participants may participate simultaneously with respect to Long Term Performance Awards that are subject to different Performance Periods and different performance factors and criteria. Long Term Performance Awards shall be confirmed by, and be subject to the terms of, a Long Term Performance Award Agreement. The terms of such awards need not be the same with respect to each participant. 14 At the beginning of each Performance Period, the Committee shall determine for each Long Term Performance Award subject to such Performance Period the range of dollar values or number of shares of Stock (including Deferred or Restricted Stock) to be awarded to the participant at the end of the Performance Period if and to the extent that the relevant measures of performance for such Long Term Performance Award are met. Such dollar values or number of shares of Stock may be fixed or may vary in accordance with such performance or other criteria as may be determined by the Committee. (b) Maximum Aggregate Amount Payable for Any Performance Period. The aggregate amount of Long Term Performance Awards payable in cash with respect to any Performance Period (determined without regard to any interest or earnings equivalent credited with respect to deferred Awards) cannot exceed the maximum aggregate amount that could have been credited to the Reserve under the Philip Morris Companies Inc. Incentive Compensation Plan during the period commencing January 1, 1986 and ending on the last day of such Performance Period (the "Calculation Period") less the sum of the amount payable out of such Reserve with respect to the Calculation Period and the amount of Long Term Performance Awards paid in cash with respect to any prior Performance Period. (c) Adjustment of Awards. The Committee may adjust the performance goals and measurements applicable to Long Term Performance Awards to take into account changes in law and accounting and tax rules and to make such adjustments as the Committee deems necessary or appropriate to reflect the inclusion or exclusion of the impact of extraordinary or unusual items, events or circumstances in order to avoid windfalls or hardships. (d) Termination of Employment. Subject to Section 11 and unless otherwise provided in the applicable Long Term Performance Award Agreement, if a participant terminates employment during a Performance Period because of death, Disability or Retirement, such participant shall be entitled to a payment with respect to each outstanding Long Term Performance Award at the end of the applicable Performance Period: (i) based, to the extent relevant under the terms of the award, upon the participant's performance for the portion of such Performance Period ending on the date of termination and the performance of the Company or any applicable business unit for the entire Performance Period and (ii) prorated for the portion of the Performance Period during which the participant was employed by the Company, a subsidiary or affiliate, all as determined by the Committee. The Committee may provide for an earlier payment in settlement of such award in such amount and under such terms and conditions as the Committee deems appropriate. Subject to Section 11 and except as otherwise provided in the applicable Long Term Performance Award Agreement, if a participant terminates employment during a Performance 15 Period for any other reason, then such participant shall not be entitled to any payment with respect to the Long Term Performance Awards subject to such Performance Period, unless the Committee shall otherwise determine. (e) Form of Payment. The earned portion of a Long Term Performance Award may be paid currently or on a deferred basis with such interest or earnings equivalent as may be determined by the Committee. Payment shall be made in the form of cash or whole shares of Stock, including Restricted Stock or Deferred Stock, or a combination thereof, either in a lump sum payment or in annual installments, all as the Committee shall determine. If and to the extent a Long Term Performance Award is payable in Stock and the full amount thereof is not paid in Stock, then the shares of Stock representing the portion of the value of the Long Term Performance Award not paid in Stock shall again become available for award under the Plan. SECTION 11. Change in Control Provisions. (a) Impact of Event. Notwithstanding any other provision of the Plan to the contrary, in the event of a Change in Control (as defined in Section 11(b)): (i) Any Stock Appreciation Rights and Stock Options outstanding as of the date such Change in Control is determined to have occurred and not then exercisable and vested shall become fully exercisable and vested to the full extent of the original grant; provided, however, that, in the case of the holder of Stock Appreciation Rights who is actually subject to Section 16(b) of the Exchange Act, such Stock Appreciation Rights shall have been outstanding for at least six months at the date such Change in Control is determined to have occurred. (ii) The restrictions and deferral limitations applicable to any Restricted Stock, Deferred Stock and Stock Purchase Rights shall lapse, and such Restricted Stock and Deferred Stock shall become free of all restrictions and fully vested to the full extent of the original grant. (iii) Subject to the rights of participants pursuant to Section 5(k), the value of all outstanding Stock Options, Restricted Stock, Deferred Stock and Stock Purchase Rights shall, unless otherwise determined by the Committee at or after grant, be cashed out on the basis of the "Change in Control Price", as defined in Section 11(c), as of the date such Change of Control is determined to have occurred or such other date as the Committee may determine prior to the Change in Control. (iv) Any Long Term Performance Awards relating to Performance Periods prior to the Performance Period in which the Change in Control occurs which are outstanding but not vested shall become immediately vested and payable in cash to participants. In addition, subject to the provisions of Section 10(b) of the Plan, with respect to the Performance Period in which the Change in Control occurs (the "Change in Control Period"), each participant in the Long Term Performance Award Plan, other than a 16 participant who is a party to an employment agreement with the Company which is effective upon the Change in Control, shall be entitled to a pro rata Long Term Performance Award in cash equal to the product of (x) such participant's maximum award opportunity for the Change in Control Period, and (y) a fraction, the numerator of which is the number of full or partial months which have elapsed since the beginning of such Period on the date on which the Change in Control occurs, and the denominator of which is the total number of months in such Period. (b) Definition of Change in Control. For purposes of the Plan, a "Change in Control" shall mean the happening of any of the following events: (i) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (A) the then outstanding shares of Stock of the Company (the "Outstanding Company Common Stock") or (B) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that the following acquisitions shall not constitute a Change in Control: (A) any acquisition directly from the Company, (B) any acquisition by the Company, (C) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (D) any acquisition by any corporation pursuant to a transaction described in clauses (A), (B) and (C) of paragraph (iii) of this subsection (b) of this Section 11; or (ii) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (iii) Approval by the shareholders of the Company of a reorganization, merger, share exchange or consolidation (a "Business Combination"), in each case, unless, following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 80% of, respectively, the then outstanding shares of common stock and the combined voting 17 power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (iv) Approval by the shareholders of the Company of (A) a complete liquidation or dissolution of the Company or (B) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation, with respect to which following such sale or other disposition, (1) more than 80% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (2) less than 20% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by any Person (excluding any employee benefit plan (or related trust) of the Company or such corporation), except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities prior to the sale or disposition and (3) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such sale or other disposition of assets of the Company or were elected, appointed or nominated by the Board. (c) Change in Control Price. For purposes of the Plan, "Change in Control Price" means the highest price per share paid in any transaction reported on the New York Stock Exchange Composite Index or paid or offered in any bona fide transaction related to a potential 18 or actual change in control of the Company at any time during the preceding 60-day period as determined by the Committee, except that, in the case of Incentive Stock Options and Stock Appreciation Rights relating to Incentive Stock Options, such price shall be based only on transactions reported for the date on which the Committee decides to cash out such options. SECTION 12. Amendments and Termination. The Board may amend, alter, or discontinue the Plan, but no amendment, alteration or discontinuation shall be made which would impair the rights of an optionee under a Stock Option or a recipient of a Stock Appreciation Right, Restricted Stock Award, Deferred Stock Award, Stock Purchase Right or Long Term Performance Award theretofore granted without the optionee's or recipient's consent or which, without the approval of the Company's stockholders, would: (a) except as expressly provided in the Plan, increase the total number of shares reserved for the purpose of the Plan; (b) except as expressly provided in the Plan, decrease the option price of (i) any Stock Option to less than the Fair Market Value on the date of grant or (ii) change the minimum price terms of Section 9(a); (c) change the class of employees eligible to participate in the Plan; or (d) extend the maximum option period under Section 5(b) or the maximum exercise period under Section 9(b). The Committee may amend the terms of any Stock Option or other award theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any holder without the holder's consent. The Committee may also substitute new Stock Options for previously granted Stock Options, including previously granted Stock Options having higher option prices. Subject to the above provisions, the Board shall have the authority to amend the Plan to take into account changes in law and tax and accounting rules, as well as other developments. SECTION 13. Unfunded Status of Plan. It is presently intended that the Plan constitute an "unfunded" plan for incentive and deferred compensation. The Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or make payments; provided, however, that, unless the Committee otherwise determines, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. 19 SECTION 14. General Provisions. (a) The Committee may require each person purchasing shares pursuant to a Stock Option or a Stock Purchase Right to represent to and agree with the Company in writing that the optionee or participant is acquiring the shares without a view to the distribution thereof. The certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer. All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Stock is then listed and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (b) Nothing contained in this Plan shall prevent the Company, a subsidiary or affiliate from adopting other or additional compensation arrangements for its employees. (c) The adoption of the Plan shall not confer upon any employee any right to continued employment nor shall it interfere in any way with the right of the Company, a subsidiary or affiliate to terminate the employment of any employee at any time. (d) No later than the date as of which an amount first becomes includible in the gross income of the participant for Federal income tax purposes with respect to any award under the Plan, the participant shall pay to the Company, or make arrangements satisfactory to the Company regarding the payment of, any Federal, state, local or foreign taxes of any kind required by law to be withheld with respect to such amount. Unless otherwise determined by the Company, withholding obligations may be settled with Stock, including Stock that is part of the award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements, and the Company, its subsidiaries and affiliates shall, to the extent permitted by law, have the right to deduct any such taxes from any payment otherwise due to the participant. (e) At the time of grant, the Committee may provide in connection with any grant made under this Plan that the shares of Stock received as a result of such grant shall be subject to a right of first refusal pursuant to which the participant shall be required to offer to the Company any shares that the participant wishes to sell at the then Fair Market Value of the Stock, subject to such other terms and conditions as the Committee may specify at the time of grant. (f) The reinvestment of dividends in additional Deferred or Restricted Stock at the time of any dividend payment shall only be permissible if sufficient shares of Stock are available under Section 3 for such reinvestment (taking into account then outstanding Stock Options, Stock Purchase Rights and other Plan awards). 20 (g) The Committee shall establish such procedures as it deems appropriate for a participant to designate a beneficiary to whom any amounts payable in the event of the participant's death are to be paid. (h) The Plan and all awards made and actions taken thereunder shall be governed by and construed in accordance with the laws of the State of New York. SECTION 15. Effective Date of Plan. The Plan shall be effective on the date it is approved by the stockholders of the Company. SECTION 16. Term of Plan. No Stock Option, Stock Appreciation Right, Restricted Stock Award, Deferred Stock Award, Stock Purchase Right or Long Term Performance Award shall be granted on or after the fifth anniversary of the effective date of the Plan, but awards granted prior to such fifth anniversary (including, without limitation, Long Term Performance Awards for Performance Periods commencing prior to such fifth anniversary) may extend beyond that date. 21 EX-10.15 8 LONG TERM DISABILITY EQUAL PLAN EXHIBIT 10.15 PHILIP MORRIS LONG-TERM DISABILITY BENEFIT EQUALIZATION PLAN Effective January 1, 1989 (As amended and in effect as of January 1, 1996) TABLE OF CONTENTS Page No. -------- PHILIP MORRIS LONG-TERM DISABILITY BENEFIT EQUALIZATION PLAN - Preamble..................................... 1 ARTICLE I........................................................ 2 DEFINITIONS................................................. 2 (a) Committee......................................... 2 (b) Compensation Limitation........................... 2 (c) Disability Benefit Equalization Allowance or Allowance......................................... 2 (d) Long-Term Disability Plan......................... 2 (e) Plan.............................................. 2 (f) Retirement Allowance.............................. 2 ARTICLE II....................................................... 3 DISABILITY BENEFIT EQUALIZATION ALLOWANCES.................. 3 A. Disability Benefit Equalization Allowances payable under this Plan........................... 3 B. Commencement and termination of Disability Benefit Equalization Allowances................... 3 ARTICLE III...................................................... 4 FUNDS FROM WHICH ALLOWANCES ARE PAYABLE..................... 4 ARTICLE IV....................................................... 5 THE CORPORATE EMPLOYEE BENEFIT COMMITTEE AND ITS DELEGATEES............................................. 5 ARTICLE V........................................................ 6 AMENDMENT AND DISCONTINUANCE OF THE PLAN.................... 6 ARTICLE VI....................................................... 7 CHANGE IN CONTROL PROVISIONS................................ 7 A. In the event of a Change of Control............... 7 B. Definition of Change of Control................... 7 PHILIP MORRIS LONG-TERM DISABILITY BENEFIT EQUALIZATION PLAN The Philip Morris Long-Term Disability Benefit Equalization Plan as hereinafter set forth shall govern the rights of an Employee or Disabled Employee who is eligible for benefits on or after January 1, 1996 under the Long-Term Disability Plan and whose benefits under the Long-Term Disability Plan are or will in the future be limited by reason of Section 505 of the Internal Revenue Code of 1986, as amended from time to time. 1 ARTICLE I DEFINITIONS The following terms as used herein shall have the meanings set forth below. All capitalized terms not defined below shall have the same meaning as in the Long-Term Disability Plan. (a) "Committee" shall mean the Corporate Employee Benefit Committee of Philip Morris Companies Inc. charged with the administration of the Plan as from time to time constituted. (b) "Compensation Limitation" shall mean the limitation of Section 505(b)(7) of the Code on the annual compensation of an Employee which may be taken into account under the Long-Term Disability Plan. (c) "Disability Benefit Equalization Allowance" or "Allowance" shall mean the amount payable under the Plan to a former Employee in equal monthly payments during a twelve (12) month period. (d) "Long-Term Disability Plan" shall mean the Philip Morris Long-Term Disability Plan, effective February 1, 1974, as amended from time to time. (e) "Plan" shall mean the Philip Morris Long-Term Disability Benefit Equalization Plan described herein and in any amendments hereto. (f) "Retirement Allowance" shall mean the total amount payable under the Retirement Plan and Benefit Equalization Plan during a twelve (12) month period to a former Employee for life. Any benefit payable to the Employee in any other form shall be converted to a Retirement Allowance in such manner as the Administrator deems fair and equitable. 2 ARTICLE II DISABILITY BENEFIT EQUALIZATION ALLOWANCES A. Disability Benefit Equalization Allowances payable under this Plan shall be as follows: (1) The Disability Benefit Equalization Allowance payable to a Disabled Employee who is eligible for a Disability Allowance under Article II, A(1)(b) or A(1)(c)(i) of the Long-Term Disability Plan shall equal the amount by which a Disability Allowance under such provisions of the Long-Term Disability Plan, if computed without regard to the Compensation Limitation, exceeds the amount of the Disability Allowance actually payable to the Disabled Employee under the Long-Term Disability Plan. (2) The Disability Benefit Equalization Allowance payable to a Disabled Employee who is eligible for a Disability Allowance under any other provision of the Long-Term Disability Plan shall be computed in the same manner as under the applicable provision of the Long-Term Disability Plan, provided, however, that (a) in computing such Disability Benefit Equalization Allowance under Article II, A(1)(c)(ii) of the Long-Term Disability Plan, the Retirement Allowance referred to in said Article II, A(1)(c)(ii) shall be computed without regard to the Compensation Limitation with respect to the compensation (as such term is defined in the Retirement Plan) of the Disabled Employee, (b) in computing such Disability Benefit Equalization Allowance under Article II, A(2)(c)(i) or (ii) of the Long-Term Disability Plan, the Retirement Allowance referred to in said Article II, A(2)(c)(i) and (ii) such Disabled Employee would have received shall be computed based on the assumptions set forth in said Article II, A(2)(c)(i) or (ii), but without regard to the Compensation Limitation and (c) the Disabled Employee's Pension Offset computed under Article I(v)(i)(A) and I(v)(ii)(A) of the Long-Term Disability Plan shall only be determined with respect to any Retirement Allowance payable under the Benefit Equalization Plan. The amount of the Disability Benefit Equalization Allowance shall be reduced by the amount of the Disability Allowance actually payable to the Disabled Employee under the Long-Term Disability Plan. B. Commencement and termination of Disability Benefit Equalization Allowances: A Disability Benefit Equalization Allowance payable to a Disabled Employee shall commence and terminate simultaneously with, and be paid in accordance with the terms of the Long-Term Disability Plan. An application for a Disability Allowance under the Long-Term Disability Plan shall be deemed an application for payment of a Disability Benefit Equalization Allowance under this Plan. 3 ARTICLE III FUNDS FROM WHICH ALLOWANCES ARE PAYABLE The Company's obligations under this Plan shall not be funded. Payments of Allowances shall be made out of the general funds of the Company. 4 ARTICLE IV THE CORPORATE EMPLOYEE BENEFIT COMMITTEE AND ITS DELEGATEES The general administration of the Plan shall be vested in the Committee and the Administrator. All powers, rights, duties and responsibilities assigned to the Committee and the Administrator under the Long-Term Disability Plan applicable to this Plan shall be the powers, rights, duties and responsibilities of the Committee and the Administrator under the terms of this Plan. 5 ARTICLE V AMENDMENT AND DISCONTINUANCE OF THE PLAN The Board may, by resolution, from time to time, and at any time, amend the Plan; provided, however, that authority to amend the Plan is delegated to the following committees or individuals where approval of the Plan amendment or amendments by the shareholders of Philip Morris Companies Inc. is not required: (1) to the Committee, if the amendment (or amendments) will not increase the annual cost of the Plan by $10,000,000, (2) to a management committee for employee benefits, if the amendment (or amendments) will not increase the annual cost of the Plan by $4,000,000, and (3) to the Administrator, if the amendment (or amendments) will not increase the annual cost of the Plan by $500,000. Any amendment to the Plan may effect a substantial change in the Plan, and may include (but shall not be limited to) any change deemed by the Philip Morris Companies Inc. to be necessary or desirable to obtain tax benefits under any existing or future laws or rules or regulations thereunder; provided, however, that no such amendment shall deprive any Disabled Employee of the Disability Benefit Equalization Allowance accrued to the time of such amendment. The Plan may be discontinued at any time by the Board; provided, however, that such discontinuance shall not deprive any Disabled Employee of his Disability Benefit Equalization Allowance accrued to the time of such discontinuance. 6 ARTICLE VI CHANGE IN CONTROL PROVISIONS A. In the event of a Change of Control, each Disabled Employee (including, for purposes of this Article VI, an Employee who incurs a disability prior to the Change in Control during the periods specified in Article II, A(1)(a) of the Long-Term Disability Plan, irrespective of his eligibility at the time of the Change in Control for disability benefits under the Social Security Act; provided, however, such Disabled Employee subsequently becomes eligible for disability benefits under the Social Security Act or becomes eligible for a Disability Allowance pursuant to Article II, A(1)(i) of the Long-Term Disability Plan, shall, upon the Change of Control, be entitled to a lump sum in cash, payable within 30 days of the Change of Control, equal to the actuarial equivalent of his Disability Benefit Equalization Allowance, determined using actuarial assumptions no less favorable than those used under the Philip Morris Salaried Employees' Retirement Plan immediately prior to the Change of Control. B. Definition of Change of Control "Change of Control" shall mean the happening of any of the following events: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, and amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of Philip Morris Companies Inc. (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of Philip Morris Companies Inc. entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from Philip Morris Companies Inc., (ii) any acquisition by Philip Morris Companies Inc., (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by Philip Morris Companies Inc. or any corporation controlled by Philip Morris Companies Inc. or (iv) any acquisition by any corporation pursuant to a transaction described in clauses (i), (ii) and (iii) of paragraph (3) of this Section B; or (2) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the shareholders of Philip Morris Companies Inc., was approved by a vote of at least a majority of the 7 directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Approval by the shareholders of Philip Morris Companies Inc. of a reorganization, merger, share exchange or consolidation (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 80% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns Philip Morris Companies Inc. through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of Philip Morris Companies Inc. or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of Philip Morris Companies Inc. of (i) a complete liquidation or dissolution of Philip Morris Companies Inc. or (ii) the sale or other disposition of all or substantially all of the assets of Philip Morris Companies Inc., other than to a corporation, with respect to which following such sale or other disposition, (A) more than 80% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially 8 the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) less than 20% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by any Person (excluding any employee benefit plan (or related trust) of Philip Morris Companies Inc. or such corporation), except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities prior to the sale or disposition and (C) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such sale or other disposition of assets of Philip Morris Companies Inc. or were elected, appointed or nominated by the Board. 9 EX-10.16 9 SURVIVOR INCOME BENEFIT EQUAL PLAN EXHIBIT 10.16 PHILIP MORRIS SURVIVOR INCOME BENEFIT EQUALIZATION PLAN Effective January 1, 1985 (As amended and in effect as of April 1, 1992) TABLE OF CONTENTS Page No. -------- PHILIP MORRIS SURVIVOR INCOME BENEFIT EQUALIZATION PLAN - Preamble......................................... 1 ARTICLE I............................................................ 2 DEFINITIONS...................................................... 2 (a) Committee.............................................. 2 (b) Compensation Limitation................................ 2 (c) Plan................................................... 2 (d) Survivor Income Benefit Equalization Allowance or Allowance.............................................. 2 (e) Survivor Income Benefit Plan........................... 2 ARTICLE II........................................................... 3 SURVIVOR INCOME BENEFIT EQUALIZATION ALLOWANCES.................. 3 A. Survivor Income Benefit Equalization Allowances and other benefits payable under this Plan................. 3 B. Commencement and termination of Survivor Income Benefit Equalization Allowances and other benefits under the Plan......................................... 3 C. Reduction of Survivor Income Benefit Equalization Retirement Allowances.................................. 3 ARTICLE III.......................................................... 5 FUNDS FROM WHICH ALLOWANCES ARE PAYABLE.......................... 5 ARTICLE IV........................................................... 6 THE COMMITTEE AND ITS DELEGATEES................................. 6 ARTICLE V............................................................ 7 AMENDMENT AND DISCONTINUANCE OF THE PLAN......................... 7 ARTICLE VI........................................................... 8 CHANGE IN CONTROL PROVISIONS..................................... 8 PHILIP MORRIS SURVIVOR INCOME BENEFIT EQUALIZATION PLAN The Philip Morris Survivor Income Benefit Equalization Plan as hereinafter set forth shall govern the rights of a Plan Beneficiary of a Deceased, Disabled or Retired Employee whose Plan Beneficiary becomes eligible for a Survivor Income Benefit Allowance on or after April 1, 1992 and whose benefits under the Philip Morris Survivor Income Benefit Plan are or will in the future be limited by reason of Section 505 of the Internal Revenue Code of 1986, as amended from time to time. 1 ARTICLE I DEFINITIONS The following terms as used herein shall have the meanings set forth below. All capitalized terms not defined below shall have the same meaning as in the Survivor Income Benefit Plan. (a) "Committee" shall mean the Corporate Employee Benefit Committee of Philip Morris Companies Inc. charged with the administration of the Plan as from time to time constituted. (b) "Compensation Limitation" shall mean the limitation of Section 505(b)(7) of the Code on the annual compensation of a Deceased, Disabled or Retired Employee which may be taken into account under the Survivor Income Benefit Plan. (c) "Plan" shall mean the Philip Morris Survivor Income Benefit Equalization Plan described herein and in any amendments hereto. (d) "Survivor Income Benefit Equalization Allowance" or "Allowance" shall mean the amount payable under the Plan to a Plan Beneficiary in equal monthly payments during a twelve (12) month period. (e) "Survivor Income Benefit Plan" shall mean the Philip Morris Survivor Income Benefit Plan, effective February 1, 1974, as amended from time to time. 2 ARTICLE II SURVIVOR INCOME BENEFIT EQUALIZATION ALLOWANCES A. Survivor Income Benefit Equalization Allowances and other benefits payable under this Plan shall be as follows: (1) The Survivor Income Benefit Equalization Allowance payable to a Plan Beneficiary who is eligible for a Survivor Income Benefit Allowance under Article II, A(1)(b) or Article II, B(3) or (4) of the Survivor Income Benefit Plan, or a benefit payable pursuant to Article II, C of the Survivor Income Benefit Plan shall equal the amount by which a Survivor Income Benefit Allowance or benefit payable under Article II,C of the Survivor Income Benefit Plan, as applicable to the Plan Beneficiary, if computed without regard to the Compensation Limitation, exceeds the amount of the Survivor Income Benefit Allowance or benefit under Article II, C of the Survivor Income Benefit Plan actually payable to the Plan Beneficiary under the Survivor Income Benefit Plan. (2) The Survivor Income Benefit Equalization Allowance payable to a Plan Beneficiary who is eligible for a Survivor Income Benefit Allowance under Article II, A(2)(b), Article II, A(3)(b) and Article II, A(4)(b) of the Survivor Income Benefit Plan shall equal the amount by which a Survivor Income Benefit Allowance payable pursuant to said provisions of Article II, as applicable to the Plan Beneficiary, if computed without regard to the Compensation Limitation, exceeds the amount of the Survivor Income Benefit Allowance actually payable to the Plan Beneficiary under the Survivor Income Benefit Plan. B. Commencement and termination of Survivor Income Benefit Equalization Allowances and other benefits under the Plan: A Survivor Income Benefit Equalization Allowance or other benefit payable to a Plan Beneficiary shall commence and terminate simultaneously with, and be paid in accordance with the terms of the Survivor Income Benefit Plan. An application for a Survivor Income Benefit Allowance under the Survivor Income Benefit Plan shall be deemed an application for payment of a Survivor Income Benefit Equalization Allowance under this Plan. C. Reduction of Survivor Income Benefit Equalization Retirement Allowances: (1) A Survivor Income Benefit Equalization Allowance shall be reduced in accordance with the terms of Article II, F(1)(a) and (b) of the Survivor Income Benefit Plan, but only to the extent that the reduction is not taken into account in determining the Survivor Income Benefit Allowance payable under the Survivor Income Benefit Plan. 3 (2) No Survivor Income Benefit Equalization Allowance shall be payable to a Plan Beneficiary to the extent attributable to benefits under the Benefit Equalization Plan which are paid to the Deceased, Disabled or Retired Employee other than in the form of a benefit equalization retirement allowance (as defined in the Philip Morris Benefit Equalization Plan. 4 ARTICLE III FUNDS FROM WHICH ALLOWANCES ARE PAYABLE The Company's obligations under this Plan shall not be funded. Payments of Allowances shall be made out of the general funds of the Company. 5 ARTICLE IV THE COMMITTEE AND ITS DELEGATEES The general administration of the Plan shall be vested in the Committee and the Administrator. All powers, rights, duties and responsibilities assigned to the Committee and the Administrator under the Survivor Income Benefit Plan applicable to this Plan shall be the powers, rights, duties and responsibilities of the Committee and the Administrator under the terms of this Plan. 6 ARTICLE V AMENDMENT AND DISCONTINUANCE OF THE PLAN The Board may, by resolution, from time to time, and at any time, amend the Plan; provided, however, that authority to amend the Plan is delegated to the following committees or individuals where approval of the Plan amendment or amendments by the shareholders of Philip Morris Companies Inc. is not required: (1) to the Committee, if the amendment (or amendments) will not increase the annual costs of the Plan by $10,000,000, (2) to the Management Committee, if the amendment (or amendments) will not increase the annual cost of the Plan by $4,000,000, and (3) to the Administrator, if the amendment (or amendments) will not increase the annual cost of the Plan by $500,000. Any amendment to the Plan may effect a substantial change in the Plan, and may include (but shall not be limited to) any change deemed by the Philip Morris Companies Inc. to be necessary or desirable to obtain tax benefits under any existing or future laws or rules or regulations thereunder; provided, however, that no such amendment shall deprive any Plan Beneficiary of the Survivor Income Benefit Equalization Allowance or other benefit accrued to the time of such amendment. The Plan may be discontinued at any time by the Board; provided, however, that such discontinuance shall not deprive any Plan Beneficiary of his Survivor Income Benefit Equalization Allowance or other benefit accrued to the time of such discontinuance. 7 ARTICLE VI CHANGE IN CONTROL PROVISIONS A. In the event of a Change of Control, each Plan Beneficiary shall, upon the Change of Control, be entitled to a lump sum in cash, payable within 30 days of the Change of Control, equal to the actuarial equivalent of his Survivor Income Benefit Equalization Allowance, determined using actuarial assumptions no less favorable than those used under the Philip Morris Salaried Employees' Retirement Plan immediately prior to the Change of Control. B. Definition of Change of Control. "Change of Control" shall mean the happening of any of the following events: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, and amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of Philip Morris Companies Inc. (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of Philip Morris Companies Inc. entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from Philip Morris Companies Inc., (ii) any acquisition by Philip Morris Companies Inc., (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by Philip Morris Companies Inc. or any corporation controlled by Philip Morris Companies Inc. or (iv) any acquisition by any corporation pursuant to a transaction described in clauses (i), (ii) and (iii) of paragraph (3) of this Section B; or (2) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the shareholders of Philip Morris Companies Inc., was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or 8 (3) Approval by the shareholders of Philip Morris Companies Inc. of a reorganization, merger, share exchange or consolidation (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 80% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns Philip Morris Companies Inc. through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of Philip Morris Companies Inc. or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the business Combination and (iii) at least a majority of the members of board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of Philip Morris Companies Inc. of (i) a complete liquidation or dissolution of Philip Morris Companies Inc. or (ii) the sale or other disposition of all or substantially all of the assets of Philip Morris Companies Inc., other than to a corporation, with respect to which following such sale or other disposition, (A) more than 80% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who where the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) less than 20% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote 9 generally in the election of directors is then beneficially owned, directly or indirectly, by any Person (excluding any employee benefit plan (or related trust) of Philip Morris Companies Inc. or such corporation), except to the extent that such Person owned 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities prior to the sale or disposition and (C) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such sale or other disposition of assets of Philip Morris Companies Inc. or were elected, appointed or nominated by the Board. 10 EX-10.18 10 COMP. SETTLEMENT DATED 10/17/97 MISS Exhibit 10.18 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 ) ) COMPREHENSIVE SETTLEMENT AGREEMENT AND RELEASE THIS COMPREHENSIVE SETTLEMENT AGREEMENT AND RELEASE is made as of this 17th day of October, 1997, by and among the undersigned, to settle and resolve with finality all present and future civil claims against all parties to this action relating to the subject matter of this litigation which have been or could have been asserted by any of the parties to this action. WHEREAS, the State of Mississippi, through its Attorney General, Michael C. Moore, commenced this action in May 1994, asserting various claims for monetary and injunctive relief on behalf of the State of Mississippi against certain tobacco manufacturers and others as Defendants; WHEREAS, Defendants deny each and every one of the State of Mississippi's allegations of unlawful conduct and have asserted a number of defenses to the State of Mississippi's claims, all of which defenses have been contested by the State of Mississippi; 1 WHEREAS, the State of Mississippi, through its Attorney General, the Honorable Michael C. Moore, has had a significant leadership role among the various states in maintaining civil litigation against the tobacco industry and in seeking to forge an unprecedented national resolution of the principal issues and controversies associated with the manufacture, marketing and sale of tobacco products in the United States; WHEREAS, through the efforts of the State of Mississippi, Attorney General Moore and others, a June 20, 1997 Memorandum of Understanding and Proposed Resolution (the "Proposed Resolution") have been agreed to by members of the tobacco industry, state attorneys general, private litigants and representatives of public health groups, which Proposed Resolution would provide for unprecedented and comprehensive regulation of the tobacco industry while preserving the right of individuals to assert claims for compensation; WHEREAS, the Proposed Resolution contemplates action by the United States Congress and the President to enact and sign a new federal law with respect to the tobacco industry, which action the tobacco industry has agreed to support and which will require study and analysis by Congress and the President; WHEREAS, trial of this action was scheduled to commence on July 7, 1997 and a continuance of such trial could have prejudiced the State of Mississippi, the State of Mississippi and the undersigned defendants ("Settling Defendants") agreed to settle independently the litigation commenced by Attorney General Moore pursuant to financial terms comparable to those contained in the 2 Proposed Resolution, which terms will achieve for Mississippi immediately the financial benefits it would receive pursuant to the national Proposed Resolution, should it become law; and WHEREAS, counsel for the State of Mississippi and the undersigned defendants entered into a Memorandum of Understanding as of July 2, 1997 (the "MOU"), setting forth the principal terms and conditions of an agreement in principle, and such MOU contemplated that the parties thereto would draft and execute a comprehensive Settlement Agreement incorporating the terms of the MOU as well as other customary terms and conditions, including releases, acceptable to such parties; NOW, THEREFORE, BE IT KNOWN THAT, in consideration of the payments to be made by Settling Defendants, the dismissal and release of claims by the State of Mississippi and such other consideration as described herein, the sufficiency of which is acknowledged, the State of Mississippi, acting by and through its duly elected and authorized Attorney General, Michael C. Moore, and the Settling Defendants, acting by and through their authorized agents, memorialize and agree as follows: 1. Jurisdiction. Settling Defendants and the State of Mississippi acknowledge that this Court has jurisdiction over the subject matter of this action and over each of the parties to this Settlement Agreement. Jurisdiction is retained by the Court for the purposes of enabling any party to this Settlement Agreement to apply to the Court at any time for further orders and directions as may be 3 necessary and appropriate to implement or enforce this Settlement Agreement, and the parties agree to present any disputes under this Settlement Agreement to this Court. 2. Applicability. This Settlement Agreement shall be binding upon all Settling Defendants and their successors and assigns in the manner expressly provided for herein and shall inure to their benefit and to that of their respective directors, officers, employees, attorneys, representatives, insurers, suppliers, distributors and agents, and to that of any of their present or former parents, subsidiaries, affiliates, divisions or other organizational units of any kind. This Settlement Agreement shall be binding on and inure to the benefit of the State of Mississippi, its administrators, representatives, employees, officers, agents and legal representatives; all agencies, departments, commissions and divisions of the State; all subdivisions, public entities, public corporations, instrumentalities and educational institutions over which the State has control; and their predecessors, successors and assigns. None of the rights granted or obligations assumed under this Agreement may be assigned or otherwise conveyed without the express prior written consent of all of the parties hereto. 3. Voluntary Agreement of Parties. The State of Mississippi and the Settling Defendants acknowledge and agree that this Settlement Agreement is voluntarily entered into by all parties hereto as the result of arms length negotiations during which all such parties were represented by counsel. Settling Defendants understand and acknowledge that certain provisions of this Settlement 4 Agreement impose specific requirements on them that could give rise to challenges under various federal and State constitutional provisions if the State of Mississippi unilaterally imposed such requirements. None of the parties hereto will seek to challenge this Settlement Agreement based on any such constitutional challenge to the provisions contained herein. 4. Definitions. For the purposes of this Settlement Agreement, the following terms shall have the meanings set forth below: (a) "State" or "State of Mississippi" means the State of Mississippi, all of its officers acting in their official capacities and any department, subdivision or agency of the State, regardless of whether a named plaintiff; (b) "Settling Defendants" means those Defendants in this Action that are signatories to this Settlement Agreement; (c) "Non-Settling Defendants" means those Defendants in this Action that are not signatories to this Settlement Agreement; (d) "Market Share" means, for each year, a Settling Defendant's respective share of sales of cigarettes for consumption in the United States; (e) "Tobacco Products" shall be defined in the same manner as in the Food and Drug Administration Rule and shall include Roll-Your-Own, Little Cigars and Fine Cut; 5 (f) "Billboards" includes billboards, as well as all signs and placards in arenas and stadia, whether open-air or enclosed; "Billboards" does not include: (1) any advertisements placed on or outside the premises of retail establishments licensed to sell Tobacco Products or any retail point-of-sale; and (2) billboards or advertisements in connection with the sponsorship by Settling Defendants of any entertainment, sporting or similar event, such as NASCAR, that appears in the State of Mississippi as part of a national or multi-state tour; (g) "Transit Advertisements" means advertising on private or public vehicles and all advertisements placed at, on or within any bus stop, taxi stand, waiting area, train station, airport or any similar location; "Transit Advertisements" does not include any advertisements placed on or outside the premises of retail establishments licensed to sell Tobacco Products or any retail point-of-sale; (h) "Final Approval" means the date on which all of the following shall have occurred: (1) The Settlement Agreement is approved by the Court; (2) Entry is made of an order of dismissal of claims or a final judgment as provided herein; and (3) The time for appeal or to seek permission to appeal from the Court's approval as described in (1) hereof and entry of such final judgment or order of dismissal as described in (2) hereof 6 has expired or, in the event of an appeal, the appeal has been dismissed or the approval described in (1) hereof and order or judgment described in (2) hereof have been affirmed in their entirety by the court of last resort to which such appeal has been taken and such affirmance has become no longer subject to further appeal or review. 5. Elimination of Billboards and Transit Advertisements. Settling Defendants agree to discontinue all Billboards and Transit Advertisements of Tobacco Products in the State of Mississippi. Settling Defendants agree to exercise their best efforts in cooperation with the State of Mississippi to identify all Billboards that are located within 1000 feet of any public or private school or playground in the State of Mississippi. Settling Defendants will remove such Tobacco Product advertisements (leaving the space unused or used for advertising unrelated to Tobacco Products) or, at the option of the State of Mississippi, will allow the State of Mississippi, at its expense, to substitute for the remaining term of the contract alternative advertising intended to discourage the use of Tobacco Products by children under the age of 18. Settling Defendants agree to provide the State of Mississippi with preliminary lists of the locations of all Billboards and stationary Transit Advertisements within 30 days from the date of execution of this Settlement Agreement, such lists to be finalized within an additional 15 days, and to remove all Billboards and Transit Advertisements for Tobacco Products within the State of Mississippi at the earlier of the expiration of 7 applicable contracts or 4 months from the date the final lists are supplied to the State of Mississippi. The parties hereto also agree to cooperate to secure the expedited removal of up to 50 Billboards or stationary Transit Advertisements designated by the State of Mississippi, within 30 days after their designation. Each Settling Defendant shall provide the Court and the Attorney General, or his designee, with the name of a contact person to whom the State of Mississippi may direct inquiries during the time such Billboards and Transit Advertisements are being eliminated, from whom the State of Mississippi may obtain periodic reports as to the progress of their elimination and who will be responsible for ensuring that appropriate action is taken to remove any Billboards or Transit Advertisements that have not been eliminated in a timely manner. 6. Support of Legislation and Rules. Following Final Approval of this Settlement Agreement, Settling Defendants agree to support legislative initiatives to enact new laws and administrative initiatives to promulgate new rules intended to effectuate the following: (a) The prohibition of the sale of cigarettes in vending machines, except in adult-only locations and facilities; (b) The strengthening of civil penalties for sales of Tobacco Products to children under the age of 18 years, including the suspension or revocation of retail licenses; and (c) The strengthening of civil penalties for possession of Tobacco Products by children under the age of 18 years. 8 7. Initial Payment. The parties hereto acknowledge that, on July 15, 1997, Settling Defendants, in accordance with the terms of the MOU and pursuant to a mutually acceptable escrow agreement, paid into a special escrow account (the "Escrow Account"), for the benefit of the State of Mississippi, to be held in escrow pending Final Approval, the sum of $170 million; that being the State of Mississippi's good faith estimate of the portion the State of Mississippi would receive of the $10 billion payment provided for in Paragraph A on page 34 of the Proposed Resolution. 8. Pilot Program Payment. In support of the State of Mississippi's demonstrated commitment to the meaningful and immediate reduction of the use of Tobacco Products by children under the age of 18 years, Settling Defendants agree to support a pilot program (the "Mississippi Tobacco Pilot Program"), the terms of which shall be submitted to the Court by the Attorney General of the State of Mississippi, and the elements of which shall be aimed specifically at the reduction of the use of Tobacco Products by children under the age of 18 years. Accordingly, on or before October 20, 1997, Settling Defendants shall, pursuant to a mutually acceptable escrow agreement attached hereto as Exhibit A, cause to be paid into a second special escrow account (the "Mississippi Tobacco Pilot Program Escrow Account"), for the benefit of the State of Mississippi, to be held in escrow pending Final Approval of this Settlement Agreement, the sum of $61,818,000. The Mississippi Tobacco Pilot Program shall commence within a reasonable period after Final Approval of this Settlement Agreement, and shall 9 last for a 24-month period. The $61,818,000 amount payable by Settling Defendants in support of the Mississippi Tobacco Pilot Program (the "Pilot Program Amount") shall be used only after Court approval of the specific terms of the Mississippi Tobacco Pilot Program for general enforcement, media, educational and other programs directed to the underage users or potential underage users of Tobacco Products, but shall not be directed against any particular tobacco company or companies or any particular brand of Tobacco Products. No expenditure from the Pilot Program Amount shall be made except upon application to the Court by the Attorney General and approval of such application by the Court. 9. Annual Payments. Each of the Settling Defendants agrees, severally and not jointly, that on December 31, 1998 and annually thereafter (subject to final adjustment within 30 days), it shall cause to be paid into a special account for the benefit of the State of Mississippi (the "Account"), pro rata in proportion equal to its respective Market Share, its share of 1.7% of the following amounts (in billions):
Year 1 2 3 4 5 6 thereafter - ---- Amount $4B $4.5B $5B $6.5B $6.5B $8B $8B - ------
The above amounts represent the amounts contemplated under the Proposed Resolution to be paid to the several States, without regard to the possibility of any claims for reimbursement or credit by any other person or entity including any federal government agency. The payments made to the Account by Settling 10 Defendants pursuant to the calculation set forth in this paragraph shall be adjusted upward by the greater of 3% or the Consumer Price Index applied each year on the previous year, beginning with the first annual payment. Such payments will also be decreased or increased, as the case may be, in accordance with decreases or increases in volume of domestic tobacco product volume sales as provided in Paragraph B.5 on pages 34-35 of the Proposed Resolution. In the absence of any of the foregoing adjustments, Settling Defendants would be obligated to pay to the State of Mississippi pursuant to this paragraph the following approximate amounts (in millions), which are set forth for illustrative purposes only:
Year 1998 1999 2000 2001 2002 2003 thereafter - ---- Amount $68M $76.5M $85M $110.5M $110.5M $136M $136M - ------
Any payment pursuant to this paragraph that is due to be paid before Final Approval of this Settlement Agreement shall be paid into the Escrow Account and shall be disbursed only as provided by the terms of the Escrow Agreement. Settling Defendants shall make their first annual payment to the State of Mississippi pursuant to this paragraph 9 of this Agreement on December 31, 1998, without adjustment and without regard to any first annual payment date provided for under any legislation implementing the Proposed Resolution or a substantially equivalent federal program, such payment to be credited against any first annual payment due under such legislation before February 28, 1999. 10. Adjustments in Event of Federal Resolution. In the event that legislation implementing the Proposed Resolution or a substantially equivalent 11 federal program is enacted into law, the settlement provided herein shall remain in place, but the terms of such legislation shall supersede the provisions of this Settlement Agreement, except such provisions as relate to the Mississippi Tobacco Pilot Program and except to the extent that the parties hereto have otherwise expressly agreed. In order to provide Settling Defendants with a full credit for all payments made hereunder pursuant to paragraphs 7 and 9 of this Settlement Agreement in the event of the enactment of legislation implementing the Proposed Resolution or a substantially equivalent federal program, and to the extent that the payments made pursuant to paragraphs 7 and 9 of this Settlement Agreement shall differ from the amounts to be received by the State of Mississippi pursuant to such legislation implementing the Proposed Resolution or a substantially equivalent federal program, the parties hereto shall take whatever steps are necessary to ensure that the principal amount of payments received by the State of Mississippi will be the same as the amounts it would receive pursuant to the Proposed Resolution or a substantially equivalent federal program. 11. Use of Funds. The monies received under this Settlement Agreement constitute reimbursement for public health expenditures made by the State of Mississippi and various political subdivisions and agencies of the State of Mississippi including the Mississippi State Employees Health Insurance Plan, University Medical Center and charity hospitals, as well as for Medicaid expenditures of the State of Mississippi, and are in satisfaction of all of the State of Mississippi's claims, including those for punitive damages. In consonance 12 with the relief sought by this Action and the Proposed Resolution, the parties hereto anticipate that funds provided hereunder, other than funds dedicated hereunder to the Mississippi Tobacco Pilot Program and legal expense reimbursement, will be used for health-related expenses of the State of Mississippi. 12. Dismissal of the State of Mississippi's Claims. Upon approval of this Settlement Agreement by the Court, the State of Mississippi shall dismiss, with prejudice as to Settling Defendants (including their parents and affiliates), and without prejudice as to Non-Settling Defendants, all claims in this Action. In the event any Non-Settling Defendants agree to comply with the non-economic terms contained in this Settlement Agreement, the State of Mississippi shall dismiss with prejudice all claims against any such Non-Settling Defendants. 13. State of Mississippi's Waiver and Release. Upon Final Approval, the State of Mississippi shall release and forever discharge all Defendants and their present and former parents, subsidiaries, divisions, affiliates, officers, directors, employees, representatives, insurers, suppliers, agents, attorneys and distributors (and the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing) (the "Released Parties"), from any and all manner of civil claims, demands, actions, suits and causes of action, damages whenever incurred, liabilities of any nature whatsoever, including civil penalties, as well as costs, expenses and attorneys' fees (except as to Settling Defendants' obligations under paragraph 16 of this Settlement Agreement), known or unknown, suspected or 13 unsuspected, accrued or unaccrued, whether legal, equitable or statutory ("Claims") that the State of Mississippi (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), whether directly, indirectly, representatively, derivatively or in any other capacity, ever had, now has or hereafter can, shall or may have, as follows: (1) for the past, as to any Claims that were or could have been made in this action or any comparable federal action; and (2) for the future, only as to Claims directly or indirectly based on, arising out of or in any way related to, in whole or in part, the use of or exposure to Tobacco Products manufactured in the ordinary course of business, including without limitation any future claims for reimbursement for heath care costs allegedly associated with smoking (such past and future Claims hereinafter referred to, collectively, as the "Released Claims"). The State of Mississippi hereby covenants and agrees that it shall not hereafter sue or seek to establish civil liability against any Released Party based, in whole or in part, upon any of the Released Claims, and the State of Mississippi agrees that this covenant and agreement shall be a complete defense to any such civil action or proceeding, provided, however, that those Non-Settling Defendants 14 which are not parents or affiliates of the Settling Defendants shall be entitled to the foregoing release and covenant not to sue only upon their assent to comply with the non-economic provisions of this Settlement Agreement, including waiver of claims, if any. 14. Settling Defendants' Waiver and Dismissal of Claims. Upon Final Approval, Settling Defendants shall waive any and all claims against the State of Mississippi and any of its officers, employees, agents, counsel, witnesses (fact or expert), whistle-blowers or contractors, relating to or in connection with this litigation and shall dismiss, with prejudice, any pending claims or actions against such persons or entities. 15. Most-Favored Nation. Settling Defendants agree that if they enter into any 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 this Settlement Agreement will be revised so that the State of Mississippi will obtain treatment at least as relatively favorable as any such non-federal governmental entity. In addition, Settling Defendants agree that, in the event of any future settlement or final judgment with respect to the claims for non-economic injunctive relief pending in the lawsuit entitled State of Florida, et al. v. American Tobacco Company, et al., Civ. Action No. 95-1466 AH (Fifteenth Judicial Circuit, Palm Beach County, Fla.), the terms of this Settlement Agreement will be revised 15 so that the State of Mississippi will receive benefits comparable to the terms of any such settlement or final judgment (after due consideration of relevant differences in population or other appropriate factors). 16. Costs and Expenses. Settling Defendants have agreed to reimburse the reasonable costs and expenses incurred by the office of the Attorney General and other appropriate state agencies and the State of Mississippi's private counsel in connection with this litigation, provided that such costs and expenses are of the same nature as costs and expenses for which Settling Defendants would reimburse to their own counsel or agents. The parties hereto acknowledge that, pursuant to this agreement, on July 30, 1997, Settling Defendants paid to the Attorney General of Mississippi $2.5 million for the Attorney General's best estimate of costs and expenses attributable to his office and other appropriate state agencies or persons in connection with this litigation (cost for public employees shall be at prevailing market rates); and further acknowledge that, on July 30, 1997, Settling Defendants paid $12.5 million to private counsel for the State of Mississippi for private counsel's best estimate of their costs and expenses. The Attorney General's Office, for itself and for other appropriate state entities, and Mississippi's private counsel shall provide Settling Defendants with an appropriately documented statement of their costs and expenses. Settling Defendants shall promptly pay the amount of such costs and expenses in excess of the above $15 million, or shall receive a refund if the total of such costs and expenses shall be less than $15 million. Any dispute as to the nature or amount of 16 reimbursable costs and expenses shall be decided with finality by the persons selected to award fees, as provided below. Settling Defendants agree to pay, separately and apart from the above, reasonable attorneys' fees to private counsel. If the Proposed Resolution or a substantially equivalent federal program is enacted, the amount of such fees will be set by a panel of independent arbitrators with finality, subject to an appropriate annual cap on all such payments and other conditions. In the absence of any such legislation enacting the Proposed Resolution or a substantially equivalent federal program, attorneys' fees in connection with this litigation will be awarded in the same manner (subject to the appropriate annual cap and other conditions) by three independent arbitrators selected by the parties hereto. In addition to the foregoing, in the event of the enactment of the Proposed Resolution or a substantially equivalent federal program, the parties hereto contemplate that the State of Mississippi and any other similar State which has made an exceptional contribution to secure the resolution of these matters may apply to the panel of independent arbitrators for reasonable compensation for its efforts in securing the Proposed Resolution, subject to an appropriate separate annual cap on all such payments. 17. Representations of Parties. The parties hereto hereby represent that this Settlement Agreement has been duly authorized and, upon execution, will constitute a valid and binding contractual obligation of each of the parties hereto enforceable in accordance with its terms. 17 18. Court Approval. If the Court refuses to approve this Settlement Agreement or any material part hereof, or if such approval is modified as to any material provision or set aside on appeal, or if the Court does not enter an order of dismissal of claims or final judgment as provided for in paragraph 12 of this Agreement, or if the Court enters the order of dismissal of claims or final judgment and appellate review is sought, and on such review such order of dismissal or final judgment is not affirmed in its entirety as to all material aspects of such order or final judgment, then this Settlement Agreement shall be cancelled and terminated and it and all orders issued pursuant hereto shall become null and void and of no effect. 19. Headings. The headings of the paragraphs of this Settlement Agreement are not binding and are for reference only and do not limit, expand or otherwise affect the contents of this Settlement Agreement. 20. No Determination or Admission. This Settlement Agreement having being executed prior to the taking of any testimony, no final determination of violation of any provision of law has been made in this Action. This Settlement Agreement and any proceedings taken hereunder are 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 party hereto or any Released Party. The parties hereto and Released Parties specifically disclaim and deny any liability or wrongdoing whatsoever with respect to the allegations and claims asserted against them in this action, and the parties hereto 18 enter into this Settlement Agreement solely to avoid the further expense, inconvenience, burden and uncertainty of litigation. 21. Non-Admissibility. The settlement negotiations resulting in this Settlement Agreement have been undertaken by the parties in good faith and for settlement purposes only, and neither this Settlement Agreement nor any evidence of negotiations hereunder, shall be offered or received in evidence in this Action, or any other action or proceeding, for any purpose other than in an action or proceeding arising under this Settlement Agreement. 22. Amendment. This Settlement Agreement may be amended only by a writing executed by all signatories hereto, and any provision hereof may be waived only by an instrument in writing executed by the waiving party. The waiver by any party of any breach of this Settlement Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this Settlement Agreement. 23. Notices. All notices or other communications to any party to this Settlement Agreement shall be in writing (including telex, telecopy or similar writing) and shall be given to the respective parties hereto at the following addresses. 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 paragraph. 19 State of Mississippi: Michael C. Moore Attorney General 450 High Street Post Office Box 220 Jackson, MS 39205 Fax: 601.359.3441 with copies to: Richard Scruggs Scruggs, Millette, Lawson, Bozeman & Dent, P.A. 734 Delmas Avenue Post Office Drawer 1425 Pascagoula, Mississippi 39568-1425 Fax: 228.762.1207 and: Joseph F. Rice Ness, Motley, Loadholt, Richardson & Poole 151 Meeting Street, Suite 600 Charleston, SC 29402 Fax: 803.720.9290 and: David O. McCormick 707 Watts Avenue P.O. Box 865 Pascagoula, MS 39568-0865 Fax: 228.762.4864 For Philip Morris Incorporated: Denise F. Keane Philip Morris Incorporated 120 Park Avenue New York, NY 10017-5592 Fax: 212.907.5399 With a copy to: Meyer G. Koplow Wachtell, Lipton, Rosen & Katz 51 West 52nd Street 20 New York, NY 10019 Fax: 212.403.2000 For R.J. Reynolds Tobacco Company: Charles A. Blixt General Counsel R.J. Reynolds Tobacco Company 401 North Main Street Winston-Salem, NC 27102 Fax: 910.741.2998 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: F. Anthony Burke Brown & Williamson Tobacco Corporation 200 Brown & Williamson Tower 401 South Fourth Avenue Louisville, KY 40202 Fax: 502.568.7297 With a copy to: Stephen R. Patton Kirkland & Ellis 200 East Randolph Dr. Chicago, IL 60601 Fax: 312.861.2200 For Lorillard Tobacco Company: Arthur J. Stevens Lorillard Tobacco Company 714 Green Valley Road Greensboro, NC 27408 Fax: 910.335.7707 21 24. Cooperation. The parties to this Settlement Agreement and their attorneys agree to use their best efforts and to cooperate with each other to cause this Settlement Agreement to become effective, to obtain all necessary approvals, consents and authorizations, if any, and to execute all documents and to take such other action as may be appropriate in connection therewith. Consistent with the foregoing, the parties hereto agree that they will not directly or indirectly challenge the Attorney General's authority to enter into this Settlement Agreement and that they will not in any way assist or encourage any challenge to this Settlement Agreement by any other person. The parties hereto may agree, without further order of the Court, to reasonable extensions of time to carry out any of the provisions of this Settlement Agreement. 25. Governing Law. This Settlement Agreement shall be governed by the law of the State of Mississippi. 26. Construction. None of the parties hereto shall be considered to be the drafter of this Settlement 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. 27. Severability. In the event that any non-material provision of this Settlement Agreement is found to be invalid, the remainder of this Settlement Agreement shall be fully enforceable. 28. Intended Beneficiaries. This Action was brought by the State of Mississippi, through its Attorney General, to recover certain monies and to 22 promote the health and welfare of the people of Mississippi. No portion of this Settlement Agreement shall provide any rights to, or be enforceable by, any person or entity that is not a party hereto or a Released Party and no portion of this Settlement Agreement shall bind any non-party (other than a Released Party) or determine, limit or prejudice the rights of any such person or entity. 29. Counterparts. This Settlement 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. IN WITNESS WHEREOF, the undersigned parties, through their fully authorized representatives, have agreed to this Comprehensive Settlement Agreement and Release as of this 17th day of OCTOBER, 1997. JACKSON, MISSISSIPPI 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 23 PHILIP MORRIS INCORPORATED By: /s/ Jeffrey M. Wintner ------------------------- Jeffrey M. Wintner, Counsel By: /s/ Denise F. Keane ------------------------ Denise F. Keane, 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 BROWN & WILLIAMSON TOBACCO CORPORATION By: /s/ Stephen R. Patton ------------------------ Stephen R. Patton, Counsel By: /s/ F. Anthony Burke ------------------------ F. Anthony Burke, Vice President-Law & General Counsel 24 EX-13 11 PAGES 21-62 OF 97 ANNUAL REPORT Annual Report to Security Holders Management's Discussion and Analysis of EXHIBIT 13 Financial Condition and Results of Operations ================================================================================ Consolidated Operating Results Operating Revenues (in millions) 1997 1996 1995 ================================================================================ Tobacco $ 39,824 $ 36,549 $ 32,316 Food 27,690 27,950 29,074 Beer 4,201 4,327 4,304 Financial services and real estate 340 378 377 - -------------------------------------------------------------------------------- Operating revenues $ 72,055 $ 69,204 $ 66,071 ================================================================================ Operating Income (in millions) 1997 1996 1995 ================================================================================ Tobacco $ 7,830 $ 8,263 $ 7,177 Food 3,647 3,362 3,188 Beer 456 437 444 Financial services and real estate 296 192 164 - -------------------------------------------------------------------------------- Operating profit $ 12,229 $ 12,254 $ 10,973 General corporate expenses (479) (442) (411) Minority interest in earnings of consolidated subsidiaries (87) (43) (36) - -------------------------------------------------------------------------------- Operating income $ 11,663 $ 11,769 $ 10,526 ================================================================================ 1997 Compared with 1996 Operating revenues for 1997 increased $2.9 billion (4.1%) and operating profit decreased $25 million (0.2%) from 1996. Operating profit, as defined for segment reporting purposes, is operating income before general corporate expenses and minority interest in earnings of consolidated subsidiaries. Operating revenues were higher due primarily to increases in domestic and international tobacco and North American food operations. Operating profit was reduced as a result of pretax charges of $1.5 billion taken by Philip Morris Incorporated ("PM Inc."), the Company's domestic tobacco subsidiary, reflecting up-front charges related to settling health care cost recovery litigation in Mississippi, Florida and Texas and a one-time charge for settling the Broin case, a Florida class action brought on behalf of airline flight attendants. Operating profit was further reduced by pretax charges of $630 million to realign the international food operations. Operating profit was increased by a $774 million pretax gain on the sale of ice cream businesses in Brazil and a $103 million pretax gain on the sale of real estate operations. Excluding the settlement charges, international food realignment charges, gains on divestitures noted above and results of operations sold, operating profit increased 11.5%, reflecting favorable results of operations in domestic tobacco, international tobacco, North American food and beer operations. Currency movements, primarily the strengthening of the U.S. dollar versus European, Japanese and other Asian currencies, decreased operating revenues by $3.2 billion ($1.9 billion, excluding excise taxes) and operating profit by $470 million in 1997 versus 1996. Although the Company cannot predict future movements in currency rates or economic developments, it anticipates that the continued global strength of the U.S. dollar will also have a significant adverse impact on operating revenues and operating profit in 1998 and that economic instability in Asia will temporarily slow the Company's businesses in that region. Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." SFAS No. 128 establishes standards for computing and presenting earnings per share ("EPS") and requires the presentation of both basic and diluted EPS. Prior years' EPS have been restated to conform with the standards established by SFAS No. 128. 21 Basic EPS of $2.61 in 1997 increased by 1.6% over 1996, due primarily to fewer shares outstanding. Similarly, diluted EPS increased 1.6% to $2.58 from $2.54 in 1996. Net earnings, basic EPS and diluted EPS in 1997 were affected by the after-tax effects of the settlement charges, international food realignment charges and gains on divestitures noted above. Excluding the impact of these items, net earnings increased 12.6% to $7.1 billion, basic EPS increased 14.0% to $2.93 and diluted EPS increased 14.6% to $2.91, respectively, in 1997 from $6.3 billion, $2.57 and $2.54, respectively, in 1996. As a result of share repurchases, the weighted average number of shares outstanding for basic and diluted EPS decreased to 2,420 million and 2,442 million shares, respectively, in 1997 from 2,456 million and 2,482 million shares, respectively, in 1996. The Company has evaluated the costs to implement century date change compliant systems conversions and is in the process of executing a planned conversion of its systems prior to the year 2000. Although such costs may be a factor in describing changes in operating profit for one or more of the Company's business segments in any given reporting period, the Company currently does not believe that the anticipated costs of year 2000 systems conversions will have a material impact on its future consolidated results of operations. However, due to the interdependent nature of computer systems, the Company may be adversely impacted in the year 2000 depending on whether it or entities not affiliated with the Company have addressed this issue successfully. 1996 Compared with 1995 Operating revenues for 1996 increased $3.1 billion (4.7%) and operating profit increased $1.3 billion (11.7%) over 1995. Operating revenues increased in 1996 over 1995 due primarily to increases in tobacco revenues, partially offset by the impact of divestitures of food businesses. Operating profit increased in 1996 over 1995 due primarily to increases in the tobacco and food segments. Excluding the results of divested North American food businesses (discussed below in Food--Business Environment), operating revenues and operating profit in 1996 increased $5.2 billion (8.1%) and $1.4 billion (12.9%), respectively, over 1995. Currency movements, primarily the strengthening of the U.S. dollar versus the Japanese yen, decreased operating profit by $116 million in 1996. Interest and other debt expense, net, decreased $93 million (7.9%) compared to 1995, due primarily to a lower average interest rate on outstanding debt and higher interest income in 1996. Excluding the cumulative effect of accounting changes discussed below, basic EPS of $2.57 in 1996 increased by 17.9% over 1995, and diluted EPS of $2.54 increased by 17.6% over 1995, both due to higher net earnings and lower shares outstanding. As a result of the Company's share repurchase program, the weighted average number of shares outstanding for basic and diluted EPS decreased to 2,456 million and 2,482 million shares, respectively, in 1996 from 2,517 million and 2,538 million shares, respectively, in 1995. Effective January 1, 1995, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," for its non-U.S. retiree health care plans. The Company also adopted SFAS No. 116, "Accounting for Contributions Received and Contributions Made." The cumulative effect at January 1, 1995 of adopting SFAS No. 106, for the non-U.S. plans, and SFAS No. 116 reduced 1995 net earnings by $28 million and basic EPS and diluted EPS each by $.01. The application of SFAS No. 106, for non-U.S. plans, and SFAS No. 116 did not materially reduce 1995 earnings before cumulative effect of accounting changes. 1993 Restructuring In the fourth quarter of 1993, the Company provided for the restructuring of its worldwide operations to reduce its cost structure and to improve its future growth, profitability and cash flow. The charge related primarily to the downsizing or closure of approximately 40 manufacturing and other facilities. This restructuring charge reduced 1993 earnings before income taxes and net earnings by $741 million and $457 million, respectively. Included in this charge were asset write-downs of $429 million, with the remainder of the charge representing anticipated cash expenditures to be funded with cash provided by operating activities. The liability established upon adoption of SFAS No. 112, "Employers' Accounting for Postemployment Benefits," was sufficient to provide for costs associated with workforce reductions contemplated by the 1993 restructuring. At December 31, 1997, the 1993 restructuring program was substantially complete, with estimated annual after-tax savings of $500 million. Operating Results by Business Segment Tobacco Business Environment The tobacco industry, including PM Inc., the Company's domestic tobacco subsidiary, and Philip Morris International Inc. ("PMI"), the Company's international tobacco subsidiary, has faced, and continues to face, a number of issues that may adversely affect volume, operating revenues, cash flows, operating income and financial position. In the United States, these issues include proposed federal regulatory controls (including, as discussed below, the issuance of final regulations by the United States Food and Drug Administration (the "FDA") that regulate cigarettes as "drugs" or "medical devices"); actual and proposed excise tax increases; 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, 22 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; 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; increased assertions of adverse health effects associated with both smoking and exposure to environmental tobacco smoke ("ETS"); legislation or other governmental action seeking to ascribe to the industry responsibility and liability for the purported adverse health effects associated with both smoking and exposure to ETS; the diminishing social acceptance of smoking; increased pressure from anti-smoking groups; unfavorable press reports; governmental and grand jury investigations; increased smoking and health litigation, including private plaintiff class action litigation and health care cost recovery actions brought by state and local governments, unions and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking; and the proposed legislative resolution of certain regulatory and litigation issues affecting the United States tobacco industry discussed below. Cigarettes are subject to substantial excise taxes in the United States and to similar taxes in most foreign markets. The United States federal excise tax on cigarettes is currently $12 per 1,000 cigarettes ($0.24 per pack of 20 cigarettes). In August 1997, legislation was enacted that will raise the federal excise tax to $17 per 1,000 cigarettes ($0.34 per pack of 20 cigarettes) starting in the year 2000 and then to $19.50 per 1,000 cigarettes ($0.39 per pack of 20 cigarettes) in 2002. In general, excise taxes, sales taxes and other cigarette-related taxes levied by the federal government and by various states, counties and municipalities have been increasing, and additional increases have been proposed at the federal level and in a number of states. These taxes vary considerably and, when combined with the recently enacted federal excise tax, may be as high as $1.50 per pack in a given locality. 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. 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. 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. 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. 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 23 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 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 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, as reflected in the proposed new health warnings set out in the proposed Resolution. Some foreign countries have also taken steps to restrict or prohibit cigarette advertising and promotion, to require ingredient disclosure, to impose maximum constituent levels, to increase taxes on cigarettes, to control prices, to restrict imports, to ban or severely restrict smoking in workplaces and public places, and otherwise to discourage cigarette smoking. It is not possible to predict what, if any, other foreign governmental legislation or regulations will be adopted relating to the manufacturing, advertising, sale or use of cigarettes or to the tobacco industry generally. On February 10, 1998, a regulation went into effect in Thailand that would require manufacturers and importers of tobacco products, including a subsidiary of PMI, to disclose to the Ministry of Public Health ("MPH") the ingredients of their products to be sold in Thailand on a by-brand basis. Although this regulation does not require the MPH to make public the submitted ingredients lists, there are no assurances that the confidentiality of lists to be 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 are as follows: PM Inc. has been informed that an investigation by the United States Attorney for the Southern District of New York, which had been initiated following the publication of an article in The New York Times that made allegations about PM Inc. documents and supposedly secret research relating to nicotine, has been consolidated with the United States Department of Justice investigation discussed immediately below. PM Inc. has been informed of an investigation by the United States Attorney for the Eastern District of New York relating to The Council for Tobacco Research-U.S.A., Inc., a research organization of which PM Inc. is a sponsor; and an investigation by the United States Department of Justice relating to issues raised in testimony provided by tobacco industry executives before Congress and other related matters. PM Inc. has been advised that the FTC has commenced an investigation to determine whether PM Inc. unfairly restricts the distribution of competing manufacturers' cigarette brands through its merchandising practices at the wholesale and retail levels. While the outcomes of these investigations cannot be predicted, PM Inc. believes it has acted lawfully. As further discussed in Note 15 to the Consolidated Financial Statements ("Note 15"), there is litigation pending in various jurisdictions related to tobacco products. These cases generally fall within three categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, and (iii) health care cost recovery cases, including class actions, brought by state and local governments, unions, federal and state taxpayers, native American tribes and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking. Damages claimed in some of the smoking and health class actions and health care cost recovery cases range into the billions of dollars. 24 In recent years there has been a substantial increase in the number of smoking and health cases being filed in the United States, a trend that accelerated in 1997. As of December 31, 1997, there were approximately 375 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 185 such cases as of December 31, 1996. Many of the new cases were filed in Florida and New York. Seventeen of the individual cases involve allegations of various personal injuries allegedly related to exposure to ETS. In addition, as of December 31, 1997, there were approximately 50 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including six that involve allegations of various personal injuries related to exposure to ETS), compared with approximately 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. As of December 31, 1997, there were three purported smoking and health class actions pending overseas against affiliates and subsidiaries of the Company, one each in Canada, Brazil and Nigeria. The number of health care cost recovery actions also increased during 1997, with approximately 105 such cases pending as of December 31, 1997, compared with approximately 25 such cases on December 31, 1996. Other foreign, state, and local government entities and others, including unions, have announced that they are considering filing health care cost recovery actions. In June 1997, PM Inc. and other companies in the United States tobacco industry agreed to a proposed Resolution to support federal legislation and ancillary undertakings that would resolve many of the regulatory and litigation issues affecting the United States industry. (See "Proposed Resolution of Certain Regulatory and Litigation Issues" below.) In furtherance of the proposed Resolution, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida and Texas, and a smoking and health class action brought on behalf of airline flight attendants, all on terms consistent with the proposed Resolution. These settlements are discussed in Note 15. It is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention, including a decision by a federal district court on a motion for summary judgment not to preclude the FDA from asserting jurisdiction over cigarettes as "drugs" or "medical devices," which decision is now under appeal. These developments, as well as the widespread media attention given to the proposed Resolution discussed below and the settlements of the Mississippi, Florida and Texas health care cost recovery actions and a smoking and health class action brought on behalf of airline flight attendants, may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. It is possible that the Company's results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially affected by an unfavorable outcome of certain pending litigation or by the proposed Resolution discussed below or by settlement, if any, of certain pending cases. However, implementation of the proposed Resolution should resolve the most significant tobacco litigation against the Company and its subsidiaries. Furthermore, the Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. Except as described below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues--Effects on Litigation," all such cases are, and will continue to be, vigorously defended. Proposed Resolution of Certain Regulatory and Litigation Issues 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 25 and increase stability in business and capital markets. The complete text of the proposed Resolution has been filed with the Securities and Exchange Commission as Exhibit 10 to the Company's Current Report on Form 8-K dated June 20, 1997, and the discussion herein is qualified by reference thereto. There can be no assurance that federal legislation in the form of the proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to the Company or that any modification would be acceptable to the Company or that, if enacted, the legislation would not face legal challenges. Moreover, the negotiation and signing of the proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry and regulation of the international tobacco industry. The proposed Resolution includes provisions relating to advertising and marketing restrictions, product warnings and labeling, access restrictions, licensing of tobacco retailers, the adoption and enforcement of "no sales to minors" laws by states, surcharges against the industry for failure to achieve underage smoking reduction goals, regulation of tobacco products by the FDA, public disclosure of industry documents and research, smoking cessation programs, compliance programs by the industry, public smoking and smoking in the workplace, enforcement of the proposed Resolution, industry payments and litigation. Surcharge for Failure to Achieve Underage Smoking Reduction Goals The proposed Resolution would require the FDA to impose annual surcharges on the industry if targeted reductions in underage smoking are not achieved in accordance with a legislative timetable. The surcharge would be based upon an approximation of the present value of the profit the companies would earn over the lives of all underage consumers in excess of the target, and would be allocated among participating manufacturers based on their market share of the United States cigarette industry. Industry Payments The proposed Resolution would require participating manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10 billion initial Industry Payment on the date that federal legislation implementing the terms of the proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations, and the Company currently estimates that PM Inc.'s share of the initial Industry Payment would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions discussed in Note 15). Thereafter, the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels)--year 1: $8.5 billion; year 2: $9.5 billion; year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15 billion. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate, and would be adjusted to reflect changes from 1996 domestic sales volume levels. The Industry Payments would be separate from any surcharges discussed above. The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities selling tobacco products in the United States (and not their affiliated companies). The proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use. Effects on Litigation If enacted, the federal legislation provided for in the proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity other than the federal government), parens patriae and smoking and health class actions and all "addiction"/dependence claims, and would bar similar actions from being maintained in the future. However, the proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. In recent months, PM Inc. and other companies in the domestic tobacco industry agreed to settle three health care cost recovery actions in Mississippi, Florida and Texas, and a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft. The Company may enter into discussions to postpone or settle other actions, pending the enactment of the legislation contemplated by the proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved or, if achieved, as to the terms thereof. The proposed Resolution would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective. Under the proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as 26 expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis and could be maintained only against tobacco manufacturing companies (and not their retailers, distributors or affiliated companies). In addition, all punitive damage claims based on past conduct would be resolved as part of the proposed Resolution, and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only if based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party. The proposed Resolution contemplates that participating tobacco manufacturers would enter into a joint sharing agreement for civil liabilities relating to past conduct. Judgments and settlements arising from tort actions would be paid as follows. The proposed Resolution would set an annual aggregate cap of up to 33% of the annual base Industry Payment (including any reductions for volume declines). Any judgments or settlements exceeding the cap in a particular year would roll over into the next year. While judgments and settlements would run against the defendant, they would give rise to an 80-cents-on-the-dollar credit against the annual Industry Payment. Finally, any individual judgments in excess of $1 million would be paid at the rate of $1 million per year unless every other judgment and settlement could first be satisfied within the annual aggregate cap. In all circumstances, however, the companies would remain fully responsible for costs of defense and certain costs associated with the fees of attorneys representing certain plaintiffs in the litigation that would be settled by the proposed Resolution. Financial Effects The Company anticipates that PM Inc.'s share of the industry's $10 billion initial payment, which it currently estimates would be approximately $6.6 billion (adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions), would be charged to expense in the period in which federal legislation implementing the terms of the proposed Resolution is enacted. In addition, the Company currently anticipates that implementation of the proposed Resolution would require a significant charge to expense in the period of enactment to comply with the proposed Resolution's regulations on advertising, marketing and production. The initial payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The initial payment would have a material adverse effect on the Company's operating income and cash flows in the quarter and year in which the proposed Resolution is enacted and on its financial position. The initial payment would result in higher debt and higher interest expense, the amounts of which would depend upon the final form of the proposed Resolution, borrowing requirements and interest rates. The Company anticipates that PM Inc.'s share of future annual Industry Payments related to cigarette sales would be charged to expense as the related sales occur, and would be funded through price increases. The Company anticipates that annual surcharges, if any, imposed by the FDA for failure to meet required reduction levels in underage smoking, beginning in the fifth year after the proposed Resolution is implemented, would be charged to expense in the year of assessment or in the year prior thereto if it is then probable that such assessment will be made. The Company believes that implementation of the proposed Resolution would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. The degree of the adverse impact would depend, among other things, on the rates of decline in United States cigarette sales in the premium and discount segments, PM Inc.'s share of the domestic premium and discount cigarette segments, interest rates and the timing of principal payments on debt incurred to finance the initial payment due under the proposed Resolution, and the effect of the proposed Resolution on cigarette consumption and the regulatory and litigation environment outside the United States. In view of the foregoing, the Company may reevaluate its share repurchase and dividend policies. Operating Results Operating Revenues Operating Profit (in millions) 1997 1996 1995 1997 1996 1995 ================================================================================ Domestic tobacco $ 13,485 $ 12,462 $ 11,493 $3,267 $4,206 $3,740 International tobacco 26,339 24,087 20,823 4,592 4,078 3,453 Amortization of goodwill (29) (21) (16) - -------------------------------------------------------------------------------- Total $ 39,824 $ 36,549 $ 32,316 $7,830 $8,263 $7,177 ================================================================================ 1997 Compared with 1996 Domestic tobacco. During 1997, PM Inc.'s operating revenues increased 8.2% over 1996, due primarily to pricing ($783 million), higher volume ($222 million, including excise taxes) and improved product mix. As discussed in Note 15, "Contingencies," of the Notes to Consolidated Financial Statements, in the third and fourth quarters of 1997, PM Inc. recorded charges totaling $1.5 billion as PM Inc. and other companies in the United States tobacco industry entered into agreements to settle health care cost recovery 27 actions in Mississippi, Florida and Texas, and an agreement to settle a class action lawsuit in Florida. Operating profit for 1997 decreased 22.3% from 1996, due primarily to these litigation settlement charges ($1.5 billion), higher marketing, administration and research costs ($195 million, primarily higher marketing expense) and higher fixed manufacturing costs ($79 million), partially offset by pricing ($625 million), higher volume ($142 million) and improved product mix. Excluding the impact of litigation settlement charges, PM Inc.'s operating profit for 1997 increased 12.3% over 1996. PM Inc.'s shipment volume for 1997 was 235.2 billion units, an increase of 1.9% over 1996 on higher Marlboro volume and increased wholesaler purchases, which PM Inc. believes was partially in anticipation of price increases. Marlboro shipment volume increased 7.8 billion units (5.0%) to 164.0 billion units for a 34.1% share of the total industry, an increase of 1.8 share points over 1996. Domestic tobacco industry volume declined 0.6%; however, PM Inc. estimates that, excluding the effects of increased wholesaler buying mentioned above and one less shipping day in 1997, the industry's volume declined by more than 2% from 1996. While PM Inc. cannot predict future rates of decline, it believes that, over the long term, industry shipments will continue to decline in line with historical trends, subject to the effects of price increases related to tobacco litigation settlements and the proposed Resolution, if implemented, discussed under "Tobacco--Business Environment" above. PM Inc.'s 1997 shipment market share was 48.9%, an increase of 1.2 share points over 1996. Based on shipments, the premium segment accounted for approximately 72.5% of the domestic cigarette industry volume in 1997, an increase of 1.0 share point over 1996. This reflects a continued shift to the higher-margin premium segment, which began in the second half of 1993. In the premium segment, PM Inc.'s volume increased 3.4%, compared with a 0.8% increase for the industry, resulting in a premium segment share of 57.8%, an increase of 1.5 share points over 1996, reflecting higher Marlboro volume. In the discount segment, PM Inc.'s shipments decreased 6.4% to 33.7 billion units in 1997, compared with an industry decline of 4.0%, resulting in a discount segment share of 25.6%, a decrease of 0.6 share points from 1996. Basic shipment volume increased 355 million units to 23.5 billion units, for a 17.8% share of the discount segment, an increase of 1.0 share point over 1996. Retail sales data (compiled by the ACNielsen Company) indicate PM Inc. and Marlboro market shares of 51.0% and 35.2%, respectively, during 1997, compared with 49.4% and 33.3%, respectively, in 1996. PM Inc. cannot predict future change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, shipment market share or retail market share; however, it believes that implementation of the proposed Resolution discussed above would materially adversely affect PM Inc.'s shipments. In January 1998, PM Inc. announced a price increase of $1.25 per thousand cigarettes on its domestic premium and discount brands. This announcement followed similar announcements of price increases of $3.50 per thousand cigarettes in September 1997, $2.50 per thousand cigarettes in March 1997 and $2.00 per thousand cigarettes in the second quarter of 1996. Each $1.00 per thousand increase by PM Inc. equates to a $.02 increase to the wholesale price of each pack of twenty cigarettes. In October 1997, PM Inc. announced that it would commence limited consumer preference testing on a new cigarette smoking system. The new cigarette smoking system consists of a cigarette specially designed to be smoked while partially inside an electronic Puff Activated Lighter so that the cigarette burns only when puffed. The limited consumer preference testing is expected to take approximately 12 months to complete. 1997 Compared with 1996 International tobacco. During 1997, tobacco operating revenues of PMI increased $2.2 billion over 1996, including a $1.2 billion increase in excise taxes (primarily reflecting the consolidation of previously unconsolidated and newly acquired subsidiaries). Excluding excise taxes, operating revenues increased $1.0 billion due primarily to price increases ($679 million), favorable volume/mix ($618 million) and the consolidation of previously unconsolidated and newly acquired subsidiaries ($577 million), partially offset by unfavorable currency movements ($961 million). Operating profit for 1997 increased 12.6% over 1996, due primarily to price increases, net of cost increases ($550 million), favorable volume/mix ($371 million) and the consolidation of previously unconsolidated and newly acquired subsidiaries ($114 million), partially offset by unfavorable currency movements ($408 million) and higher marketing, administration and research costs. PMI's volume grew 51.3 billion units (7.8%) in 1997 over 1996 to 711.5 billion units, including local brands manufactured by Tabaqueira-Empresa Industrial de Tabacos, S.A., Portugal's leading tobacco company in which PMI acquired a controlling interest in January 1997. Volume advanced in most major markets, including Germany, Italy, the Benelux countries, Spain, Central and Eastern Europe, the Middle East, Turkey, the Asia/Pacific region, Argentina and Mexico. In addition, PMI recorded market share gains in most major markets. In France, industry and PMI volumes were down, and in Brazil and Australia, PMI lost volume and share. However, volume and market share for Marlboro increased in France and Brazil. Overall volume growth was driven by PMI's portfolio of international brands, including Marlboro, which increased 5.5% over 1996, and Bond Street, Parliament, Chesterfield and Virginia Slims, each of which recorded double-digit volume increases. 28 1996 Compared with 1995 Domestic tobacco. PM Inc.'s 1996 operating revenues increased 8.4% over 1995, due to higher volume ($465 million, including excise taxes), pricing ($414 million) and improved product mix ($90 million). 1996 operating profit increased 12.5% over 1995, due primarily to price increases, net of product cost increases ($362 million), higher volume ($289 million), improved product mix ($75 million) and lower fixed manufacturing costs ($82 million, due primarily to the costs of a product recall in 1995), partially offset by higher marketing, administration and research expense ($342 million). PM Inc.'s 1996 shipment volume was 230.8 billion units, an increase of 4.1% over 1995, compared with an industry increase of 0.4%. Industry volume increased due to two extra shipping days in 1996 and distributor buying patterns. Based on shipments, the premium and discount segments accounted for 71.5% and 28.5%, respectively, of domestic cigarette industry volume in 1996, versus approximately 70.0% and 30.0%, respectively, in 1995, reflecting a continued shift to the higher-margin premium segment, which began in the second half of 1993. PM Inc.'s 1996 shipment market share was 47.7%, an increase of 1.7 share points from 1995. In the premium segment, PM Inc.'s volume increased 6.3%, compared with a 2.7% increase for the industry, resulting in a premium segment share of 56.3%, an increase of 1.9 share points from 1995. Marlboro volume increased 11.3 billion units (7.8%) for a 32.3% share of the total industry, an increase of 2.2 share points from 1995. In the discount segment, PM Inc.'s shipments decreased 6.3%, to 36.0 billion units in 1996 compared with an industry decline of 4.9%, resulting in a discount segment share of 26.2%, a decrease of 0.4 share points from 1995. Retail sales data (compiled by the ACNielsen Company) indicate PM Inc. and Marlboro market shares of 49.4% and 33.3%, respectively, in 1996, compared with 47.3% and 30.7%, respectively, in 1995. PM Inc. cannot predict future change or rates of change in the relative sizes of the premium and discount segments or in PM Inc.'s shipments, shipment market share or retail market share; however, it believes that implementation of the proposed Resolution discussed above would materially adversely affect PM Inc.'s shipments. 1996 Compared with 1995 International tobacco. PMI's 1996 operating revenues increased 15.7%, due primarily to higher foreign excise taxes ($1.6 billion, including those for previously unconsolidated and newly acquired subsidiaries), favorable volume/mix ($1.1 billion), pricing ($469 million) and the impact of previously unconsolidated and newly acquired subsidiaries ($390 million), partially offset by unfavorable currency movements ($287 million). Operating profit increased 18.1%, due primarily to favorable volume/mix ($506 million) and price increases, net of cost increases ($297 million) and the impact of previously unconsolidated and newly acquired subsidiaries ($22 million), partially offset by unfavorable currency movements ($128 million) and higher marketing, administration and research costs. PMI's volume grew 67.1 billion units (11.3%) in 1996 over 1995 to 660.2 billion units, including local brands manufactured by Zaklady Przemyslu Tytoniowego w Krakowie S.A., a Polish cigarette manufacturer in which PMI acquired a controlling interest in February 1996. Excluding this acquisition, PMI's overall volume grew 8.4%. Volume advanced in most major markets, including Germany, Italy, the Netherlands, Belgium, Spain, Central and Eastern Europe, Turkey, the Middle East, Japan, Korea, Singapore, the Philippines and Argentina. In Australia, PMI's volume was lower, following the unusually high levels reached during the 1995 price war. Volume and share declined in Mexico, due to economic conditions and retail price increases. In Brazil, PMI lost volume and share due to intense competition. PMI's market shares rose in most major markets. Food Business Environment Kraft Foods, Inc. ("Kraft"), the largest processor and marketer of retail packaged food in the United States, and its subsidiary Kraft Foods International, Inc. ("KFI"), which markets coffee, confectionery and grocery products in Europe and the Asia/Pacific region, are subject to fluctuating commodity costs and competitive challenges in various product categories and markets. Certain subsidiaries and affiliates of PMI that manufacture and sell food products in Latin America are also subject to competitive challenges in various product categories and markets. In addition, the results of KFI, as well as PMI's food operations in Latin America, are subject to the impact of currency fluctuations. Kraft, KFI and PMI continue to take steps to build the value of premium brands with new product and marketing initiatives, to reduce costs and to improve their food business portfolios. During 1997, PMI sold its Brazilian ice cream businesses, Kraft sold North American maple-flavored syrup businesses and KFI sold a Scandinavian sugar confectionery business. During 1996, Kraft sold its bagel business and KFI sold margarine businesses in the U.K. and Italy. During 1995, Kraft sold its North American bakery, margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. Kraft and KFI have also sold several smaller non-strategic businesses in 1997, 1996 and 1995. 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 29 in the charges were provisions for incremental postemployment benefits, primarily related to severance. Kraft acquired the Taco Bell grocery and Del Monte shelf-stable pudding businesses during 1996 and 1995, respectively. In Latin America, PMI acquired nearly all of the remaining voting shares of Industrias de Chocolate Lacta S.A. ("Lacta"), a Brazilian confectionery company, in the second quarter of 1996. The North American and international food businesses are affected by fluctuating commodity costs, particularly coffee bean, cocoa and dairy prices. Increases in commodity costs can influence consumer and trade buying patterns, and affect retail price volatility, leading to price competition in some markets. Coffee bean prices reached a twenty-year high in May 1997 after price volatility in 1995 and lower prices in 1996. Higher coffee bean prices led to price increases by Kraft, KFI and their competitors. Coffee volume declined in 1997 from 1996 as customers reacted to these commodity-driven price increases. Kraft and KFI estimate that softness in coffee consumption may continue in 1998, as long as higher than average coffee bean prices persist. KFI was affected by higher sterling-denominated cocoa costs, which lowered profit margins on confectionery products. Kraft was affected by record high cheese commodity costs in the third quarter of 1996, as well as other higher dairy commodity costs, arising from low U.S. milk production. Cheese and dairy commodity costs have since moderated and remained stable. Kraft's cereal business continues to be affected by intense price competition, particularly from value brands. In the second quarter of 1996, Kraft implemented a price rollback and simplified couponing of its cereal products. Several competitors followed with similar pricing strategies. The reduction of cereal prices in 1996 lowered operating revenues and operating profit in 1996 and the first quarter of 1997 in relation to prior period results. Operating Results Operating Revenues Operating Profit (in millions) 1997 1996 1995 1997 1996 1995 ================================================================================ North American food $ 16,838 $ 16,447 $ 17,891 $2,873 $2,628 $2,542 International food 10,852 11,503 11,183 1,326 1,303 1,218 Amortization of goodwill (552) (569) (572) - -------------------------------------------------------------------------------- Total $ 27,690 $ 27,950 $ 29,074 $3,647 $3,362 $3,188 ================================================================================ 1997 Compared with 1996 North American food. During 1997, operating revenues increased 2.4% over 1996, due to volume increases in ongoing operations ($576 million), pricing ($275 million, primarily due to commodity-driven cost increases) and the impact of acquisitions ($93 million), partially offset by the impact of divestitures ($372 million), unfavorable product mix ($155 million) and unfavorable currency movements ($26 million). Operating profit for 1997 increased 9.3% over 1996, due primarily to price increases and net cost decreases (aggregating $377 million, aided by productivity-driven cost savings and lower cheese commodity costs) and volume increases in ongoing operations ($335 million), partially offset by unfavorable product mix ($97 million), the impact of divestitures ($61 million), and higher marketing, administration and research costs ($304 million, due primarily to higher marketing expense, which included additional marketing activities for new products). Included in marketing, administration and research costs was a gain of $159 million on the sale of maple-flavored syrup businesses, as well as charges of $64 million related to the discontinuation of several small operations, year 2000 systems conversion costs of $38 million and the above mentioned additional marketing expense for new product initiatives. Excluding operating results of the divested North American food businesses discussed above, ongoing operating revenues and ongoing operating profit increased 4.8% and 12.0%, respectively, in 1997 over 1996. Strong ongoing volume gains were driven by frozen pizza, resulting from geographic expansion and new products that have increased United States frozen pizza volume; beverages, from the strength of ready-to-drink products; meals, due to the acquisition and subsequent growth of Taco Bell grocery products as well as strength in macaroni and cheese dinners; cereals, aided by new product introductions; and desserts and snacks, due to new product introductions and strength in refrigerated ready-to-eat desserts, shelf-stable puddings and dry packaged desserts. Cheese volume also increased, benefiting from lower prices due to lower commodity costs, new products and marketing initiatives. Volume gains were also realized in processed meats, driven by continued growth of lunch combinations (including new product introductions) and growth in hot dogs and cold cuts. Coffee volume in 1997 declined from 1996 as customers reacted to commodity-driven price increases. Volume for pourable salad dressings increased despite intense competition. In Canada, volume decreased due to a planned exit of lower-margin foodservice product lines; however, retail volume increased. 1997 Compared with 1996 International food. Operating revenues for 1997 decreased 5.7% from 1996, due to unfavorable currency movements ($955 million), lower volume/mix ($70 million) and the impact of divestitures ($295 million), partially offset by pricing, ($397 million) and the impact of newly acquired and previously unconsolidated subsidiaries ($272 million). Operating profit for 1997 increased 1.8% over 1996, due primarily to lower marketing, administration and research costs ($52 million), the impact of newly acquired and previously unconsolidated subsidiaries ($41 million) and the gain on the sale of PMI's Brazilian ice cream businesses ($774 30 million), partially offset by unfavorable currency movements ($62 million), cost increases, net of price increases (aggregating $59 million, primarily related to higher coffee and cocoa costs), the impact of divestitures ($108 million) and charges recorded during 1997 for the realignment of international food operations ($630 million). Marketing, administration and research costs include a $774 million gain on the divestiture of the Brazilian ice cream businesses and charges totaling $630 million for the previously discussed realignment of international food operations and related incremental postemployment costs. Excluding the operating results of the divested international food businesses, the gain on the sale of the Brazilian ice cream businesses and the charges for realignment of international food operations, discussed above, underlying operating revenues decreased 3.3% and underlying operating profit decreased 1.1% in 1997 from 1996. KFI's coffee volume decreased during 1997, reflecting customers' reactions to commodity-driven price increases. KFI's confectionery volume, excluding the impact of divestitures, increased slightly due to volume increases in the Ukraine and the former Yugoslavia, partially offset by lower Scandinavian volume, due to an exceptionally warm summer, and lower volume in Romania and Bulgaria, reflecting poor economic environments. KFI's cheese and grocery volumes, excluding the impact of divestitures, increased due primarily to gains in KFI's Asia/Pacific region, principally China, the Philippines and Australia. PMI's food volume in Latin America for 1997 increased over 1996, due primarily to the acquisition of Lacta and higher beverage volume. 1996 Compared with 1995 North American food. During 1996, operating revenues decreased 8.1% from 1995, due primarily to the impact of divestitures ($2.0 billion), product mix ($95 million) and pricing ($82 million), partially offset by volume increases in ongoing operations ($662 million), the impact of acquisitions ($63 million) and favorable currency movements ($39 million). Operating profit increased 3.4% over 1995 due primarily to volume increases in ongoing operations ($405 million) and lower marketing, administration and research costs ($46 million), partially offset by net price reductions and net cost increases ($158 million), the impact of divestitures ($116 million), and product mix ($101 million). Kraft had net gains from sales of businesses of $250 million in 1996. Kraft initiated cost-saving actions in 1996 and provided $250 million for the downsizing and closure of facilities. The effect of pricing on 1996 operating revenues was due primarily to price reductions in coffee and cereals, partially offset by price increases in cheese. The effect of net price reductions on 1996 operating profit was due primarily to price reductions in cereals. The effect of net cost increases on 1996 operating profit was due primarily to higher cheese commodity costs. Excluding operating results of the divested businesses discussed above, 1996 North American food ongoing operating revenues and ongoing operating profit increased 3.8% and 8.5%, respectively, over 1995. Significant volume gains were achieved in beverages, on the strength of ready-to-drink and powdered products, and in frozen pizza, helped by new product introductions and geographic market expansion. Volume also increased in desserts, due to strength in packaged and refrigerated products, as well as the acquisition of a shelf-stable pudding product line in the fourth quarter of 1995; coffee, aided by sales of premium-priced line extensions; processed meats, with growth in lunch combinations, driven by product introductions, and cold cuts; and meals, due to strength in dinners and stuffing. Volume increased in cereals in 1996, due primarily to product introductions and the implementation of price reductions and simplified couponing in the second quarter of 1996. Despite lower consumption in the process cheese category as prices rose, total cheese volume grew slightly due to new product introductions. 1996 Compared with 1995 International food. Operating revenues for 1996 increased 2.9% over 1995, due primarily to higher volume ($44 million), the consolidation of previously unconsolidated operations ($612 million) and the impact of acquisitions ($105 million), partially offset by pricing ($255 million, primarily coffee), the impact of divestitures ($137 million) and unfavorable currency movements ($49 million). Operating profit during 1996 increased 7.0% over 1995, reflecting higher volume ($23 million), cost decreases, net of price reductions ($81 million), the consolidation of previously unconsolidated operations ($66 million) and favorable currency movements ($7 million), partially offset by higher marketing, administration and research costs ($101 million, primarily higher marketing costs) and the impact of divestitures ($7 million). KFI had net gains of $70 million from sales of businesses in 1996 as discussed previously. Steps were taken during 1996 to lower KFI's overhead costs and strengthen the marketing of KFI brands in the price competitive environments of Europe. KFI provided $70 million for cost-saving actions that included increased severance for workforce reductions. Higher international food volume was due primarily to the consolidation of previously unconsolidated businesses, the acquisition of Lacta and growth in coffee. KFI's coffee volume increased in all regions during 1996, particularly in several key markets such as Germany and France, KFI's largest coffee markets. The gains were a result of increased marketing and several premium product introductions. KFI's confectionery volume increased, due primarily to the emerging markets of Central and Eastern Europe, but declined in Western Europe where competition remained intense. KFI's cheese and grocery volumes decreased, due to divestitures of businesses, lower consumption of beef in Italy, and the effects of a peanut butter recall in Australia, partially offset by increased sales of snacks in Scandinavia. Latin America volume was higher as a result of the 31 acquisition of Lacta and strong sales of powdered soft drinks throughout the region. Beer 1997 Compared with 1996 Operating revenues of the Miller Brewing Company ("Miller") for 1997 decreased $126 million (2.9%) from 1996, due to unfavorable price/mix ($114 million) and lower volume ($12 million). Operating profit for 1997 increased $19 million (4.3%) over 1996, due primarily to lower marketing, administration and research costs ($67 million) and lower manufacturing costs ($25 million), partially offset by unfavorable price/mix ($71 million) and lower volume ($5 million). Included in marketing, administration and research costs is a $12 million gain on the sale of Miller's 20% equity interest in Molson Breweries of Canada ("Molson Canada"), a Canadian beer operation, and a 49% interest in Molson USA, LLC, a beer import operation. Operating revenues, manufacturing costs and marketing, administration and research costs in 1997 were impacted by actions taken by Miller in 1996 to restore growth, streamline its organization and reduce future costs. Miller's total shipment volume (which excludes international shipments of Miller products by other brewers under license and contract brewing arrangements) of 43.7 million barrels for 1997 decreased 0.3% from 1996, reflecting lower export shipments of premium-priced brands, partially offset by increased domestic shipments. Miller's estimated market share of the U.S. malt beverage industry (based on shipments) was 21.8%, the same as in the prior year. Wholesalers' sales to retailers in 1997 increased slightly from 1996, reflecting higher sales of Miller Lite, as Miller's new advertising and promotional campaigns renewed focus on major brands. Domestic shipments rose 0.8%, while export shipments decreased in 1997, reflecting a shift toward international licensing and contract brewing arrangements. International sales of Miller products under such arrangements more than offset the 1997 decrease in export shipments. 1996 Compared with 1995 Operating revenues of Miller for 1996 increased $23 million (0.5%) from 1995, due to price/mix improvements ($136 million) and the impact of acquisitions ($7 million), partially offset by lower volume ($119 million). Operating profit decreased $7 million (1.6%) from 1995, due to lower volume ($49 million) and unfavorable fixed manufacturing costs ($18 million), partially offset by price/mix improvements, net of higher material costs ($25 million) and lower marketing, administration and research costs ($36 million, primarily marketing). During 1996, Miller recorded its share of a restructuring charge at then 20%-owned Molson Canada and realized the benefit of lower than anticipated costs for integrating Molson USA's operations. Also, in 1996, Miller took several actions to restore growth, streamline its organization and reduce future costs. These included a workforce reduction, the costs of which were charged against the existing postemployment liability. The impact of these items was not material to Miller's operating profit for 1996. Miller's 1996 total shipment volume of 43.8 million barrels decreased 2.7% from 1995. Despite higher shipments of Miller Lite in 1996, shipments of premium-priced brands decreased, as did shipments of budget-priced brands. Lower volume was due to softness in most of Miller's brands and intense competition. Miller's market share of the U.S. malt industry (based on shipments) was 21.8%, down 0.8 share points from 1995. Despite lower overall volume, Miller's premium shipments increased to 82.5% from 81.8% of Miller's total shipments. Financial Services and Real Estate During 1997, Philip Morris Capital Corp. ("PMCC") sold its real estate subsidiary, Mission Viejo Company, for a pretax gain of $103 million. Operating revenues and operating profit from PMCC's financial services business increased in 1997 and 1996 over the prior years due to the continued growth of its leasing and structured finance portfolio. Financial Review Net Cash Provided by Operating Activities During 1997, net cash provided by operating activities was $8.3 billion compared with $7.6 billion in 1996. The increase was due primarily to the increase in net earnings excluding the litigation settlement charges. Unpaid tobacco litigation settlement accruals increased other working capital. During 1996, cash provided by operating activities was $947 million higher than in 1995 due primarily to higher net earnings. Net Cash Used in Investing Activities During 1997, net cash used in investing activities was $619 million, compared with $2.1 billion used during 1996. The change was due primarily to higher cash provided by divestitures of $2.2 billion in 1997 compared with $612 million in 1996, partially offset by slight increases in cash used for capital expenditures and acquisitions. During 1997, $2.2 billion was provided by the sales of PMI's Brazilian ice cream businesses, Mission Viejo Company's real estate operations and several other food and beer businesses. During 1997, PMI acquired a controlling interest in a Portuguese tobacco company and increased its ownership interest in a Mexican cigarette business. During 1996, PMI acquired a controlling interest in a Polish tobacco company and nearly all of the remaining voting shares of a Brazilian confectionery company in 1996. During 1996, net cash used in investing activities was $2.1 billion, compared with $109 million during 1995. The change was due primarily to cash used in 1996 for acquisitions, discussed 32 above, compared with cash received in 1995 from the sales of food businesses. During 1995, Kraft sold its North American bakery, margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. In addition, several smaller international food businesses were sold in 1995. Total proceeds from the sales of these businesses were $2.1 billion. In 1996, the Company sold several domestic and international food businesses, including the North American bagel business, for proceeds of $612 million. Capital expenditures for 1997 increased 5.2%, to $1.9 billion, of which 50% related to tobacco operations and 39% related to food operations, primarily for modernization and consolidation of manufacturing facilities and expansion of certain production capacity. Capital expenditures are expected to be approximately the same amount in 1998. Estimated future capital expenditures are subject to the availability of funding if the legislation implementing the proposed Resolution or its substantial equivalent is enacted. Net Cash Used in Financing Activities During 1997, the Company's net cash used in financing activities decreased to $5.5 billion, compared to $6.4 billion used in 1996, due primarily to lower stock repurchases, partially offset by higher dividends paid and an increase in net repayments of short-term borrowings and long-term debt. During 1996, the Company's net cash used in financing activities increased to $6.4 billion, from $5.6 billion in 1995, due primarily to increases in stock repurchases and dividends paid, partially offset by lower net repayments of short-term borrowings and long-term debt. Debt The Company's total debt (consumer products and financial services) was $14.1 billion, $15.2 billion and $15.8 billion at December 31, 1997, 1996 and 1995, respectively. Total consumer products debt was $13.3 billion, $13.9 billion and $14.4 billion at December 31, 1997, 1996 and 1995, respectively. At December 31, 1997 and December 31, 1996, the Company's ratio of consumer products debt to total equity was 0.89 and 0.98, respectively. The ratio of total debt to total equity was 0.95 and 1.07 at December 31, 1997 and December 31, 1996, respectively. As discussed above in "Tobacco--Business Environment," PM Inc. estimates that the proposed Resolution in its current form would result in an initial payment by PM Inc. of approximately $6.6 billion upon enactment (to be adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions). The Company anticipates that the payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The Company further anticipates that the payment will result in significant increases in its consumer products debt to total equity ratio, total debt to total equity ratio and total debt outstanding. Fixed rate debt constituted approximately 98% and 86% of total consumer products debt at December 31, 1997 and 1996, respectively. The increase reflects the Company's use of cash to repay commercial paper borrowings in 1997. The average interest rate on total consumer products debt, including the impact of currency swap agreements discussed below, was approximately 7.6% and 7.5% at December 31, 1997 and 1996, respectively. The Company and its subsidiaries maintain credit facilities with a number of lending institutions, amounting to approximately $12.0 billion at December 31, 1997. Approximately $11.8 billion of these facilities were unused at December 31, 1997. These include revolving bank credit agreements totaling $10.0 billion. These facilities may be used to support any commercial paper borrowings by the Company and are available for acquisitions and other corporate purposes. An agreement for $2.0 billion expires in October 1998. An agreement for $8.0 billion expires in 2002, enabling the Company to refinance short-term debt on a long-term basis. Based upon the Company's intent and ability to refinance such debt, consumer products short-term borrowings of $37 million and $1.4 billion were reclassified as long-term debt at December 31, 1997 and 1996, respectively. The Company expects to continue to refinance long-term and short-term debt from time to time. The nature and amount of the Company's long-term and short-term debt and the proportionate amount of each can be expected to vary as a result of future business requirements, market conditions and other factors. The Company operates internationally, with manufacturing and sales facilities in various locations around the world. The Company continually evaluates its foreign currency net asset exposure (primarily the Swiss franc, German mark, Netherlands guilder, Swedish krona and Canadian dollar) based on current market conditions and business strategies, and it acts to manage such exposure, when deemed prudent, through various hedging transactions. The Company has entered into currency and related interest rate swap agreements to manage exposure to currency movements. The U.S. dollar value of aggregate notional principal amounts for these agreements outstanding was equivalent to $1.4 billion and $2.2 billion at December 31, 1997 and 1996, respectively. Of these amounts, $736 million and $1.5 billion related to consumer products debt at December 31, 1997 and 1996, respectively. The Company enters into forward exchange and option contracts, for purposes other than trading, to reduce the effects of fluctuating foreign currency on foreign currency denominated current assets, liabilities, commitments and short-term intercompany transactions. At December 31, 1997 and 1996, the Company had entered into contracts with maturities of less than one year and U.S. dollar equivalents of $2.5 billion (including $1.1 billion in option contracts) and $1.7 billion, respectively. 33 Use of the above-mentioned derivative financial instruments has not had a material impact on the Company's financial position at December 31, 1997 and 1996 or the Company's results of operations for the years ended December 31, 1997, 1996 and 1995. The Company enters into commodity futures and forward contracts to procure raw materials, primarily coffee, cocoa, sugar, wheat and corn. Commodity futures and options are also used to hedge the price of certain commodities, primarily coffee and cocoa. At December 31, 1997 and 1996, the Company had net long commodity positions of $266 million and $197 million, respectively. Unrealized losses on net commodity positions were immaterial at December 31, 1997 and 1996. The Company's credit ratings by Moody's at December 31, 1997 and 1996 were "P-1" in the commercial paper market and "A2" for long-term debt obligations. The Company's credit ratings by Standard & Poor's ("S&P") at December 31, 1997 and 1996 were "A-1" in the commercial paper market and "A" for long-term debt obligations. In April 1997, S&P placed the debt ratings of the Company on its CreditWatch list with the intent of monitoring tobacco litigation developments. Equity and Dividends On February 26, 1997, the Company's Board of Directors declared a three-for-one split of the Company's common stock, effected by a distribution on April 10, 1997, of two shares for each share held of record at the close of business on March 17, 1997. All share and per share data have been restated to reflect this stock split for all periods presented. During 1997, the Company repurchased 18.2 million shares of its common stock at an aggregate cost of $743 million. Of these purchases, 16.9 million shares ($692 million) were made pursuant to the Company's repurchase program, announced in 1994, to purchase up to $6.0 billion of its common stock in the open market, and the remainder were made under an $8.0 billion share repurchase program approved by the Board of Directors in the first quarter of 1997. These 1997 repurchases, net of 12.3 million shares issued under the Company's stock award plans during 1997, resulted in lower weighted average shares outstanding for 1997 as compared to 1996. Dividends paid in 1997 were 12.2% higher than in 1996, reflecting a higher dividend rate in 1997, partially offset by fewer shares outstanding. The Board of Directors increased the Company's quarterly dividend rate to $0.40 per share in the third quarter of 1996, resulting in an annualized dividend rate of $1.60 per share. As discussed above in the last paragraph of "Tobacco--Business Environment--Proposed Resolution of Certain Regulatory and Litigation Issues," the Company may reevaluate its share repurchase and dividend policies. During 1997, currency translation adjustments reduced equity by $1.3 billion due to the strengthening of the U.S. dollar versus European currencies, primarily the Swiss franc, German mark, Netherlands guilder and Swedish krona. Return on average stockholders' equity decreased to 43.3% in 1997 from 44.7% in 1996. The decrease from 1996 primarily reflects higher average stockholders' equity and the effect of litigation settlements in 1997. Cash and Cash Equivalents Cash and cash equivalents increased to $2.3 billion at December 31, 1997 from $240 million at December 31, 1996. The increase primarily reflects cash provided by divestitures and lower repurchases of common stock, partially offset by tobacco litigation settlement payments and higher dividend payments. Market Risk The Company is exposed to the impact of changes in interest rates, foreign exchange rates and commodity prices. In the normal course of business, the Company manages such exposures through the use of a variety of financial and derivative financial instruments when deemed prudent. The Company's objective in managing these exposures is to reduce fluctuations in earnings and cash flows associated with changes in interest rates, foreign currency rates and commodity prices. The Company manages its exposure to interest rate risk through the proportion of fixed rate and variable rate debt in its total debt portfolio. The Company enters into various contracts, which change in value as foreign exchange rates change, to preserve the carrying value of foreign currency assets, liabilities, commitments and anticipated foreign currency transactions. The Company uses foreign currency option contracts to hedge certain anticipated foreign currency revenues and raw materials purchases. The Company also enters into short-term currency forward contracts, primarily to hedge intercompany transactions denominated in foreign currencies and commodity purchases. In addition, the Company seeks to protect the carrying value of certain of its net investments in foreign subsidiaries generally through the use of foreign currency-denominated debt or currency swap agreements. Raw materials used by the Company's food businesses are exposed to the impact of changing commodity prices. Accordingly, the Company enters into commodity future, forward and option contracts to manage fluctuations in prices of anticipated purchases of certain commodities, primarily coffee, cocoa, sugar, wheat and corn. It is the Company's policy and practice to use foreign currency and commodity derivative financial instruments only to the extent necessary to manage exposures as stated above. The Company does not enter into foreign currency or commodity derivative transactions for speculative purposes. 34 Value at Risk The Company uses a value at risk ("VAR") computation to estimate the maximum potential one-day loss in the fair value of its interest rate-sensitive financial instruments and to estimate the maximum one-day loss in pretax earnings of its foreign currency and commodity price-sensitive derivative financial instruments. The VAR computation includes the Company's debt; short-term investments; foreign currency forwards, swaps and options; and commodity futures, forwards and options. Anticipated transactions, foreign currency payables and receivables, and net investments in foreign subsidiaries, which the foregoing instruments are intended to hedge, were excluded from the computation. Since the Company uses currency rate-sensitive and commodity price-sensitive instruments to hedge a certain portion of its existing and anticipated transactions, the Company expects that any loss in value for those instruments generally would be offset by increases in the value of those hedged transactions. The VAR estimates were made assuming normal market conditions, using a 95% confidence interval. The Company used a "variance/co-variance" model to determine the observed interrelationships between movements in interest rates and various currencies. These interrelationships were determined by observing interest rate and forward currency rate movements over the preceding quarter for the calculation of VAR amounts at December 31, 1997 and over each of the four preceding quarters for the calculation of average VAR amounts during the year. The values of foreign currency and commodity options do not change on a one-to-one basis with the underlying currency or commodity and were valued accordingly in the VAR computation. The estimated maximum potential one-day loss in fair value of the Company's interest rate-sensitive instruments, primarily debt, under normal market conditions and the estimated maximum potential one-day loss in pretax earnings from foreign currency and commodity instruments under normal market conditions, as calculated in the previously discussed VAR model, follow: Earnings Impact Fair Value Impact ----------------- ----------------- At 1997 At 1997 (in millions) 12/31/97 Average 12/31/97 Average ================================================================================ Instruments sensitive to: Interest rates $37 $40 Foreign currency rates $5 $7 Commodity prices $7 $8 ================================================================================ The VAR computation is a risk analysis tool designed to statistically estimate the maximum probable daily loss from adverse movements in interest rates, foreign currency rates and commodity prices under normal market conditions. The computation does not purport to represent actual losses in fair value or earnings to be incurred by the Company, nor does it consider the effect of favorable changes in market rates. The Company cannot predict actual future movements in such market rates and does not present these VAR results to be indicative of future movements in such market rates or to be representative of any actual impact that future changes in market rates may have on its future results of operations or financial position. Contingencies See Note 15 to the 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, of the proposed Resolution 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 and local economic conditions. 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. 35 Selected Financial Data--Eleven-Year Review (in millions of dollars, except per share data)
1997 1996 1995 1994 1993 ============================================================================================================================= Summary of Operations: Operating revenues $ 72,055 $ 69,204 $ 66,071 $ 65,125 $ 60,901 United States export sales 6,705 6,476 5,920 4,942 4,105 Cost of sales 26,689 26,560 26,685 28,351 26,771 Federal excise taxes on products 3,596 3,544 3,446 3,431 3,081 Foreign excise taxes on products 12,345 11,107 9,486 7,918 7,199 - ----------------------------------------------------------------------------------------------------------------------------- Operating income 11,663 11,769 10,526 9,449 7,587 Interest and other debt expense, net 1,052 1,086 1,179 1,233 1,391 Earnings before income taxes and cumulative effect of accounting changes 10,611 10,683 9,347 8,216 6,196 Pretax profit margin 14.7% 15.4% 14.1% 12.6% 10.2% Provision for income taxes 4,301 4,380 3,869 3,491 2,628 - ----------------------------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting changes 6,310 6,303 5,478 4,725 3,568 Cumulative effect of accounting changes (28) (477) Net earnings 6,310 6,303 5,450 4,725 3,091 Basic EPS before cumulative effect of accounting changes 2.61 2.57 2.18 1.82 1.35 Per share cumulative effect of accounting changes (0.01) (0.18) - ----------------------------------------------------------------------------------------------------------------------------- Basic EPS 2.61 2.57 2.17 1.82 1.17 Diluted EPS before cumulative effect of accounting changes 2.58 2.54 2.16 1.81 1.35 Per share cumulative effect of accounting changes (0.01) (0.18) Diluted EPS 2.58 2.54 2.15 1.81 1.17 Dividends declared per share 1.60 1.47 1.22 1.01 0.87 Weighted average shares (millions)--Basic 2,420 2,456 2,517 2,597 2,633 Weighted average shares (millions)--Diluted 2,442 2,482 2,538 2,610 2,645 - ----------------------------------------------------------------------------------------------------------------------------- Capital expenditures 1,874 1,782 1,621 1,726 1,592 Depreciation 1,045 1,038 1,023 1,025 1,042 Property, plant and equipment, net (consumer products) 11,621 11,751 11,116 11,171 10,463 Inventories (consumer products) 9,039 9,002 7,862 7,897 7,358 Total assets 55,947 54,871 53,811 52,649 51,205 Total long-term debt 12,430 12,961 13,107 14,975 15,221 Total debt--consumer products 13,258 13,933 14,372 14,978 16,364 --financial services and real estate 845 1,307 1,454 1,494 1,792 - ----------------------------------------------------------------------------------------------------------------------------- Total deferred income taxes 3,382 3,336 2,827 2,496 2,168 Stockholders' equity 14,920 14,218 13,985 12,786 11,627 Common dividends declared as a % of Basic EPS 61.3% 57.2% 56.2% 55.5% 74.4% Common dividends declared as a % of Diluted EPS 62.0% 57.9% 56.7% 55.8% 74.4% Book value per common share outstanding 6.15 5.85 5.61 5.00 4.42 Market price per common share--high/low 48.13-36.00 39.67-28.54 31.46-18.58 21.50-15.75 25.88-15.00 - ----------------------------------------------------------------------------------------------------------------------------- Closing price of common share at year end 45.25 37.67 30.08 19.17 18.54 Price/earnings ratio at year end--Basic 17 15 14 11 16 Price/earnings ratio at year end--Diluted 18 15 14 11 16 Number of common shares outstanding at year end (millions) 2,425 2,430 2,493 2,559 2,631 Number of employees 152,000 154,000 151,000 165,000 173,000 ============================================================================================================================= 1992 1991 1990 1989 =========================================================================================================== Summary of Operations: Operating revenues $ 59,131 $ 56,458 $ 51,169 $ 44,080 United States export sales 3,797 3,061 2,928 2,288 Cost of sales 26,082 25,612 24,430 21,868 Federal excise taxes on products 2,879 2,978 2,159 2,140 Foreign excise taxes on products 6,157 5,416 4,687 3,608 - ----------------------------------------------------------------------------------------------------------- Operating income 10,059 8,622 7,946 6,789 Interest and other debt expense, net 1,451 1,651 1,635 1,731 Earnings before income taxes and cumulative effect of accounting changes 8,608 6,971 6,311 5,058 Pretax profit margin 14.6% 12.3% 12.3% 11.5% Provision for income taxes 3,669 3,044 2,771 2,112 - ----------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting changes 4,939 3,927 3,540 2,946 Cumulative effect of accounting changes (921) Net earnings 4,939 3,006 3,540 2,946 Basic EPS before cumulative effect of accounting changes 1.82 1.41 1.28 1.06 Per share cumulative effect of accounting changes (0.33) - ----------------------------------------------------------------------------------------------------------- Basic EPS 1.82 1.08 1.28 1.06 Diluted EPS before cumulative effect of accounting changes 1.80 1.40 1.27 1.05 Per share cumulative effect of accounting changes (0.33) Diluted EPS 1.80 1.07 1.27 1.05 Dividends declared per share 0.78 0.64 0.52 0.42 Weighted average shares (millions)--Basic 2,717 2,773 2,774 2,778 Weighted average shares (millions)--Diluted 2,741 2,798 2,792 2,797 - ----------------------------------------------------------------------------------------------------------- Capital expenditures 1,573 1,562 1,355 1,246 Depreciation 963 938 876 755 Property, plant and equipment, net (consumer products) 10,530 9,946 9,604 8,457 Inventories (consumer products) 7,785 7,445 7,153 5,751 Total assets 50,014 47,384 46,569 38,528 Total long-term debt 14,583 14,213 16,121 14,551 Total debt--consumer products 16,269 15,289 17,182 14,887 --financial services and real estate 1,934 1,611 1,560 1,538 - ----------------------------------------------------------------------------------------------------------- Total deferred income taxes 2,248 1,803 2,083 1,732 Stockholders' equity 12,563 12,512 11,947 9,571 Common dividends declared as a % of Basic EPS 42.9% 59.3% 40.6% 39.6% Common dividends declared as a % of Diluted EPS 43.3% 59.8% 40.9% 40.0% Book value per common share outstanding 4.69 4.53 4.30 3.43 Market price per common share--high/low 28.88-23.17 27.25-16.08 17.33-12.00 15.17-8.33 - ----------------------------------------------------------------------------------------------------------- Closing price of common share at year end 25.71 26.75 17.25 13.88 Price/earnings ratio at year end--Basic 14 25 13 13 Price/earnings ratio at year end--Diluted 14 25 14 13 Number of common shares outstanding at year end (millions) 2,679 2,760 2,778 2,787 Number of employees 161,000 166,000 168,000 157,000 ===========================================================================================================
1988 1987 ================================================================================ Summary of Operations: Operating revenues $ 31,273 $ 27,650 United States export sales 1,863 1,592 Cost of sales 13,565 12,183 Federal excise taxes on products 2,127 2,085 Foreign excise taxes on products 3,755 3,331 - -------------------------------------------------------------------------------- Operating income 4,397 3,990 Interest and other debt expense, net 670 646 Earnings before income taxes and cumulative effect of accounting changes 3,727 3,344 Pretax profit margin 11.9% 12.1% Provision for income taxes 1,663 1,502 - -------------------------------------------------------------------------------- Earnings before cumulative effect of accounting changes 2,064 1,842 Cumulative effect of accounting changes 273 Net earnings 2,337 1,842 Basic EPS before cumulative effect of accounting changes 0.74 0.65 Per share cumulative effect of accounting changes 0.10 - -------------------------------------------------------------------------------- Basic EPS 0.84 0.65 Diluted EPS before cumulative effect of accounting changes 0.73 0.64 Per share cumulative effect of accounting changes 0.10 Diluted EPS 0.83 0.64 Dividends declared per share 0.34 0.26 Weighted average shares (millions)--Basic 2,796 2,854 Weighted average shares (millions)--Diluted 2,805 2,868 - -------------------------------------------------------------------------------- Capital expenditures 1,024 718 Depreciation 608 564 Property, plant and equipment, net (consumer products) 8,648 6,582 Inventories (consumer products) 5,384 4,154 Total assets 36,960 21,437 Total long-term debt 16,812 5,983 Total debt--consumer products 16,442 6,355 --financial services and real estate 1,504 1,378 - -------------------------------------------------------------------------------- Total deferred income taxes 1,559 2,044 Stockholders' equity 7,679 6,823 Common dividends declared as a % of Basic EPS 40.5% 40.0% Common dividends declared as a % of Diluted EPS 41.0% 40.6% Book value per common share outstanding 2.77 2.40 Market price per common share--high/low 8.50-6.71 10.38-6.04 - -------------------------------------------------------------------------------- Closing price of common share at year end 8.50 7.13 Price/earnings ratio at year end--Basic 10 11 Price/earnings ratio at year end--Diluted 10 11 Number of common shares outstanding at year end (millions) 2,772 2,841 Number of employees 155,000 113,000 ================================================================================ During 1997, the Company's Board of Directors declared a three-for-one split of the Company's common stock. In addition, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." All prior year share and per share data have been restated to reflect the impact of the stock split and adoption of SFAS No. 128. See notes to the consolidated financial statements regarding acquisitions and divestitures in 1997, 1996 and 1995; the adoption of SFAS No. 116 and SFAS No. 106 for non-U.S. benefit plans in 1993; the international food realignment in 1997; and tobacco litigation settlement charges in 1997. 36 & 37 Consolidated Balance Sheets (in millions of dollars, except per share data) at December 31, 1997 1996 ================================================================================ Assets Consumer products Cash and cash equivalents $ 2,282 $ 240 Receivables, net 4,294 4,466 Inventories: Leaf tobacco 4,348 4,143 Other raw materials 1,689 1,854 Finished product 3,002 3,005 - -------------------------------------------------------------------------------- 9,039 9,002 Other current assets 1,825 1,482 - -------------------------------------------------------------------------------- Total current assets 17,440 15,190 Property, plant and equipment, at cost: Land and land improvements 666 664 Buildings and building equipment 5,114 5,168 Machinery and equipment 12,667 12,481 Construction in progress 1,555 1,659 - -------------------------------------------------------------------------------- 20,002 19,972 Less accumulated depreciation 8,381 8,221 - -------------------------------------------------------------------------------- 11,621 11,751 Goodwill and other intangible assets (less accumulated amortization of $4,814 and $4,391) 17,789 18,998 Other assets 3,211 3,015 - -------------------------------------------------------------------------------- Total consumer products assets 50,061 48,954 Financial services and real estate Finance assets, net 5,712 5,345 Other assets 174 572 - -------------------------------------------------------------------------------- Total financial services and real estate assets 5,886 5,917 - -------------------------------------------------------------------------------- Total Assets $55,947 $54,871 ================================================================================ See notes to consolidated financial statements. 38
1997 1996 ================================================================================================= Liabilities Consumer products Short-term borrowings $ 157 $ 260 Current portion of long-term debt 1,516 1,846 Accounts payable 3,318 3,409 Accrued liabilities: Marketing 2,149 2,106 Taxes, except income taxes 1,234 1,331 Employment costs 1,083 942 Other 3,780 2,726 Income taxes 862 1,269 Dividends payable 972 978 - ------------------------------------------------------------------------------------------------- Total current liabilities 15,071 14,867 Long-term debt 11,585 11,827 Deferred income taxes 889 731 Accrued postretirement health care costs 2,432 2,372 Other liabilities 6,218 5,773 - ------------------------------------------------------------------------------------------------- Total consumer products liabilities 36,195 35,570 Financial services and real estate Short-term borrowings 173 Long-term debt 845 1,134 Deferred income taxes 3,877 3,636 Other liabilities 110 140 - ------------------------------------------------------------------------------------------------- Total financial services and real estate liabilities 4,832 5,083 - ------------------------------------------------------------------------------------------------- Total liabilities 41,027 40,653 Contingencies (Note 15) Stockholders' Equity Common stock, par value $0.33 1/3 per share (2,805,961,317 shares issued) 935 935 Earnings reinvested in the business 24,924 22,478 Currency translation adjustments (1,109) 192 - ------------------------------------------------------------------------------------------------- 24,750 23,605 Less cost of repurchased stock (380,474,028 and 374,615,043 shares) 9,830 9,387 - ------------------------------------------------------------------------------------------------- Total stockholders' equity 14,920 14,218 - ------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 55,947 $54,871 =================================================================================================
See notes to consolidated financial statements. 39 Consolidated Statements of Earnings (in millions of dollars, except per share data)
for the years ended December 31, 1997 1996 1995 ========================================================================================================= Operating revenues $ 72,055 $69,204 $66,071 Cost of sales 26,689 26,560 26,685 Excise taxes on products 15,941 14,651 12,932 - --------------------------------------------------------------------------------------------------------- Gross profit 29,425 27,993 26,454 Marketing, administration and research costs 15,720 15,630 15,337 Settlement charges (Note 15) 1,457 Amortization of goodwill 585 594 591 - --------------------------------------------------------------------------------------------------------- Operating income 11,663 11,769 10,526 Interest and other debt expense, net 1,052 1,086 1,179 - --------------------------------------------------------------------------------------------------------- Earnings before income taxes and cumulative effect of accounting changes 10,611 10,683 9,347 Provision for income taxes 4,301 4,380 3,869 - --------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting changes 6,310 6,303 5,478 Cumulative effect of accounting changes (28) - --------------------------------------------------------------------------------------------------------- Net earnings $ 6,310 $ 6,303 $ 5,450 ========================================================================================================= Per share data: Basic earnings per share before cumulative effect of accounting changes $ 2.61 $ 2.57 $ 2.18 Cumulative effect of accounting changes (.01) - --------------------------------------------------------------------------------------------------------- Basic earnings per share $ 2.61 $ 2.57 $ 2.17 ========================================================================================================= Diluted earnings per share before cumulative effect of accounting changes $ 2.58 $ 2.54 $ 2.16 Cumulative effect of accounting changes (.01) - --------------------------------------------------------------------------------------------------------- Diluted earnings per share $ 2.58 $ 2.54 $ 2.15 =========================================================================================================
Consolidated Statements of Cash Flows (in millions of dollars)
for the years ended December 31, 1997 1996 1995 ================================================================================================================= Cash Provided By (Used In) Operating Activities Net earnings--Consumer products $ 6,152 $ 6,180 $ 5,345 --Financial services and real estate 158 123 105 - ----------------------------------------------------------------------------------------------------------------- Net earnings 6,310 6,303 5,450 Adjustments to reconcile net earnings to operating cash flows: Consumer products Depreciation and amortization 1,700 1,691 1,671 International food realignment 630 Deferred income tax (benefit) provision (188) 163 15 Gain on sale of Brazilian ice cream businesses (774) Gains on sales of other businesses (196) (320) (275) Cumulative effect of accounting changes 46 Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net (168) 35 (466) Inventories (531) (952) (5) Accounts payable 37 60 (260) Income taxes 48 373 266 Other working capital items 726 (448) (482) Other 582 467 354 =================================================================================================================
See notes to consolidated financial statements. 40 Consolidated Statements of Cash Flows (continued)
for the years ended December 31, 1997 1996 1995 ========================================================================================= Financial services and real estate Deferred income tax provision $ 257 $ 224 $ 299 Gain on sale of business (103) Other 10 38 74 - ----------------------------------------------------------------------------------------- Net cash provided by operating activities 8,340 7,634 6,687 - ----------------------------------------------------------------------------------------- Cash Provided By (Used In) Investing Activities Consumer products Capital expenditures (1,874) (1,782) (1,621) Purchase of businesses, net of acquired cash (630) (616) (217) Proceeds from sales of businesses 1,784 612 2,202 Other 42 (47) 17 Financial services and real estate Investments in finance assets (652) (439) (613) Proceeds from finance assets 287 217 123 Proceeds from sale of business 424 - ----------------------------------------------------------------------------------------- Net cash used in investing activities (619) (2,055) (109) - ----------------------------------------------------------------------------------------- Cash Provided By (Used In) Financing Activities Consumer products Net repayment of short-term borrowings (1,482) (1,119) (21) Long-term debt proceeds 2,893 2,699 564 Long-term debt repaid (1,987) (1,979) (1,302) Financial services and real estate Net (repayment) issuance of short-term borrowings (173) (498) 67 Long-term debt proceeds 174 363 Long-term debt repaid (387) (139) Repurchase of outstanding stock (805) (2,770) (2,111) Dividends paid (3,885) (3,462) (2,939) Issuance of shares 205 448 291 Stock rights redemption (9) Other (74) (88) (28) - ----------------------------------------------------------------------------------------- Net cash used in financing activities (5,521) (6,406) (5,627) - ----------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents (158) (71) 3 - ----------------------------------------------------------------------------------------- Cash and cash equivalents: Increase (decrease) 2,042 (898) 954 Balance at beginning of year 240 1,138 184 - ----------------------------------------------------------------------------------------- Balance at end of year $ 2,282 $ 240 $ 1,138 ========================================================================================= Cash paid: Interest--Consumer products $ 1,219 $ 1,244 $ 1,293 ========================================================================================= --Financial services and real estate $ 79 $ 95 $ 89 ========================================================================================= Income taxes $ 3,794 $ 3,424 $ 3,067 =========================================================================================
See notes to consolidated financial statements. 41 Consolidated Statements of Stockholders' Equity (in millions of dollars, except per share data)
Earnings Currency Cost of Total Common Reinvested in Translation Repurchased Stockholders' Stock the Business Adjustments Stock Equity ============================================================================================================== Balances, January 1, 1995 $935 $17,489 $ (47) $(5,591) $12,786 Net earnings 5,450 5,450 Exercise of stock options and issuance of other stock awards (77) 470 393 Cash dividends declared ($1.22 per share) (3,065) (3,065) Redemption of stock rights (9) (9) Currency translation adjustments 514 514 Stock repurchased (2,075) (2,075) Net unrealized depreciation on securities (9) (9) - -------------------------------------------------------------------------------------------------------------- Balances, December 31, 1995 935 19,779 467 (7,196) 13,985 Net earnings 6,303 6,303 Exercise of stock options and issuance of other stock awards (28) 609 581 Cash dividends declared ($1.47 per share) (3,606) (3,606) Currency translation adjustments (275) (275) Stock repurchased (2,800) (2,800) Net unrealized appreciation on securities 30 30 - -------------------------------------------------------------------------------------------------------------- Balances, December 31, 1996 935 22,478 192 (9,387) 14,218 Net earnings 6,310 6,310 Exercise of stock options and issuance of other stock awards 14 300 314 Cash dividends declared ($1.60 per share) (3,880) (3,880) Currency translation adjustments (1,301) (1,301) Stock repurchased (743) (743) Net unrealized appreciation on securities 2 2 - -------------------------------------------------------------------------------------------------------------- Balances, December 31, 1997 $935 $24,924 $(1,109) $(9,830) $14,920 ==============================================================================================================
See notes to consolidated financial statements. 42 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies: Basis of presentation: The consolidated financial statements include all significant subsidiaries. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of operating revenues and expenses during the reporting periods. Actual results could differ from those estimates. Balance sheet accounts are segregated by two broad types of business. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services and real estate assets and liabilities are unclassified, in accordance with respective industry practices. Certain prior years' amounts have been reclassified to conform with the current year's presentation. Cash and cash equivalents: Cash equivalents include demand deposits with banks and all highly liquid investments with original maturities of three months or less. Inventories: Inventories are stated at the lower of cost or market. The last-in, first-out ("LIFO") method is used to cost substantially all domestic inventories. The cost of other inventories is determined by the average cost or first-in, first-out methods. It is a generally recognized industry practice to classify the total amount of leaf tobacco inventory as a current asset although part of such inventory, because of the duration of the aging process, ordinarily would not be utilized within one year. Impairment of long-lived assets: The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. The Company performs undiscounted cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed, if any, are based on the estimated proceeds to be received, less costs of disposal. Depreciation, amortization and goodwill valuation: Depreciation is recorded by the straight-line method. Goodwill and other intangible assets is substantially comprised of brand names, purchased through acquisitions, which are amortized on the straight-line method over 40 years. The Company periodically evaluates the recoverability of its intangible assets and measures any impairment by comparison to estimated undiscounted cash flows from future operations. Advertising costs: Advertising costs are expensed generally as incurred. Revenue recognition: The Company recognizes operating revenues generally upon shipment of goods to customers. Financial instruments: Derivative financial instruments are used by the Company to manage its foreign currency and interest rate exposures. Realized and unrealized gains and losses on foreign currency swaps that are effective as hedges of net assets in foreign subsidiaries are offset against currency translation adjustments as a component of stockholders' equity. The interest differential to be paid or received under the currency and related interest rate swap agreements is recognized over the life of the related debt and is included in interest and other debt expense, net. Unrealized gains and losses on forward currency contracts that are effective as hedges of assets, liabilities and commitments are deferred and recognized in income as the related transaction is realized. Commodity futures and forward contracts are used by the Company to procure raw materials, primarily coffee, cocoa, sugar, wheat and corn. Commodity futures and options are also used to hedge the price of certain commodities, primarily coffee and cocoa. Realized gains and losses on commodity futures, forward contracts and options are deferred as a component of raw materials and are recognized when related materials costs are charged to cost of sales. Accounting changes: Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." SFAS No. 128 establishes standards for computing and presenting earnings per share ("EPS") and requires the presentation of both basic and diluted EPS. Prior years' EPS have been restated to conform with the standards established by SFAS No. 128. The calculation of basic and diluted EPS is presented in Note 10. Effective January 1, 1997, the Company adopted the American Institute of Certified Public Accountants' Accounting Standards Executive Committee's Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities." The adoption of SOP No. 96-1 at January 1, 1997 and its application during 1997 had no material effect on the Company's 1997 financial position or results of operations. Effective December 31, 1997, the Company adopted Emerging Issues Task Force ("EITF") Issue No. 97-13, "Accounting for Costs Incurred in Connection with a Consulting Contract or an Internal Project That Combines Business Process Reengineering and 43 Information Technology Transformation." EITF Issue No. 97-13 requires companies to expense rather than capitalize certain costs related to contracts or internal projects that combine business process reengineering and information technology transformation. The adoption of EITF Issue No. 97-13 during the fourth quarter of 1997 had no material effect on the Company's 1997 financial position or results of operations. Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This Statement requires that certain assets be reviewed for impairment and, if impaired, remeasured at fair value, whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The adoption of SFAS No. 121 at January 1, 1996 and its application during 1996 had no material effect on the Company's financial position or results of operations. Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which allows companies either to measure compensation cost in connection with the employee stock compensation plans using a fair value based method or to continue to use an intrinsic value based method. The Company continues to use the intrinsic value based method, which generally does not result in compensation cost. The Company's stock compensation plans are discussed in Note 9. Effective January 1, 1995, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," for non-U.S. postretirement benefits other than pensions. The Company also adopted SFAS No. 116, "Accounting for Contributions Received and Contributions Made." The cumulative effect at January 1, 1995 of adopting SFAS No. 106, for the non-U.S. plans, and SFAS No. 116 reduced 1995 net earnings and basic EPS by $28 million and $.01, respectively. The application of SFAS No. 106, for non-U.S. plans, and SFAS No. 116 did not materially reduce 1995 earnings before cumulative effect of accounting changes. Note 2. Divestitures: During 1997, the Company sold several domestic and international food businesses, including its Brazilian ice cream businesses and its North American maple-flavored syrup businesses, for total proceeds of $1.5 billion and net pretax gains of $958 million. In addition, the Company sold its equity interest in a Canadian beer operation and sold a minority interest in a beer import operation for proceeds of $306 million and a pretax gain of $12 million. The Company also sold its real estate operations for total proceeds of $424 million and a pretax gain of $103 million. The operating results of businesses divested in 1997 were not material to the Company's consolidated operating results in any of the periods presented. During 1996, the Company sold several domestic and international food businesses, including its North American bagel business, for total proceeds of $612 million and net pretax gains of $320 million. The operating results of businesses divested in 1996 were not material to the Company's consolidated operating results in any of the periods presented. During 1995, the Company sold its bakery businesses and its North American margarine, specialty oils, marshmallows, caramels and Kraft Foodservice distribution businesses. In addition, several smaller international food businesses were sold. Operating revenues and operating income of these businesses for the period owned in 1995 were $2.0 billion and $107 million, respectively. Net assets of the businesses sold were $1.8 billion. Total proceeds and net pretax gains from the sales of these businesses were $2.1 billion and $275 million, respectively. Note 3. Acquisitions: During 1997, the Company acquired a controlling interest in a Portuguese tobacco company at a cost of $217 million and increased its ownership interest in a Mexican cigarette business from 28.8% to 50.0% at a cost of $403 million. During 1996, the Company acquired a controlling interest in a Polish tobacco company, at a cost of $285 million and nearly all of the remaining voting shares of a Brazilian confectionery company, at a cost of $314 million. The effects of these and other smaller acquisitions were not material to the Company's financial position or results of operations in any of the periods presented. Note 4. Food Realignment Charges: In the fourth quarter of 1997, the Company recorded a charge of $342 million related primarily to the downsizing or closure of manufacturing and other facilities, as well as the discontinuance of certain low-margin product lines of its international food operations. The Company also recorded a charge of $288 million for incremental postemployment benefits, primarily related to severance. These charges, which were recorded to marketing, administration and research costs, reduced 1997 earnings before income taxes by $630 million. In 1996 and 1995, the Company recorded to marketing, administration and research costs, charges of $320 million and $275 million, respectively, related primarily to the downsizing and closure of certain food manufacturing facilities, related incremental postemployment costs, primarily severance, and an early retirement program. 44 Note 5. Inventories: The cost of approximately 50% of inventories in 1997 and 1996 was determined using the LIFO method. The stated LIFO values of inventories were approximately $1.0 billion lower than the current cost of inventories at December 31, 1997 and 1996, respectively. Note 6. Short-Term Borrowings and Borrowing Arrangements: At December 31, the Company's short-term borrowings and related average interest rates consisted of the following: 1997 1996 ================================================================================ Average Average Amount Year-End Amount Year-End (in millions) Outstanding Rate Outstanding Rate ================================================================================ Consumer products: Bank loans $ 194 8.8% $ 295 8.1% Commercial paper 1,373 5.7% Amount reclassified as long-term debt (37) (1,408) - -------------------------------------------------------------------------------- $ 157 $ 260 ================================================================================ Financial services and real estate: Commercial paper $ -- $ 173 6.0% ================================================================================ The fair values of the Company's short-term borrowings at December 31, 1997 and 1996, based upon market rates, approximate the amounts disclosed above. The Company and its subsidiaries maintain credit facilities with a number of lending institutions, amounting to approximately $12.0 billion at December 31, 1997. Approximately $11.8 billion of these facilities were unused at December 31, 1997. Certain of these facilities are used to support commercial paper borrowings, are available for acquisitions and other corporate purposes and require the maintenance of a fixed charges coverage ratio. The Company's credit facilities include revolving bank credit agreements totaling $10.0 billion. An agreement for $2.0 billion expires in October 1998. An agreement for $8.0 billion, expiring in 2002, enables the Company to refinance short-term debt on a long-term basis. Accordingly, short-term borrowings intended to be refinanced were reclassified as long-term debt. Note 7. Long-Term Debt: At December 31, the Company's long-term debt consisted of the following: (in millions) 1997 1996 ================================================================================ Consumer products: Short-term borrowings, reclassified $ 37 $ 1,408 Notes, 6.15% to 9.25% (average effective rate 7.53%), due through 2008 9,735 9,550 Debentures, 6.00% to 8.50% (average effective rate 9.66%), $2.0 billion face amount, due through 2027 1,830 1,046 Foreign currency obligations: Swiss franc, 1.72% to 6.88% (average effective rate 5.77%), due through 2000 857 957 German mark, 5.63% and 6.38% (average effective rate 6.0%), due through 2002 341 411 Other foreign 61 49 Other 240 252 - -------------------------------------------------------------------------------- 13,101 13,673 Less current portion of long-term debt (1,516) (1,846) - -------------------------------------------------------------------------------- $ 11,585 $ 11,827 ================================================================================ Financial services and real estate: Eurodollar note, 6.63%, due 1999 $ 200 $ 400 Foreign currency obligations: ECU note, 8.50%, due 1998 165 372 German mark, 6.50% and 5.38%, (average effective rate 5.88%) due 2003 and 2004 311 166 French franc, 6.88%, due 2006 169 196 - -------------------------------------------------------------------------------- $ 845 $ 1,134 ================================================================================ Aggregate maturities of long-term debt, excluding short-term borrowings reclassified as long-term debt, are as follows: Financial Consumer Services and (in millions) Products Real Estate ================================================================================ 1998 $1,516 $165 1999 1,756 200 2000 797 2001 1,722 2002 1,337 2003-2007 4,467 480 2008-2012 670 Thereafter 981 ================================================================================ The revolving credit facility under which the consumer products short-term debt was reclassified as long-term debt expires in 2002 and any amounts then outstanding mature. 45 Based on market quotes, where available, or interest rates currently available to the Company for issuance of debt with similar terms and remaining maturities, the aggregate fair value of consumer products and financial services and real estate long-term debt, including current portion of long-term debt, at December 31, 1997 and 1996 was $14.6 billion and $15.3 billion, respectively. Note 8. Capital Stock: In February 1997, the Company's Board of Directors declared a three-for-one split of the Company's common stock, effected by a distribution on April 10, 1997, of two shares for each share held of record at the close of business on March 17, 1997. In addition, the par value of the Company's common stock was changed from $1.00 to $0.33 1/3 per share and authorized shares of common stock were increased from 4 billion to 12 billion shares. All references in the consolidated financial statements to shares and related prices, weighted average number of shares, per share amounts and stock plan data have been adjusted to reflect the split. Shares of common stock issued, repurchased and outstanding were as follows: Shares Shares Net Shares Issued Repurchased Outstanding ================================================================================ Balances, January 1, 1995 2,805,961,317 (247,384,122) 2,558,577,195 Exercise of stock options and issuance of other stock awards 19,410,786 19,410,786 Repurchased (84,477,963) (84,477,963) - -------------------------------------------------------------------------------- Balances, December 31, 1995 2,805,961,317 (312,451,299) 2,493,510,018 Exercise of stock options and issuance of other stock awards 23,672,505 23,672,505 Repurchased (85,836,249) (85,836,249) - -------------------------------------------------------------------------------- Balances, December 31, 1996 2,805,961,317 (374,615,043) 2,431,346,274 Exercise of stock options and issuance of other stock awards 12,345,228 12,345,228 Repurchased (18,204,213) (18,204,213) - -------------------------------------------------------------------------------- Balances, December 31, 1997 2,805,961,317 (380,474,028) 2,425,487,289 ================================================================================ At December 31, 1997, 188,254,449 shares of common stock were reserved for stock options and other stock awards under the Company's stock plans and 10 million shares of Serial Preferred Stock, $1.00 par value, were authorized, none of which have been issued. Note 9. Stock Plans: Under the Philip Morris 1997 Performance Incentive Plan (the "Plan"), the Company may grant to eligible employees stock options, stock appreciation rights, restricted stock, and other stock-based awards, as well as cash-based annual and long-term incentive awards. Up to 120 million shares of common stock may be issued under the Plan, of which no more than 36 million shares may be awarded as restricted stock. Shares available to be granted at December 31, 1997 were 104,181,840. Stock options are granted at an exercise price of not less than fair value on the date of the grant. Stock options granted under the Plan generally become exercisable on the first anniversary of the grant date and have a maximum term of ten years. The Company applies the intrinsic value-based methodology permitted by SFAS No. 123 in accounting for the Plan. Accordingly, no compensation expense has been recognized other than for restricted stock awards. Had compensation cost for stock option awards under the Plan been determined on the fair value at the grant date, the Company's net earnings, basic EPS and diluted EPS would have been $6,218 million, $2.57 and $2.55, respectively, for the year ended December 31, 1997; $6,235 million, $2.54 and $2.51, respectively, for the year ended December 31, 1996; and $5,422 million, $2.15 and $2.14, respectively, for the year ended December 31, 1995. The foregoing impact of compensation cost, calculated in accordance with the fair value method prescribed by SFAS No. 123, was determined under the modified Black-Scholes method using the following assumptions: Weighted Average Expected Risk-Free Expected Expected Dividend Fair Value at Interest Rate Life Volatility Yield Grant Date =============================================================================== 1997 6.38% 5 27.86% 3.65% $10.83 1996 6.70% 5 23.80% 3.83% $ 7.73 1995 5.98% 5 21.18% 4.89% $ 4.07 =============================================================================== 46 Option activity was as follows for the years ended December 31, 1995, 1996 and 1997: Weighted Shares Subject Options Average to Option Exercisable Exercise Price ================================================================================ Balance at January 1, 1995 83,295,471 81,760,641 $17.58 Options granted 23,949,600 24.93 Options exercised (20,250,336) 15.23 Options cancelled (1,770,363) 22.82 - -------------------------------------------------------------------------------- Balance at December 31, 1995 85,224,372 62,102,802 20.09 Options granted 22,627,215 36.08 Options exercised (25,310,940) 18.94 Options cancelled (1,327,266) 26.21 - -------------------------------------------------------------------------------- Balance at December 31, 1996 81,213,381 58,949,796 24.81 Options granted 16,105,390 43.88 Options exercised (12,782,568) 19.86 Options cancelled (890,644) 34.75 - -------------------------------------------------------------------------------- Balance at December 31, 1997 83,645,559 67,827,399 $29.13 ================================================================================ The weighted average exercise prices of options exercisable at December 31, 1997, 1996 and 1995 were $25.69, $20.56 and $18.28, respectively. The following table summarizes the status of stock options outstanding and exercisable as of December 31, 1997, by range of exercise price: Options Outstanding Options Exercisable ===================================== ======================= Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price ================================================================================ $ 6.97-$15.66 6,234,769 2 years $13.31 6,234,769 $13.31 $15.67-$24.99 39,874,474 6 years 22.17 39,874,474 22.17 $25.00-$45.16 37,536,316 8 years 39.15 21,718,156 35.70 - -------------------------------------------------------------------------------- 83,645,559 67,827,399 ========== ========== The Company may grant shares of restricted stock and rights to receive shares of stock to eligible employees, giving them in most instances all of the rights of stockholders, except that they may not sell, assign, pledge or otherwise encumber such shares and rights. Such shares and rights are subject to forfeiture if certain employment conditions are not met. During 1997, 1996 and 1995 the Company granted 692,100, 180,000 and 636,000 shares, respectively, of restricted stock to eligible U.S. based employees and also issued to eligible non-U.S. employees rights to receive 392,400 and 144,000 like shares, respectively, in 1997 and 1995. At December 31, 1997, restrictions on the stock, net of forfeitures, lapse as follows: 1998-150,000 shares; 1999-60,000 shares; 2000-774,600 shares; 2002-1,407,750 shares; and 2003 and thereafter-159,000 shares. The fair value of the restricted shares and rights at the date of grant is amortized to expense ratably over the restriction period. The Company recorded compensation expense related to restricted stock of $29 million, $37 million and $54 million for the years ended December 31, 1997, 1996 and 1995, respectively. The unamortized portion is reported as a reduction of earnings reinvested in the business and was $49 million on December 31, 1997. Note 10. Earnings per Share: Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per Share." Prior years' earnings per share have been restated. Basic and diluted earnings per share were calculated using the following: (in millions) 1997 1996 1995 ================================================================================ Net earnings $6,310 $6,303 $5,450 ================================================================================ Weighted average shares for basic EPS 2,420 2,456 2,517 Plus incremental shares from conversions: Restricted stock and stock rights 1 8 7 Stock options 21 18 14 - -------------------------------------------------------------------------------- Weighted average shares for diluted EPS 2,442 2,482 2,538 ================================================================================ In 1997, 1996, and 1995, options on 11,988,118, 18,737,224 and 19,971,870 shares of common stock, respectively, were not included in the calculation of weighted average shares for diluted EPS because their effects were antidilutive. 47 Note 11. Pretax Earnings and Provision for Income Taxes: Pretax earnings and provision for income taxes consisted of the following: (in millions) 1997 1996 1995 ================================================================================ Pretax earnings: United States $ 7,515 $ 7,399 $6,622 Outside United States 3,096 3,284 2,725 - -------------------------------------------------------------------------------- Total pretax earnings $10,611 $ 10,683 $9,347 ================================================================================ Provision for income taxes: United States federal: Current $ 2,027 $ 1,836 $1,946 Deferred 12 438 97 - -------------------------------------------------------------------------------- 2,039 2,274 2,043 State and local 354 430 434 - -------------------------------------------------------------------------------- Total United States 2,393 2,704 2,477 - -------------------------------------------------------------------------------- Outside United States: Current 1,851 1,727 1,175 Deferred 57 (51) 217 - -------------------------------------------------------------------------------- Total outside United States 1,908 1,676 1,392 - -------------------------------------------------------------------------------- Total provision for income taxes $ 4,301 $ 4,380 $3,869 ================================================================================ At December 31, 1997, applicable United States federal income taxes and foreign withholding taxes have not been provided on approximately $3.0 billion of accumulated earnings of foreign subsidiaries that are expected to be permanently reinvested abroad. If these amounts were not considered permanently reinvested, additional deferred income taxes of approximately $167 million would have been provided. The Company and its subsidiaries are subject to tax examinations in various U.S. and foreign jurisdictions. The Company believes that adequate tax payments have been made and accruals recorded for all years. The effective income tax rate on pretax earnings differed from the U.S. federal statutory rate for the following reasons: 1997 1996 1995 ================================================================================ Provision computed at U.S. federal statutory rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State and local income taxes, net of federal tax benefit 2.2 2.6 3.0 Rate differences--foreign operations 3.7 3.3 1.9 Goodwill amortization 1.7 1.8 2.1 Other (2.1) (1.7) (0.6) - -------------------------------------------------------------------------------- Provision for income taxes 40.5% 41.0% 41.4% ================================================================================ The tax effects of temporary differences which gave rise to consumer products deferred income tax assets and liabilities consisted of the following: December 31, (in millions) 1997 1996 ================================================================================ Deferred income tax assets: Accrued postretirement and postemployment benefits $ 1,084 $ 1,070 Accrued liabilities 577 588 Restructuring, strategic and other reserves 427 315 Settlement charges 261 Other 249 399 - -------------------------------------------------------------------------------- Gross deferred income tax assets 2,598 2,372 Valuation allowance (82) (87) - -------------------------------------------------------------------------------- Total deferred income tax assets 2,516 2,285 - -------------------------------------------------------------------------------- Deferred income tax liabilities: Property, plant and equipment (1,695) (1,699) Prepaid pension costs (326) (286) - -------------------------------------------------------------------------------- Total deferred income tax liabilities (2,021) (1,985) - -------------------------------------------------------------------------------- Net deferred income tax assets $ 495 $ 300 ================================================================================ Financial services and real estate deferred income tax liabilities are primarily attributable to temporary differences from investments in finance leases. Note 12. Segment Reporting: Tobacco, food, beer, and financial services and real estate are the major segments of the Company's operations. The Company's major products are cigarettes, coffee, cheese, chocolate confections, processed meat products, various packaged grocery products and beer. The Company's consolidated operations outside the United States, which are principally in the tobacco and food businesses, are organized into geographic regions by segment, with Europe the most significant. Intersegment transactions are not reported separately since they are not material. For purposes of segment reporting, operating profit is operating income exclusive of general corporate expenses. Substantially all goodwill amortization is attributable to the food segment. Identifiable assets are those assets applicable to the respective industry segments. See Notes 2, 3 and 4 regarding divestitures, acquisitions and the realignment of international food operations. Additionally, operating profit for the year ended December 31, 1997 for the tobacco segment included charges of $1,457 million for the settlement of certain domestic tobacco litigation. 48 Reportable segment data were as follows: Data by Segment for the years ended December 31, (in millions) 1997 1996 1995 ================================================================================ Operating revenues: Tobacco $39,824 $36,549 $32,316 Food 27,690 27,950 29,074 Beer 4,201 4,327 4,304 Financial services and real estate 340 378 377 - -------------------------------------------------------------------------------- Total operating revenues $72,055 $69,204 $66,071 ================================================================================ Operating profit: Tobacco $ 7,830 $ 8,263 $ 7,177 Food 3,647 3,362 3,188 Beer 456 437 444 Financial services and real estate 296 192 164 - -------------------------------------------------------------------------------- Total operating profit 12,229 12,254 10,973 General corporate expenses 566 485 447 - -------------------------------------------------------------------------------- Operating income $11,663 $11,769 $10,526 ================================================================================ Identifiable assets: Tobacco $14,820 $13,314 $11,196 Food 30,926 32,934 33,447 Beer 1,455 1,707 1,751 Financial services and real estate 5,886 5,917 5,632 - -------------------------------------------------------------------------------- 53,087 53,872 52,026 Other assets 2,860 999 1,785 - -------------------------------------------------------------------------------- Total assets $55,947 $54,871 $53,811 ================================================================================ Depreciation expense: Tobacco $ 407 $ 378 $ 350 Food 514 538 556 Beer 104 104 101 Capital expenditures: Tobacco $ 937 $ 829 $ 525 Food 738 812 948 Beer 115 122 115 ================================================================================ Data by Geographic Region for the years ended December 31, (in millions) 1997 1996 1995 ================================================================================ Operating revenues: United States--domestic $33,208 $31,993 $32,479 --export 6,705 6,476 5,920 Europe 24,796 24,232 23,076 Other 7,346 6,503 4,596 - -------------------------------------------------------------------------------- Total operating revenues $72,055 $69,204 $66,071 ================================================================================ Operating profit: United States $ 8,149 $ 8,762 $ 8,031 Europe 2,560 2,635 2,366 Other 1,520 857 576 - -------------------------------------------------------------------------------- Total operating profit 12,229 12,254 10,973 General corporate expenses 566 485 447 - -------------------------------------------------------------------------------- Operating income $11,663 $11,769 $10,526 ================================================================================ Identifiable assets: United States $33,734 $33,314 $32,521 Europe 15,209 15,836 15,981 Other 4,144 4,722 3,524 - -------------------------------------------------------------------------------- 53,087 53,872 52,026 Other assets 2,860 999 1,785 - -------------------------------------------------------------------------------- Total assets $55,947 $54,871 $53,811 ================================================================================ Note 13. Pension Plans: The Company and its subsidiaries sponsor noncontributory defined benefit pension plans covering substantially all U.S. employees. The plans provide retirement benefits for salaried employees based generally on years of service and compensation during the last years of employment. Retirement benefits for hourly employees generally are a flat dollar amount for each year of service. The Company funds these plans in amounts consistent with the funding requirements of federal laws and regulations. Pension coverage for employees of the Company's non-U.S. subsidiaries is provided, to the extent deemed appropriate, through separate plans, many of which are governed by local statutory requirements. The plans provide pension benefits that are based primarily on years of service and employees' salaries near retirement. The Company provides for obligations under such plans by depositing funds with trustees or purchasing insurance policies. The Company records liabilities for unfunded foreign plans. 49 U.S. Plans Net pension (income) cost consisted of the following: (in millions) 1997 1996 1995 ================================================================================ Service cost--benefits earned during the year $ 137 $ 143 $ 110 Interest cost on projected benefit obligation 382 373 367 Return on assets --actual (1,308) (980) (1,344) --deferred gain 744 447 848 Amortization of net gain upon adoption of SFAS No. 87 (24) (25) (26) Amortization of unrecognized net loss (gain) from experience differences 9 (13) Amortization of prior service cost 14 14 13 Other (income) cost (22) (35) 75 - -------------------------------------------------------------------------------- Net pension (income) cost $ (77) $ (54) $ 30 ================================================================================ During 1997, 1996 and 1995, the Company sold businesses and instituted early retirement and workforce reduction programs resulting in settlement gains of $22 million in 1997, settlement gains of $69 million and additional pension cost of $34 million in 1996, and additional pension cost of $103 million and curtailment gains of $28 million in 1995. The funded status of U.S. plans at December 31 was as follows: (in millions) 1997 1996 ================================================================================ Actuarial present value of accumulated benefit obligation--vested $ 4,221 $ 3,871 --nonvested 458 359 - -------------------------------------------------------------------------------- 4,679 4,230 Benefits attributable to projected salaries 844 650 - -------------------------------------------------------------------------------- Projected benefit obligation 5,523 4,880 Plan assets at fair value 8,085 7,101 - -------------------------------------------------------------------------------- Excess of assets over projected benefit obligation 2,562 2,221 Unamortized net gain upon adoption of SFAS No. 87 (83) (108) Unrecognized prior service cost 121 124 Unrecognized net gain from experience differences (1,659) (1,404) - -------------------------------------------------------------------------------- Prepaid pension cost $ 941 $ 833 ================================================================================ The projected benefit obligation at December 31, 1997, 1996 and 1995 was determined using an assumed discount rate of 7.25%, 7.75% and 7.25%, respectively, and assumed compensation increases of 4.5% at December 31, 1997, 1996 and 1995. The assumed long-term rate of return on plan assets was 9% at December 31, 1997, 1996 and 1995. Plan assets consist principally of common stock and fixed income securities. The Company and certain of its subsidiaries sponsor deferred profit-sharing plans covering certain salaried, nonunion and union employees. Contributions and costs are determined generally as a percentage of pretax earnings, as defined by the plans. Certain other subsidiaries of the Company also maintain defined contribution plans. Amounts charged to expense for defined contribution plans totaled $200 million, $199 million and $191 million in 1997, 1996 and 1995, respectively. In addition, certain of the Company's subsidiaries participate in multiemployer defined benefit plans. Contributions to these plans were immaterial in 1997, 1996 and 1995. Non-U.S. Plans Net pension cost consisted of the following: (in millions) 1997 1996 1995 ================================================================================ Service cost--benefits earned during the year $ 83 $ 80 $ 80 Interest cost on projected benefit obligation 163 166 160 Return on assets --actual (269) (201) (195) --deferred gain 134 70 74 Amortization of net deferred charges 5 3 1 - -------------------------------------------------------------------------------- Net pension cost $ 116 $ 118 $ 120 ================================================================================ The funded status of the non-U.S. plans at December 31 was as follows: Assets Exceed Accumulated Accumulated Benefits Exceed Benefits Assets ================================================================================ (in millions) 1997 1996 1997 1996 ================================================================================ Actuarial present value of accumulated benefit obligation --vested $ 1,387 $ 1,336 $ 731 $ 721 --nonvested 38 39 83 77 - -------------------------------------------------------------------------------- 1,425 1,375 814 798 Benefits attributable to projected salaries 341 342 121 127 - -------------------------------------------------------------------------------- Projected benefit obligation 1,766 1,717 935 925 Plan assets at fair value 2,074 1,891 115 36 - -------------------------------------------------------------------------------- Plan assets in excess of (less than) projected benefit obligation 308 174 (820) (889) Unamortized net (gain) loss upon adoption of SFAS No. 87 (11) (14) 22 13 Unrecognized net (gain) loss from experience differences (156) (22) 9 (5) - -------------------------------------------------------------------------------- Prepaid (accrued) pension cost $ 141 $ 138 $(789) $(881) ================================================================================ 50 The assumptions used in 1997, 1996 and 1995 were as follows: 1997 1996 1995 ================================================================================ Discount rates 3.5% to 12.0% 4.0% to 12.0% 4.5% to 10.0% Compensation increases 3.0% to 10.0% 3.0% to 10.5% 3.5% to 9.0% Long-term rates of return on plan assets 4.0% to 13.0% 4.0% to 13.0% 4.5% to 11.0% ================================================================================ Plan assets consist primarily of common stock and fixed income securities. Note 14. Postretirement Benefits Other Than Pensions: The Company and its subsidiaries have accrued the estimated cost of retiree health care benefits during the active service periods of employees in the United States and Canada. Health care benefits for retirees outside the United States and Canada are generally covered through local government plans. The Company and its U.S. and Canadian subsidiaries provide health care and other benefits to substantially all retired employees, their covered dependents and beneficiaries. Generally, employees who have attained age 55 and who have rendered at least 5 to 10 years of service are eligible for these benefits. Certain health care plans are contributory; others are noncontributory. Net postretirement health care costs consisted of the following: (in millions) 1997 1996 1995 ================================================================================ Service cost--benefits earned during the period $ 54 $ 59 $ 46 Interest cost on accumulated postretirement benefit obligation 182 180 179 Amortization of unrecognized net (gain) loss from experience differences (3) 4 (2) Amortization of unrecognized prior service cost (12) (12) (13) Other income (8) (13) - -------------------------------------------------------------------------------- Net postretirement health care costs $ 221 $ 223 $ 197 ================================================================================ During 1996 and 1995, the Company sold businesses and instituted early retirement and workforce reduction programs resulting in curtailment gains included above in other income. The Company's postretirement health care plans currently are not funded. The status of the plans at December 31 was as follows: (in millions) 1997 1996 ================================================================================ Actuarial present value of accumulated postretirement benefit obligation: Retirees $ 1,522 $ 1,289 Fully eligible active plan participants 222 278 Other active plan participants 883 859 - -------------------------------------------------------------------------------- 2,627 2,426 Unrecognized net loss from experience differences (173) (75) Unrecognized prior service cost 109 127 - -------------------------------------------------------------------------------- Accrued postretirement health care costs $ 2,563 $ 2,478 ================================================================================ The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for U.S. plans was 8.5% in 1996, 8.0% in 1997 and 7.5% in 1998, gradually declining to 5.0% by the year 2003 and remaining at that level thereafter. For Canadian plans, the assumed health care cost trend rate was 14.0% in 1996, 13.0% in 1997 and 12.0% in 1998, gradually declining to 4.0% by the year 2005 and remaining at that level thereafter. A one-percentage-point increase in the assumed health care cost trend rates for each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 and net postretirement health care cost for the year then ended by approximately 15.0% and 10.0%, respectively. The accumulated postretirement benefit obligations for U.S. plans at December 31, 1997, 1996 and 1995 were determined using assumed discount rates of 7.25%, 7.75% and 7.25%, respectively. The accumulated postretirement benefit obligation at December 31, 1997, 1996 and 1995 for Canadian plans was determined using an assumed discount rate of 6.50%, 7.50% and 8.25%, respectively. Note 15. Contingencies: Legal proceedings covering a wide range of matters are pending in various U.S. and foreign jurisdictions against the Company, its subsidiaries, including Philip Morris Incorporated ("PM Inc."), the Company's domestic tobacco subsidiary, and 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 51 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, including class actions, brought by state and local governments, unions, federal and state taxpayers, native American tribes and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking. 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, a trend which accelerated in 1997. As of December 31, 1997, there were approximately 375 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 185 such cases as of December 31, 1996. Many of the new cases were filed in Florida and New York. Seventeen of the individual cases involve allegations of various personal injuries allegedly related to exposure to environmental tobacco smoke ("ETS"). In addition, as of December 31, 1997, there were approximately 50 purported smoking and health class actions pending in the United States against PM Inc. and, in some cases, the Company (including six that involve allegations of various personal injuries related to exposure to ETS), compared with approximately 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. As of December 31, 1997, there were three purported smoking and health class actions pending overseas against affiliates and subsidiaries of the Company, in Canada, Brazil and Nigeria. The number of health care cost recovery actions also increased during 1997, with approximately 105 such cases pending as of December 31, 1997, compared with approximately 25 such cases on December 31, 1996. Recent Verdicts In August 1996, a Florida jury awarded a former smoker and his spouse $750,000 in a smoking and health case against another United States cigarette manufacturer (Carter v. American Tobacco Co., et al.), and that manufacturer was subsequently ordered to pay approximately $1.8 million in attorneys' fees and costs. Neither PM Inc. nor the Company was a party to that litigation. The defendant in that action has appealed the verdict. Later that month, a jury returned a verdict for defendants in a smoking and health case in Indiana against United States cigarette manufacturers, including PM Inc. (Rogers v. R.J. Reynolds Tobacco Company, et al.). Plaintiff has filed a motion seeking a new trial based on the alleged discovery of new evidence. In May and October 1997, Florida juries also returned verdicts for defendants in smoking and health cases involving another United States cigarette manufacturer (Connor v. R.J. Reynolds Tobacco Company; Karbiwnyk v. R.J. Reynolds Tobacco Company). In September 1997, a court in Brazil awarded plaintiffs in a smoking and health case the Brazilian 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 (Alves v. Souza Cruz). Defendant is appealing the judgment. Neither the Company nor its affiliates were parties to that action. Recent Settlements In June 1997, PM Inc. and other companies in the United States tobacco industry agreed to a proposed Resolution to support federal legislation and ancillary undertakings that would resolve many of the regulatory and litigation issues affecting the industry. (See "Proposed Resolution of Certain Regulatory and Litigation Issues" below.) In furtherance of the proposed Resolution, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida and Texas and a smoking and health class action brought on behalf of airline flight attendants, all on terms consistent with the proposed Resolution. These settlements are discussed below. Trial Dates Trial in a health care cost recovery case brought by the State of Minnesota began in January 1998. A number of other health care cost recovery and smoking and health cases pending against PM Inc. and, in some cases, the Company, are scheduled for trial during 1998. The following health care cost recovery actions are currently scheduled for trial later in 1998: Washington (September), Arizona (October) and Oklahoma (November). Approximately 25 individual cases are currently scheduled for trial in 1998 against PM Inc. and, in some cases, the Company, of which approximately 20 are set for trial in Florida commencing in June 1998. Trials in New York and Florida class actions, previously scheduled to begin in February, have been delayed (Frosina, et al. v. Philip Morris, Inc., et al.; and Engle, et al. v. R.J. Reynolds Tobacco Company, et al.). 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 52 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. Plaintiffs in these 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 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 December 31, 1997, 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, South Dakota, Tennessee, Texas, West Virginia and Wisconsin, as well as in Canada, Brazil and Nigeria. Classes have been certified in four of these smoking and health class actions, in Florida, Louisiana and New York (2). Class certification has been denied or reversed in three cases involving PM Inc., in Louisiana, the District of Columbia and Pennsylvania. One smoking and health class action was settled in 1997 as discussed below. The Broin Settlement The Broin, et al. v. Philip Morris Incorporated, et al. class action was settled in October 1997 by PM Inc. and other companies in the domestic tobacco industry, subject to final approval by the Florida state court. A number of third parties have filed objections to the settlement. The Broin class consisted of "all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from various diseases and disorders caused by their exposure to second-hand smoke in airline cabins." Under the settlement, the settling defendants will pay $300 million to establish a foundation to sponsor scientific research with respect to diseases associated with cigarette smoking. These funds will be paid in three equal annual installments, with interest, commencing in April 1998. Settling defendants also agreed to pay attorneys' fees of up to $46 million and costs of $3 million, subject to court approval. PM Inc.'s share of all the foregoing payments (exclusive of interest) is approximately $175 million and was charged to expense in the third quarter of 1997. Under the settlement, all defendants (and certain other entities and persons) are released from liability for the claims asserted in the present action. Each individual member of the class, however, may later bring an individual action for diseases and conditions existing on or before January 15, 1997 ("retained claims"), based upon certain legal theories against the settling defendants, but may only seek compensatory, and not punitive, damages. The defendants expressly did not admit liability for injury of any member of the settlement class or that ETS can cause any disease. In any individual lawsuits brought by members of the settlement class for retained claims, the settling defendants would assume the burden of proof as to whether ETS can cause certain conditions, but the plaintiff would retain the burden of proving that his or her condition was caused by exposure to ETS. The settling defendants have also agreed not to raise a statute of limitations defense with respect to any retained claims brought by a member of the settlement class within one year after final court approval of the settlement. The settlement does not apply to, nor does it have any effect on, "future" claims brought by members of the settlement class for any new and unrelated diseases or conditions arising after January 15, 1997. Health Care Cost Recovery Litigation In certain of the pending proceedings, foreign, state and local government entities, unions, federal and state taxpayers, native 53 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 two health care cost recovery cases, private citizens seek recovery of alleged tobacco-related health care expenditures incurred by the federal Medicare and/or Medicaid programs and, in another case, seek recovery of such expenditures by the Department of Defense and the Department of Veterans Administration. In one purported class action, Blue Cross/Blue Shield subscribers in the United States are seeking reimbursement of allegedly increased medical insurance premiums caused by tobacco products. In the native American cases, claims are also asserted for alleged lost productivity of tribal government employees. Other relief sought by some but not all plaintiffs includes punitive damages, treble/ 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 recover because they participated in, and benefited from, the sale of cigarettes), lack of antitrust injury, federal preemption, lack of proximate cause and statute of limitations. In addition, defendants argue that they should be entitled to "set-off" any alleged damages to the extent the plaintiff benefits economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that these cases are improper because plaintiffs must proceed under principles of subrogation and assignment. Under traditional theories of recovery, a payor of medical costs (such as an insurer or a state) can seek recovery of health care costs from a third party solely by "standing in the shoes" of the injured party. Defendants argue that plaintiffs should be required to bring an action on behalf of each individual health care recipient and should be subject to all defenses available against the injured party. In certain of these cases, defendants have also challenged the ability of the plaintiffs to use contingency fee counsel to prosecute these actions. Further, certain cigarette companies, including PM Inc., have filed declaratory judgment actions in 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 of December 31, 1997, there were approximately 105 health care cost recovery cases pending against PM Inc. and, in some cases, the Company, including cases filed by states, through their attorneys general and/or other state agencies, in Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Washington, West Virginia and Wisconsin. In addition, approximately 45 of the pending health care cost recovery actions were filed by unions, eight by city and county governments, six by federal and state taxpayers and four by native American tribes. Health care cost recovery actions have also been brought by the Republic of the Marshall Islands and the Commonwealth of Puerto Rico. Three health care cost recovery cases were settled recently as discussed below. The Mississippi, Florida and Texas Settlements In June 1997, PM Inc. and other companies in the United States tobacco industry agreed to a proposed Resolution to support federal legislation and ancillary undertakings that would resolve much of the litigation facing the United States tobacco industry. (See "Proposed Resolution of Certain Regulatory and Litigation Issues" below.) In furtherance of the proposed Resolution, PM Inc. and other companies in the United States tobacco industry settled health care cost recovery actions brought by the States of Mississippi, Florida and Texas on terms consistent with the proposed Resolution. The Mississippi action was settled in July 1997, Florida was settled in September 1997 and Texas was settled in January 1998. Under the Mississippi settlement agreement, the settling defendants paid $170 million, representing Mississippi's estimated share of the $10 billion initial payment under the proposed Resolution, and paid an additional $15 million to reimburse Mississippi and its private counsel for out-of-pocket costs. The settling defendants also paid approximately $62 million to support a pilot program aimed at reducing the use of tobacco products by persons under the age of eighteen. PM Inc.'s share of all the foregoing payments, approximately $153 million, was charged to expense in the third quarter of 1997. Beginning December 31, 1998, the settling defendants will pay Mississippi amounts based on its anticipated share of the annual industry payments under the proposed Resolution. These payments, which (except for the payment with respect to 1998) will 54 be adjusted as provided in the proposed Resolution, are estimated to be $68 million with respect to 1998 and will increase annually thereafter to an estimated $136 million by 2003, continuing at that level thereafter, and will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. Under the Florida settlement agreement, the settling defendants paid $550 million, representing Florida's estimated share of the $10 billion initial payment under the proposed Resolution, and also reimbursed Florida's expenses and those of its private counsel. The settling defendants also paid $200 million to support a pilot program by Florida aimed at reducing the use of tobacco products by persons under the age of eighteen. PM Inc.'s share of all the foregoing payments, approximately $484 million, was charged to expense in the third quarter of 1997. On September 15, 1998, and annually thereafter on December 31, the settling defendants will make ongoing payments to Florida in the following estimated amounts--1998: $220 million; 1999: $247.5 million; 2000: $275 million; 2001: $357.5 million; 2002: $357.5 million; and each year thereafter: $440 million. These amounts are projected to approximate that portion of the annual industry payments under the proposed Resolution which is contemplated to be paid to Florida. These payments (except for the payment with respect to 1998) will be adjusted as provided in the proposed Resolution and will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. Under the Texas settlement agreement, the settling defendants agreed to pay Texas an up-front payment of $725 million in 1998, representing Texas's estimated share of the $10 billion initial payment under the proposed Resolution, and agreed to reimburse Texas and its private counsel for expenses in the estimated amount of $45 million. The settling defendants also agreed to pay Texas $264 million to support a pilot program aimed at reducing the use of tobacco by persons under the age of eighteen. PM Inc.'s share of all of the foregoing payments, approximately $645 million, was charged to expense in the fourth quarter of 1997. Beginning in November and December 1998, and on December 31 of each subsequent year, the settling defendants will pay Texas 7.25% of the annual industry payments contemplated to be paid to the states under the proposed Resolution. These payments, which (except for the payments with respect to 1998) will be adjusted as provided in the proposed Resolution, will be in the following estimated amounts--1998: $290 million; 1999: $326 million; 2000: $363 million; 2001: $471 million; 2002: $471 million; and 2003 and each year thereafter: $580 million. These payments will be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales. The settling defendants have also agreed to pay reasonable attorneys' fees of private contingency fee counsel of Mississippi, Florida and Texas as set by a panel of independent arbitrators. Each of these payments would be allocated among the settling defendants in accordance with their relative unit volume of domestic tobacco product sales and will be subject to an aggregate national annual cap of $500 million. Certain of Florida's private contingency fee counsel have challenged the attorneys' fees provision set forth in the Florida settlement agreement, arguing that the settlement agreement has no effect on their rights under their contingency fee agreement with Florida. In November 1997, the court ordered all parties to comply with the provisions for obtaining attorneys' fees, as set forth in the settlement agreement. Certain contingency fee counsel are appealing this ruling. One of these contingency fee counsel has filed suit against PM Inc. and others alleging, among other things, tortious interference with such counsel's contingency fee agreement with the State. If legislation implementing the proposed Resolution or its substantial equivalent is enacted, the settlements will remain in place, but the terms of the federal legislation will supersede the settlement agreements (except for the terms of the pilot programs and payments thereunder, the initial payments and the annual payments with respect to 1998), and the other payments described above will be adjusted so that Mississippi, Florida and Texas will receive the same payments as they would receive under such legislation. If the settling defendants enter into any future pre-verdict settlement agreement with a non-federal governmental plaintiff on more favorable terms (after due consideration of relevant differences in population or other appropriate factors), Mississippi, Florida and Texas will obtain treatment at least as relatively favorable as such governmental plaintiff. If federal legislation implementing the proposed Resolution or its substantial equivalent is enacted, the parties contemplate that Mississippi, Florida and Texas and any other state that has made an exceptional contribution to secure resolution of these matters may apply to a panel of independent arbitrators for reasonable compensation for its efforts in securing the proposed Resolution. The settling defendants have agreed not to oppose applications for $75 million by Mississippi, $250 million by Florida and $329.5 million by Texas, subject to a nationwide annual cap for all such payments of $100 million. Finally, the settlement agreements provide that they are not an admission or concession or evidence of any liability or wrongdoing on the part of any party, and were entered into by the settling defendants solely to avoid the further expense, inconvenience, burden and uncertainty of litigation. Certain Other Tobacco-Related Litigation In June 1995, an action was filed in federal court in Maryland against PM Inc. seeking certification of a purported class consisting of "all persons and estates injured as a result of the defendant's alleged failure to manufacture a fire safe cigarette since 55 1987" (Sacks, et al. v. Philip Morris Inc.). Plaintiffs alleged in their complaint that PM Inc. intentionally withheld and suppressed material information relating to technology to produce a cigarette less likely to cause fires, and failed to design and sell its cigarettes using the alleged technology. Compensatory and punitive damages were sought. In September 1996, an order was entered granting defendant's motion to dismiss. Plaintiffs have appealed the order. In September 1997, a purported class action was commenced by private plaintiffs in Alabama state court alleging that the U.S. tobacco companies and others conspired to fix cigarette prices in Alabama, that agreements leading to price increases were reached during the negotiations leading to the proposed Resolution discussed below, and that prices were increased pursuant to the alleged conspiracy in 1997 (Mosley, et al. v. Philip Morris Companies Inc., et al.). The purported class consists of Alabama residents who purchased cigarettes in 1997. Plaintiffs seek actual damages of no more than $500 per class member and statutory damages of $500 for each instance of injury or damages, and costs and interest. In September 1997, the state court conditionally certified the class. Defendants subsequently removed the case to federal court, and the federal court then vacated the state court's conditional class certification. Since September 1997, six 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.; and H.K. Porter Company, Inc. v. B.A.T. Industries, PLC, 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. Certain Other Actions In April 1994, the Company, PM Inc. and certain officers and directors were named as defendants in a complaint filed as a purported class action in federal court in New York (Lawrence, et al. v. Philip Morris Companies Inc., et al.). Plaintiffs allege that defendants violated the federal securities laws by maintaining artificially high levels of profitability through an inventory management practice pursuant to which defendants allegedly shipped more inventory to customers than was necessary to satisfy market demand. In August 1995, the court granted plaintiffs' motion for class certification, certifying a class of all persons who purchased common stock of the 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, PM Inc. and certain officers and directors were named as defendants in several 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. and State Board of Administration of Florida, et al. v. Philip Morris Companies Inc., et al.). In those cases, plaintiffs asserted that defendants violated federal securities laws by making allegedly false and misleading statements regarding the allegedly "addictive" qualities of cigarettes. In September 1995, the court granted defendants' motion to dismiss the two complaints in their entirety. The court then granted plaintiffs in the State Board action leave to replead one of their claims. The court dismissed the State Board claims in April 1996 and the Kurzweil claims in August 1996. In April 1997, the court granted a motion filed by the Kurzweil plaintiffs to vacate the judgment and for leave to amend their complaint. 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 U.S. In October 1997, a purported class action suit was filed in Illinois against Kraft only (Vincent, et al. v. Kraft Foods, Inc.). This suit contains allegations similar to those in the consolidated Wisconsin class action, but only seeks a class comprising Kraft's milk suppliers. 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 billion. In addition, the Italian lira equivalent of $6.0 billion in interest and penalties has been assessed. The Company anticipates that value-added and income tax assessments may also be received in respect of 1996. In September 1997, in the first of several appeals filed by an affiliate of the Company, the Italian administrative tax court in Milan overturned one of the assessments for value-added taxes. A hearing on a second appeal was held in October 1997, and hearings on additional appeals were held in December 1997 and January 1998. Additional hearings are anticipated over the course of 1998. In a separate proceeding in Naples, a court has dismissed charges of criminal association 56 against certain present and former officers and directors of affiliates of the Company, but permitted charges of tax evasion to proceed to trial. The Company, its affiliates and the officers and directors who are subject to the proceedings believe they have complied with applicable Italian tax laws and are vigorously contesting the pending tax assessments and the pending proceedings in Naples. It is not possible to predict the outcome of the litigation pending against the Company and its subsidiaries. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the commencement of additional similar litigation. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention, including a decision by a federal district court on a motion for summary judgment not to preclude the United States Food and Drug Administration (the "FDA") from asserting jurisdiction over cigarettes as "drugs" or "medical devices," which decision is now under appeal. These developments, as well as the widespread media attention given to the proposed Resolution discussed below and the settlements of the Mississippi, Florida and Texas health care cost recovery actions and the Broin class action, may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation. Management is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. It is possible that the Company's results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially affected by an unfavorable outcome of certain pending litigation or by the proposed Resolution discussed below or by settlement, if any, of certain pending cases. However, implementation of the proposed Resolution should resolve the most significant tobacco litigation against the Company and its subsidiaries. Furthermore, the Company and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has a number of valid defenses to all litigation pending against it. Except as described below under the heading "Proposed Resolution of Certain Regulatory and Litigation Issues--Effects on Litigation," all such cases are, and will continue to be, vigorously defended. Proposed Resolution of Certain Regulatory and Litigation Issues On June 20, 1997, PM Inc. and other companies in the United States tobacco industry entered into a Memorandum of Understanding (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. There can be no assurance that federal legislation in the form of the proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to the Company or that any modification would be acceptable to the Company or that, if enacted, the legislation would not face legal challenges. Moreover, the negotiation and signing of the proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry and regulation of the international tobacco industry. The proposed Resolution includes provisions relating to advertising and marketing restrictions, product warnings and labeling, access restrictions, licensing of tobacco retailers, the adoption and enforcement of "no sales to minors" laws by states, surcharges against the industry for failure to achieve underage smoking reduction goals, regulation of tobacco products by the FDA, public disclosure of industry documents and research, smoking cessation programs, compliance programs by the industry, public smoking and smoking in the workplace, enforcement of the proposed Resolution, industry payments and litigation. Surcharge for Failure to Achieve Underage Smoking Reduction Goals The proposed Resolution would require the FDA to impose annual surcharges on the industry if targeted reductions in underage smoking are not achieved in accordance with a legislative timetable. The surcharge would be based upon an approximation of the present value of the profit the companies would earn over the lives of all underage consumers in excess of the target and would be allocated among participating manufacturers based on their market share of the United States cigarette industry. Industry Payments The proposed Resolution would require participating manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10 billion initial Industry Payment on the date that federal legislation implementing the terms of the proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations, and the Company currently estimates that PM Inc.'s share of the initial Industry Payment would be approximately $6.6 billion (to be adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions described above). Thereafter, the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 57 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels)--year 1: $8.5 billion; year 2: $9.5 billion; year 3: $11.5 billion; year 4: $14 billion; and each year thereafter: $15 billion. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate, and would be adjusted to reflect changes from 1996 domestic sales volume levels. The Industry Payments would be separate from any surcharges discussed above. The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities selling tobacco products in the United States (and not their affiliated companies). The proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use. Effects on Litigation If enacted, the federal legislation provided for in the proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity other than the federal government), parens patriae and smoking and health class actions and all "addiction"/dependence claims, and would bar similar actions from being maintained in the future. However, the proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. In recent months, PM Inc. and other companies in the domestic tobacco industry agreed to settle three health care cost recovery actions in Mississippi, Florida and Texas, and a smoking and health class action brought on behalf of flight attendants alleging injury caused by exposure to ETS aboard aircraft. The Company may enter into discussions to postpone or settle other actions, pending the enactment of the legislation contemplated by the proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved or, if achieved, as to the terms thereof. The proposed Resolution would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective. Under the proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis and could be maintained only against tobacco manufacturing companies (and not their retailers, distributors or affiliated companies). In addition, all punitive damage claims based on past conduct would be resolved as part of the proposed Resolution, and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only if based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party. The proposed Resolution contemplates that participating tobacco manufacturers would enter into a joint sharing agreement for civil liabilities relating to past conduct. Judgments and settlements arising from tort actions would be paid as follows. The proposed Resolution would set an annual aggregate cap of up to 33% of the annual base Industry Payment (including any reductions for volume declines). Any judgments or settlements exceeding the cap in a particular year would roll over into the next year. While judgments and settlements would run against the defendant, they would give rise to an 80-cents-on-the-dollar credit against the annual Industry Payment. Finally, any individual judgments in excess of $1 million would be paid at the rate of $1 million per year unless every other judgment and settlement could first be satisfied within the annual aggregate cap. In all circumstances, however, the companies would remain fully responsible for costs of defense and certain costs associated with the fees of attorneys representing certain plaintiffs in the litigation that would be settled by the proposed Resolution. Financial Effects The Company anticipates that PM Inc.'s share of the industry's $10 billion initial payment, which it currently estimates would be approximately $6.6 billion (adjusted downward for initial payments made to Mississippi, Florida and Texas pursuant to settlements of health care cost recovery actions), would be charged to expense in the period in which federal legislation implementing the terms of the proposed Resolution is enacted. In addition, the Company currently anticipates that implementation of the proposed Resolution would require a significant charge to expense in the period of enactment to comply with the proposed Resolution's regulations on advertising, marketing and production. The initial payment would be funded from a combination of available cash, commercial paper issuances, bank borrowings and long-term debt issuances in global markets. The initial payment would have a material adverse effect on the Company's operating income and cash flows in the quarter and year in which the proposed Resolution is enacted and on its financial position. 58 The initial payment would result in higher debt and higher interest expense, the amounts of which would depend upon the final form of the proposed Resolution, borrowing requirements and interest rates. The Company anticipates that PM Inc.'s share of future annual Industry Payments related to cigarette sales would be charged to expense as the related sales occur, and would be funded through price increases. The Company anticipates that annual surcharges, if any, imposed by the FDA for failure to meet required reduction levels in underage smoking, beginning in the fifth year after the proposed Resolution is implemented, would be charged to expense in the year of assessment or in the year prior thereto if it is then probable that such assessment will be made. The Company believes that implementation of the proposed Resolution would materially adversely affect the volume, operating revenues, cash flows and/or operating income of the Company in future years. The degree of the adverse impact would depend, among other things, on the rates of decline in United States cigarette sales in the premium and discount segments, PM Inc.'s share of the domestic premium and discount cigarette segments, interest rates and the timing of principal payments on debt incurred to finance the initial payment due under the proposed Resolution, and the effect of the proposed Resolution on cigarette consumption and the regulatory and litigation environment outside the United States. Note 16. Additional Information: (in millions) 1997 1996 1995 ================================================================================ Years ended December 31: Depreciation expense $ 1,045 $ 1,038 $ 1,024 ================================================================================ Research and development expense $ 533 $ 515 $ 481 ================================================================================ Advertising expense $ 3,451 $ 3,633 $ 3,724 ================================================================================ Interest and other debt expense, net: Interest expense $ 1,180 $ 1,183 $ 1,259 Interest income (133) (97) (80) - -------------------------------------------------------------------------------- $ 1,047 $ 1,086 $ 1,179 ================================================================================ Interest expense of financial services and real estate operations included in cost of sales $ 67 $ 80 $ 84 ================================================================================ Rent expense $ 443 $ 430 $ 390 ================================================================================ Note 17. Financial Services and Real Estate Operations: Philip Morris Capital Corporation ("PMCC") is a wholly-owned subsidiary of the Company. PMCC invests in leveraged and direct finance leases, other tax-oriented financing transactions and third party financial instruments. During 1997, PMCC sold its wholly-owned subsidiary, Mission Viejo Company, which was engaged in land planning, development and sales activities in California and Colorado. Pursuant to a support agreement, the Company has agreed to retain ownership of 100% of the voting stock of PMCC and make periodic payments to PMCC to the extent necessary to ensure that earnings available for fixed charges equal at least 1.25 times its fixed charges. No payments were required in 1997, 1996 or 1995. Condensed balance sheet data at December 31, follows: (in millions) 1997 1996 ================================================================================ Assets Finance leases $8,561 $7,554 Other investments 214 474 - -------------------------------------------------------------------------------- 8,775 8,028 Less unearned income and allowances 3,063 2,682 - -------------------------------------------------------------------------------- Finance assets, net 5,712 5,346 Other assets 175 572 - -------------------------------------------------------------------------------- Total assets $5,887 $5,918 ================================================================================ Liabilities and stockholder's equity Intercompany payables $ 550 $ 5 Short-term borrowings 173 Long-term debt 845 1,134 Deferred income taxes 3,877 3,636 Other liabilities 110 140 Stockholder's equity 505 830 - -------------------------------------------------------------------------------- Total liabilities and stockholder's equity $5,887 $5,918 ================================================================================ The amounts shown above include receivables and payables with the Company and its other subsidiaries. These amounts were eliminated in the Company's consolidated balance sheets. Finance leases consist of a portfolio of investments in transportation, manufacturing facilities, power generation and real estate. Rentals receivable for finance leases represent unpaid rentals, less principal and interest on third-party nonrecourse debt, if any. PMCC's investment securities, included in other investments, are classified as available for sale and are recorded at fair value, with unrealized gains and losses included as a component of stockholder's equity, net of related deferred income taxes. The total estimated fair value of other investments, which principally includes commercial receivables at December 31, 1997 and 1996, approximated their carrying values. Fair values were estimated by discounting projected cash flows using the current rates for similar loans to borrowers with similar credit ratings and maturities. 59 Condensed income statement data follow for the years ended December 31, (in millions) 1997 1996 1995 ================================================================================ Revenues: Financial services $241 $222 $197 Real estate 99 157 184 - -------------------------------------------------------------------------------- Total revenues 340 379 381 Expenses: Financial services 104 107 107 Real estate 66 98 129 - -------------------------------------------------------------------------------- Total expenses 170 205 236 Gain on disposal of real estate subsidiary 103 Equity in earnings of limited partnership investments 17 15 15 - -------------------------------------------------------------------------------- Earnings before income taxes 290 189 160 Provision for income taxes 132 66 55 - -------------------------------------------------------------------------------- Net earnings $158 $123 $105 ================================================================================ Note 18. Financial Instruments: Derivative financial instruments The Company operates internationally, with manufacturing and sales facilities in various locations around the world. Derivative financial instruments are used by the Company for purposes other than trading, principally to reduce exposures to market risks resulting from fluctuations in interest rates and foreign exchange rates by creating offsetting exposures. The Company is not a party to leveraged derivatives. The Company has foreign currency and related interest rate swap agreements which were executed to reduce the Company's borrowing costs and serve as hedges of the Company's net assets in foreign subsidiaries, principally those denominated in Swiss francs. At December 31, 1997 and 1996, the notional principal amounts of these agreements were $1.4 billion and $2.2 billion, respectively. Aggregate maturities at December 31, 1997 were as follows (in millions): 1998-$166; 1999-$350; 2000-$215; 2002-$171; and 2003 and thereafter-$492. The notional amount is the amount used for the calculation of interest payments which are exchanged over the life of the swap transaction and is equal to the amount of foreign currency or dollar principal exchanged at maturity. Forward exchange contracts and foreign currency options are used by the Company to reduce the effect of fluctuating foreign currencies on short-term foreign currency denominated intercompany and third party transactions. At December 31, 1997, the Company had forward exchange and option contracts, all maturing within one year, with U.S. dollar equivalent values of $1.4 billion and $1.1 billion, respectively. At December 31, 1996, the Company had foreign exchange contracts, all maturing within one year, with U.S. dollar equivalent values of $1.7 billion. Credit exposure and credit risk The Company is exposed to credit loss in the event of nonperformance by counterparties to the swap agreements. However, such exposure was not material at December 31, 1997, and the Company does not anticipate nonperformance. Further, the Company does not have a significant credit exposure to an individual counterparty. Fair value The aggregate fair value, based on market quotes, of the Company's total debt at December 31, 1997 was $14.7 billion as compared to its carrying value of $14.1 billion. The aggregate fair value of the Company's total debt at December 31, 1996 was $15.7 billion as compared to its carrying value of $15.2 billion. The estimated fair value of financial services' other investments and receivables approximated their carrying values at December 31, 1997 and 1996. The carrying values of the foreign currency and related interest rate swap agreements, the forward currency contracts and the currency option contracts, which did not differ materially from their fair values, were not material. See Notes 6, 7 and 17 for additional disclosures of fair value for short-term borrowings, long-term debt and financial instruments within the financial services and real estate operations, respectively. 60 Note 19. Quarterly Financial Data (Unaudited): 1997 Quarters (in millions, except per share data) 1st 2nd 3rd 4th ================================================================================ Operating revenues $18,217 $18,413 $18,092 $17,333 ================================================================================ Gross profit $ 7,376 $ 7,600 $ 7,420 $ 7,029 ================================================================================ Net earnings $ 1,773 $ 1,836 $ 1,406 $ 1,295 ================================================================================ Per share data: Basic EPS $ 0.73 $ 0.76 $ 0.58 $ 0.54 ================================================================================ Diluted EPS $ 0.72 $ 0.75 $ 0.58 $ 0.53 ================================================================================ Dividends declared $ 0.40 $ 0.40 $ 0.40 $ 0.40 ================================================================================ Market price--high $ 46 37/64 $ 48 1/8 $ 46 9/16 $ 45 7/8 --low $ 36 $ 37 1/4 $ 39 15/16 $ 36 15/16 ================================================================================ During the fourth quarter of 1997, the Company sold several international food businesses, including its Brazilian ice cream businesses, for total proceeds of $1.1 billion and net pretax gains of $775 million. In addition, the Company sold its equity interest in a Canadian beer operation and sold a minority interest in a beer import operation for proceeds of $306 million and a pretax gain of $12 million. During the fourth quarter of 1997, the Company recorded a charge of $342 million related primarily to the downsizing or closure of manufacturing and other facilities, as well as the discontinuance of certain low-margin product lines of its international food operations. The Company also recorded a charge of $288 million for incremental postemployment benefits, primarily related to severance. During the third and fourth quarters of 1997, the Company recorded litigation settlement charges of $812 million and $645 million, respectively. 1996 Quarters (in millions, except per share data) 1st 2nd 3rd 4th ================================================================================ Operating revenues $17,491 $17,509 $17,414 $16,790 ================================================================================ Gross profit $ 6,989 $ 7,100 $ 7,092 $ 6,812 ================================================================================ Net earnings $ 1,565 $ 1,621 $ 1,646 $ 1,471 ================================================================================ Per share data: Basic EPS $ 0.63 $ 0.66 $ 0.67 $ 0.61 ================================================================================ Diluted EPS $ 0.62 $ 0.65 $ 0.67 $ 0.60 ================================================================================ Dividends declared $ 0.33 1/3 $ 0.33 1/3 $ 0.40 $ 0.40 ================================================================================ Market price--high $ 34 7/8 $ 35 3/4 $ 35 53/64 $ 39 43/64 --low $ 28 35/64 $ 28 35/64 $ 28 35/64 $ 29 59/64 ================================================================================ During 1996, the Company sold several domestic and international food businesses at net pretax gains of $320 million, most of which were reflected in fourth quarter earnings. During 1996, the Company initiated cost saving programs that included the downsizing and closure of certain food manufacturing facilities, with related workforce reductions, which resulted in a charge to pretax earnings of $320 million. ========================== The principal stock exchange, on which the Company's common stock (par value $0.33 1/3 per share) is listed, is the New York Stock Exchange. At January 31, 1998, there were approximately 149,900 holders of record of the Company's common stock. 61 Report of Independent Accountants To the Board of Directors and Stockholders of Philip Morris Companies Inc.: We have audited the accompanying consolidated balance sheets of Philip Morris Companies Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Philip Morris Companies Inc. and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. New York, New York January 26, 1998 Company Report on Financial Statements The consolidated financial statements and all related financial information herein are the responsibility of the Company. The financial statements, which include amounts based on judgments, have been prepared in accordance with generally accepted accounting principles. Other financial information in the annual report is consistent with that in the financial statements. The Company maintains a system of internal controls that it believes provides reasonable assurance that transactions are executed in accordance with management's authorization and properly recorded, that assets are safeguarded, and that accountability for assets is maintained. The system of internal controls is characterized by a control-oriented environment within the Company, which includes written policies and procedures, careful selection and training of personnel, and audits by a professional staff of internal auditors. Coopers & Lybrand L.L.P., independent accountants, have audited and reported on the Company's consolidated financial statements. Their audits were performed in accordance with generally accepted auditing standards. The Audit Committee of the Board of Directors, composed of six non-management directors, meets periodically with Coopers & Lybrand L.L.P., the Company's internal auditors and management representatives to review internal accounting control, auditing and financial reporting matters. Both Coopers & Lybrand L.L.P. and the internal auditors have unrestricted access to the Audit Committee and may meet with it without management representatives being present. 62 EX-21 12 SUBSIDIARIES OF THE COMPANY Exhibit 21 SUBSIDIARIES OF THE COMPANY Certain active subsidiaries of the Company and their subsidiaries as of December 31, 1997, are listed below. The names of certain subsidiaries, which considered in the aggregate would not constitute a significant subsidiary, have been omitted. State or Country of Name Organization ---- ------------------- AB Estrella ................................................... Sweden AB Kraft Jacobs Suchard Lietuva ............................... Lithuania AGF SP, Inc. .................................................. Japan Ajinomoto General Foods, Inc. ................................. Japan Aktieselskabet F.C. Af 11. juni 1971 .......................... Denmark Aktieselskabet FMD af 11. juni 1920 ........................... Denmark Aktieselskabet M Af 2. januar 1992 ............................ Denmark A/O Almaty Tobacco Company .................................... Kazakhstan A/O Krasnadortabakprom ........................................ Russia A/O Philip Morris NEVA ........................................ Russia A/S Freia ..................................................... Norway A/S Maarud .................................................... Norway Beijing Kraft Food Corporation Limited ........................ China Branded Restaurant Group Inc. ................................. Delaware Burlington Foods, Inc. ........................................ Delaware C.A. Tabacalera Nacional ...................................... Venezuela Cafe GRAND'MERE S.A. .......................................... France Cafe HAG S.A. ................................................. France Callard & Bowser-Suchard, Inc. ................................ Delaware Capri Sun, Inc. ............................................... Delaware Celis Brewery, Inc. ........................................... Texas Churny Company, Inc. .......................................... Delaware Comptoir De La Confiserie ..................................... France Cote d'Or Italia S.p.A. ....................................... Italy Dart & Kraft Finance N.V. ..................................... Netherlands Antilles Dart Resorts Inc. ............................................. Delaware Dong Suh Foods Corporation .................................... Korea Dong Suh Oil & Fats Co., Ltd. ................................. Korea Egri Dohanygyar kft. .......................................... Hungary El Gallito Industrial, S.A. ................................... Costa Rica Estrella A/S .................................................. Denmark Fabriques de Tabac Reunies S.A. ............................... Switzerland Fattorie Osella S.p.A. ........................................ Italy Franklin Baker Company of the Philippines ..................... Philippines FTR Holding S.A. .............................................. Switzerland Gardner's Good Foods, Inc. .................................... New Jersey General Foods Credit Corporation .............................. Delaware General Foods Credit Investors No. 1 Corporation .............. Delaware General Foods Credit Investors No. 2 Corporation .............. Delaware State or Country of Name Organization ---- ------------------- General Foods Credit Investors No. 3 Corporation ............... Delaware General Foods Foreign Sales Corporation ........................ Virgin Islands (U.S.) Gevaliarosteriet AB ............................................ Sweden Grant Holdings, Inc. ........................................... Pennsylvania Grant Transit Co. .............................................. Delaware Grundstucksgemeinschaft Kraft Jacobs Suchard GbR ............... Germany HAG-Coffex ..................................................... France HAG GF AG ...................................................... Germany HNB Investment Corp. ........................................... Delaware International Pet Foods Ltd. ................................... New Zealand Jacob Leinenkugel Brewing Company, Inc. ........................ Wisconsin Jacobs Suchard do Brasil Alimentos LTDA ........................ Brazil Jacobs Suchard Figaro A.S. ..................................... Czechoslovakia Jacobs Suchard Pavlides SA ..................................... Greece The Kenco Coffee Company Limited ............................... United Kingdom Kharkiv Tobacco Factory ........................................ Ukraine Kraft Canada Inc. .............................................. Canada Kraft Chorzele Sp. z o.o. ...................................... Poland Kraft Food Ingredients Corp. ................................... Delaware Kraft Foods AS ................................................. Norway Kraft Foods (Australia) Limited ................................ Australia Kraft Foods de Mexico S.A. de C.V. ............................. Mexico Kraft Foods Egypt LLC .......................................... Egypt Kraft Foods Holdings Norway, Inc. .............................. Delaware Kraft Foods, Inc. .............................................. Delaware Kraft Foods International, Inc. ................................ Delaware Kraft Foods International Services, Inc. ....................... Delaware Kraft Foods Limited ............................................ Australia Kraft Foods Limited (Asia) ..................................... Hong Kong Kraft Foods Manufacturing Corporation .......................... Delaware Kraft Foods (New Zealand) Limited .............................. New Zealand Kraft Foods (Philippines), Inc. ................................ Philippines Kraft Foods (Puerto Rico), Inc. ................................ Puerto Rico Kraft Foods (Singapore) Pte Ltd ................................ Singapore Kraft Foods (Thailand) Limited ................................. Thailand Kraft Freia Marabou AB ......................................... Sweden Kraft Freia Marabou ApS ........................................ Denmark Kraft Freia Marabou Danmark A/S ................................ Denmark Kraft Guangtong Food Company, Limited .......................... China Kraft Hellas SA ................................................ Greece Kraft Jacobs Suchard AG ........................................ Switzerland Kraft Jacobs Suchard (Australia) Pty. Ltd. ..................... Australia Kraft Jacobs Suchard BV ........................................ Netherlands Kraft Jacobs Suchard Bulgaria AD ............................... Bulgaria Kraft Jacobs Suchard Central & Eastern Europe Service BV .................................................. Netherlands Kraft Jacobs Suchard Erzeugnisse GmbH & Co. KG ................. Germany Kraft Jacobs Suchard France .................................... France Kraft Jacobs Suchard GmbH (Bremen) ............................. Germany Kraft Jacobs Suchard (Holdings) Limited (United Kingdom) ................................................... United Kingdom Kraft Jacobs Suchard Hungaria KFT .............................. Hungary 2 State or Country of Name Organization ---- ------------------- Kraft Jacobs Suchard Iberia, S.A. .............................. Spain Kraft Jacobs Suchard Ireland Ltd. .............................. Ireland Kraft Jacobs Suchard Laverune .................................. France KJS Limited .................................................... Hong Kong Kraft Jacobs Suchard Limited ................................... United Kingdom Kraft Jacobs Suchard Management & Consulting AG ................ Switzerland Kraft Jacobs Suchard Manufacturing GmbH & Co KG ................ Germany KJS Namur SA ................................................... Belgium Kraft Jacobs Suchard Oesterreich Gesellschaft MBH .............. Austria Kraft Jacobs Suchard Polska Sp. z o.o. ......................... Poland Kraft Jacobs Suchard Portugal Productos Alimentares Lda. ........................................... Portugal Kraft Jacobs Suchard Produktion GmbH ........................... Germany Kraft Jacobs Suchard R & D, Inc. ............................... Delaware Kraft Jacobs Suchard Reims ..................................... France Kraft Jacobs Suchard Romania SA ................................ Romania Kraft Jacobs Suchard S.A. ...................................... Belgium Kraft Jacobs Suchard (Schweiz) AG .............................. Switzerland Kraft Jacobs Suchard Service AG (Switzerland) .................. Switzerland Kraft Jacobs Suchard S.p.A. .................................... Italy Kraft Jacobs Suchard spol. s r.o. .............................. Czech Republic Kraft Jacobs Suchard Strasbourg ................................ France Kraft Jacobs Suchard Ukraina Open Joint Stock Company .................................................... Ukraine Kraft Japan, K.K. .............................................. Japan Kraft Korea Inc. ............................................... Korea, Republic of Kraft Lacta Suchard Brasil, S.A. ............................... Brazil Kraft Pizza Company ............................................ Delaware Kraft Suchard Argentina, S.A. .................................. Argentina Kraft Tianmei Food (Tianjin) Co., Ltd. ......................... China Krema Limited .................................................. Ireland La Loire Investment Corp. ...................................... Delaware La Seine Investment Corp. ...................................... Delaware Le Rhone Investment Corp. ...................................... Delaware MBC Holdings, Inc. ............................................. Wisconsin Marsa Kraft Jacobs Suchard Sabanci Gida Sanayi ve Ticaret A.S. .................................. Turkey Martlet Importing Co. Inc. ..................................... New York Massalin Particulares S.A. ..................................... Argentina Maxpax France SA ............................................... France Michigan Investment Corp. ...................................... Delaware Miller Brewing Company ......................................... Wisconsin Miller Brewing do Brasil, Ltda. ................................ Brazil Miller Brewing 1855, Inc. ...................................... Delaware Miller Brewing of Europe, Ltd. ................................. United Kingdom Mirabell Salzburger Confiserie-und Bisquit GmbH ............................................... German Democratic Rep. Molson Breweries U.S. Holdings Inc. ............................ Delaware Molson USA, LLC ................................................ Delaware Oy Estrella AB ................................................. Finland Oy Kraft Freia Marabou Finland AB .............................. Finland Packaged Food & Beverage Co., Inc. ............................. Delaware Perdue Trademark Subsidiary, Inc. .............................. Delaware Phenix Leasing Corporation ..................................... Delaware 3 State or Country of Name Organization ---- ------------------- Phenix Management Corporation .................................. Delaware Philip Morris Asia Incorporated ................................ Delaware Philip Morris Belgium S.A. ..................................... Belgium P.M. Beverage Holdings, Inc. ................................... Delaware Philip Morris Brasil S.A. ...................................... Delaware Philip Morris Capital Corporation .............................. Delaware Philip Morris Capital (Dublin) Limited ......................... Ireland Philip Morris Capital (Ireland) Limited ........................ Ireland Philip Morris Corporate Services Inc. .......................... Delaware Philip Morris Europe S.A. ...................................... Delaware Philip Morris Finance Europe B.V. .............................. Netherlands Philip Morris G.m.b.H. ......................................... Germany Philip Morris Holland B.V. ..................................... Netherlands Philip Morris Hong Kong Limited ................................ Hong Kong Philip Morris Incorporated ..................................... Virginia Philip Morris International Finance Corporation ................ Delaware Philip Morris International Inc. ............................... Delaware Philip Morris Izhora ........................................... Russia Philip Morris Kabushiki Kaisha ................................. Japan Philip Morris Korea C.H. ....................................... Korea Philip Morris Latin America Inc. ............................... Delaware Philip Morris Limited .......................................... Australia Philip Morris (Malaysia) Sdn. Bhd. ............................. Malaysia Philip Morris Management Corp. ................................. New York Philip Morris Mexico S.A. de C.V. .............................. Mexico Philip Morris Products Inc. .................................... Virginia Philip Morris Romania S.R.L. ................................... Romania Philip Morris SA, Philip Morris Sabanci Pazarlama ve Satis A.S.................................................. Turkey Philip Morris Sales Inc. ....................................... Delaware Philip Morris Sdn. Bhd. ........................................ Brunei Philip Morris Services India Inc. .............................. Delaware Philip Morris Singapore Pte. Ltd. .............................. Singapore PHILSA Philip Morris Sabanci Sigara ve Tutunculuk Sanayi ve Ticaret, A.S. ...................................... Turkey Pietro Negroni Limited ......................................... United Kingdom Pietro Negroni S.A. ............................................ Switzerland PMCC Investors No. 1 Corporation ............................... Delaware PMCC Investors No. 2 Corporation ............................... Delaware PMCC Investors No. 3 Corporation ............................... Delaware PMCC Investors No. 4 Corporation ............................... Delaware PMCC Leasing Corporation ....................................... Delaware Porta Pack Corporation ......................................... Delaware Premierfoods Corporation ....................................... Taiwan P.T. Kraft Ultrajaya Indonesia ................................. Indonesia Riespri, S.A. .................................................. Spain Roskill Cartage and Storage Limited ............................ New Zealand Rye Ventures, Inc. ............................................. Delaware San Dionisio Realty Corporation ................................ Philippines SB Leasing Inc. ................................................ Delaware Seven Seas Foods, Inc. ......................................... Delaware Shipyard Brewing Company LLC ................................... Maine Societa Immobiliare Modenese S.p.A. ............................ Italy 4 State or Country of Name Organization ---- ------------------- Suchard Limited ................................................ United Kingdom Suchard Schokolade Ges. mbH Bludenz (Austria) .................. Austria Superior AgResource, Inc. ...................................... Delaware Tabacalera Centroamericana S.A. ................................ Guatemala Tabacalera Costarricense S.A. .................................. Costa Rica Tabak A.S. ..................................................... Czech Republic Tabaqueira - Empresa Industrial de Tabacos, S.A. ............... Portugal Taloca AG ...................................................... Switzerland Taloca Ltda. ................................................... Brazil UAB Philip Morris Lietuva ...................................... Lithuania Vict. Th. Engwall & Co., Inc. .................................. Delaware Votesor BV ..................................................... Netherlands Wolverine Investment Corp. ..................................... Delaware Zaklady Przemyslu Tytoniowego w Krakowie S.A. .................. Poland 5 EX-23 13 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in Post-Effective Amendment No. 13 to the registration statement of Philip Morris Companies Inc. (the "Company") on Form S-14 (File No. 2-96149) and in the Company's registration statements on Form S-3 (File Nos. 333-16955 and 333-35143) and Form S-8 (File Nos. 333-28631, 333-20747, 333-16127, 33-1479, 33-1480, 33-10218, 33-13210, 33-14561, 33-17870, 33-37115, 33-38781, 33-39162, 33-40110, 33-48781, 33-59109, 33-63975 and 33-63977) of our reports dated January 26, 1998, on our audits of the consolidated financial statements and financial statement schedule of the Company as of December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997, which reports are included or incorporated by reference in this Annual Report on Form 10-K. /s/ Coopers & Lybrand L.L.P. New York, New York March 5, 1998 EX-24 14 POA Exhibit 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Elizabeth E. Bailey --------------------------------- Elizabeth E. Bailey POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Murray H. Bring --------------------------------- Murray H. Bring POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Harold Brown --------------------------------- Harold Brown POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ William H. Donaldson --------------------------------- William H. Donaldson POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Jane Evans --------------------------------- Jane Evans POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Robert E.R. Huntley --------------------------------- Robert E.R. Huntley POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Rupert Murdoch --------------------------------- Rupert Murdoch POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ John D. Nichols --------------------------------- John D. Nichols POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Lucio A. Noto --------------------------------- Lucio A. Noto POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Richard D. Parsons --------------------------------- Richard D. Parsons POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Roger S. Penske --------------------------------- Roger S. Penske POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ John S. Reed --------------------------------- John S. Reed POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Carlos Slim Helu --------------------------------- Carlos Slim Helu POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS THAT the undersigned, a Director of Philip Morris Companies Inc., a Virginia corporation (the "Company"), does hereby constitute and appoint Geoffrey C. Bible, Murray H. Bring and Louis C. Camilleri, or any one or more of them, his/her true and lawful attorney, for him/her and in his/her name, place and stead, to execute, by manual or facsimile signature, electronic transmission or otherwise, the Annual Report on Form 10-K of the Company for the year ended December 31, 1997 and any amendments or supplements to said Annual Report and to cause the same to be filed with the Securities and Exchange Commission, together with any exhibits, financial statements and schedules included or to be incorporated by reference therein, hereby granting to said attorneys full power and authority to do and perform all and every act and thing whatsoever requisite or desirable to be done in and about the premises as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things which said attorneys may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned has hereunto set his/her hand and seal this 25th day of February, 1998. /s/ Stephen M. Wolf --------------------------------- Stephen M. Wolf EX-99 15 CERTAIN PENDING LITIGATION EXHIBIT 99 CERTAIN PENDING LITIGATION MATTERS AND RECENT DEVELOPMENTS As described in Item 3 of this Annual Report on Form 10-K and Note 15 to the Company's consolidated financial statements included as Exhibit 13 hereto, there are legal proceedings covering a wide range of matters pending in various U.S. and foreign jurisdictions against the Company, its subsidiaries, including PM Inc., 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, including class actions, brought by state and local governments, unions, federal and state taxpayers, native American tribes and others seeking reimbursement for Medicaid and/or other health care expenditures allegedly caused by cigarette smoking. The following lists the pending claims included in the latter two of these categories and also certain other pending claims. Certain developments in these cases since January 1, 1997 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 as of February 27, 1998, and describes certain developments since January 1, 1997. BROIN, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., CIRCUIT COURT, DADE COUNTY, FLORIDA, FILED OCTOBER 31, 1991. This case was settled in October 1997 (see Item 3. LEGAL PROCEEDINGS). CASTANO, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED MARCH 29, 1994. In January 1998, PM Inc. and certain other members of the United States tobacco industry agreed with plaintiffs to dismiss this action without prejudice and to toll the statute of limitations. In connection with that agreement, PM Inc. paid $5.9 million to reimburse costs and expenses of plaintiffs' counsel, such reimbursement to be credited against any award of costs and expenses incurred in connection with this action that such counsel may obtain in the future resulting from federal legislation implementing the proposed Resolution or against any judgment or settlement such counsel may obtain in the future in similar actions. ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO CO., ET AL., CIRCUIT COURT, DADE COUNTY, FLORIDA, FILED MAY 5, 1994. The class, as certified by the court, consists of all Florida citizens and residents and their survivors who have suffered injury "caused by their addiction to cigarettes that contain nicotine." In May 1997, the court agreed to reconsider its earlier order granting partial summary judgment on the grounds that certain of plaintiffs' claims were preempted by the Federal Cigarette Labeling and Advertising Act. Plaintiffs' claim for medical monitoring was dismissed by the court in July 1997. In January 1998, the court denied a motion to decertify the class, but expressed reservations and concerns about the manageability of the class action and postponed the trial date to permit an appeal of that decision. 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 SAN 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. In January 1998, the court certified a class consisting of certain persons in Maryland who are nicotine- dependent and certain Maryland residents who have suffered injury as a result of using tobacco products. 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. In April 1997, the court certified a class consisting of certain Louisiana residents who are or were smokers and who desire to participate in smoking cessation and/or medical monitoring programs. FROSINA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED JUNE 19, 1996. In October 1997, the court certified a class consisting of certain New York residents who smoked cigarettes manufactured by PM Inc. Trial may commence during the spring or summer of 1998. REED, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, DISTRICT OF COLUMBIA, FILED JUNE 21, 1996. In August 1997, the court denied plaintiffs' motion for class certification. BARNES (FORMERLY ARCH), ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, PENNSYLVANIA, FILED AUGUST 8, 1996. In October 1997, the court decertified the class and granted defendants' motion for summary judgment. LYONS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED AUGUST 8, 1996. 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. 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. 2 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. WALLS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OKLAHOMA, FILED FEBRUARY 6, 1997 . 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., CIRCUIT COURT, ROCK COUNTY, WISCONSIN, FILED APRIL 21, 1997. Trial is scheduled for February 1999. GEIGER, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPREME COURT, QUEENS COUNTY, NEW YORK, FILED APRIL 30, 1997. In July 1997, the court denied defendants' motion to dismiss and granted interim certification of a class consisting of certain New York residents. COLE, ET AL. V. THE TOBACCO INSTITUTE, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TEXAS, TEXARKANA DIVISION, FILED MAY 5, 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. 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. COSENTINO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, NEW JERSEY, FILED MAY 28, 1997. 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. KNOWLES, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED JUNE 30, 1997. 3 DALEY, ET AL. V. AMERICAN BRANDS, INC., ET AL., CIRCUIT COURT, COOK COUNTY, ILLINOIS, FILED JULY 7, 1997. PISCITELLO, ET AL. V. PHILIP MORRIS INCORPORATED, 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 15, 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. LANGDEAU, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, LOWER BRULE SIOUX TRIBE, FILED ON AN UNKNOWN DATE. In October 1997, this case was dismissed without prejudice by the tribal court on the grounds that plaintiffs failed to effect proper service of process and otherwise failed to follow tribal court rules. In November 1997, the complaint was refiled. HERRERA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., FOURTH JUDICIAL DISTRICT COURT, UTAH COUNTY, UTAH, FILED JANUARY 28, 1998. JACKSON, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., THIRD JUDICIAL DISTRICT COURT, SALT LAKE COUNTY, UTAH, FILED FEBRUARY 13, 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 as of February 27, 1998, and describes certain developments since January 1, 1997. MOORE V. THE AMERICAN TOBACCO COMPANY, ET AL., CHANCERY COURT, JACKSON COUNTY, MISSISSIPPI, FILED MAY 23, 1994. This case was settled in July 1997 (see Item 3. LEGAL PROCEEDINGS). STATE OF MINNESOTA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., DISTRICT COURT, RAMSEY COUNTY, MINNESOTA, FILED AUGUST 17, 1994. Trial began in January 1998 (see Item 3. LEGAL PROCEEDINGS). 4 MCGRAW V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, KANAWHA COUNTY, WEST VIRGINIA, FILED SEPTEMBER 20, 1994. In February 1997, the court granted defendants' motion to dismiss plaintiffs' common law and equitable claims and thereafter denied defendants' motion to dismiss plaintiffs' statutory claims. THE STATE OF FLORIDA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, PALM BEACH COUNTY, FLORIDA, FILED FEBRUARY 21, 1995. This case was settled in September 1997 (see Item 3. LEGAL PROCEEDINGS). COMMONWEALTH OF MASSACHUSETTS V. PHILIP MORRIS INC., ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, MASSACHUSETTS, FILED DECEMBER 19, 1995. In October 1997, the court denied in part defendants' motion to dismiss the complaint, but reserved ruling on plaintiff's claims of special duty and a portion of plaintiff's deceptive trade practices claim. Trial is set for February 1999. IEYOUB V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT, LOUISIANA, FILED MARCH 13, 1996. In January 1997, the court denied defendants' motion to dismiss which argued that the attorney general lacked the procedural capacity to bring this action. A similar motion challenging the attorney general's authority to bring this action is also pending. In March 1997, the attorney general amended his complaint to join over 100 insurance companies, alleged to have issued insurance policies to defendants covering all or some of the damages asserted in the complaint. THE STATE OF TEXAS V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TEXAS, FILED MARCH 28, 1996. This case was settled in January 1998 (see Item 3. LEGAL PROCEEDINGS). STATE OF MARYLAND V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, BALTIMORE CITY, MARYLAND, FILED MAY 1, 1996. In May 1997, the court dismissed all of plaintiff's claims other than those based on antitrust and consumer protection theories and held that plaintiff is limited to its statutory remedy of subrogation. Trial is scheduled for January 1999. STATE OF WASHINGTON V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, KING COUNTY, WASHINGTON, FILED JUNE 5, 1996. In June 1997, the court dismissed claims of special duty and unjust enrichment and a claim for disgorgement of profits. In August 1997, the court reinstated plaintiff's previously dismissed consumer protection statute claims for damages solely to the extent such claims are confined to relief sought for individual consumers, but not for the State itself. Trial 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. In February 1997, the court dismissed the complaint with leave to amend. In March 1997, plaintiffs filed an amended complaint. On March 4, 1998, the court denied defendants' motion to dismiss the negligent breach of special duty and fraud counts of the amended complaint, but granted the motion to dismiss the claim for intentional breach of special duty. STATE OF CONNECTICUT V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, LITCHFIELD DISTRICT, CONNECTICUT, FILED JULY 18, 1996. COUNTY OF LOS ANGELES V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT, SAN DIEGO COUNTY, CALIFORNIA, FILED AUGUST 5, 1996. In April 1997, the court dismissed plaintiffs' fraud claims without leave to amend, and denied defendants' motion to dismiss plaintiffs' claim for breach of express warranty. In December 1997, the court dismissed certain other causes of action, holding that there was no common-law basis for plaintiffs' recoupment claims and that the California Civil Code, which bars claims for injury or death caused by certain consumer products, barred all of plaintiff's statutory claims for recoupment, with the exception of a claim for breach of express warranty. The court further held that plaintiffs could state statutory recoupment causes of action if they could base their claims exclusively on defendants' conduct occurring after June 12, 1997 (the date the California Legislature amended the California Civil Code to no longer bar public entities from suing to recover health care costs for treating smoking-related illnesses), and granted plaintiffs leave to amend to try to state such causes of action. Finally, the court dismissed, without 5 leave to amend, a cause of action for violation of a penal code provision prohibiting sales of tobacco products to minors. The court had consolidated for trial beginning in February 1999, the claims under the California Unfair Competition Act and False Advertising Law with similar claims brought in two other cases pending in California. The court indicated that it would consider the health care cost recovery portion of the COUNTY OF LOS ANGELES case at a feasible date after the conclusion of the trial of the claims under the California Unfair Competition Act and False Advertising Law. CROZIER V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, MONTGOMERY COUNTY, ALABAMA, FILED AUGUST 8, 1996. This health care cost recovery action was brought as a class action on behalf of Alabama taxpayers. In September 1997, the court dismissed plaintiffs' claims that were asserted on behalf of the State of Alabama, but denied defense motions to dismiss claims insofar as they related to plaintiffs' individual claims or those asserted on behalf of children. STATE OF ARIZONA V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, MARICOPA COUNTY, ARIZONA, FILED AUGUST 20, 1996. In May 1997, the court granted defendants' motion to dismiss plaintiffs' claims of breach of assumed duty and performance of another's duty to the public, negligence PER SE, public nuisance, and unjust enrichment and restitution and denied defendants' dismissal motion with respect to plaintiffs' claims for antitrust violations, fraud and violations of a deceptive trade practices statute. In July 1997, the court granted defendants' motion to dismiss plaintiffs' RICO claim without prejudice. In December 1997, the attorney general amended the complaint to include claims for Medicaid reimbursement, which had been dropped from the original complaint on instructions of the State's previous governor. Trial is scheduled for October 1998. 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 May 1997, the court granted plaintiff's motion contending that statutory subrogation is not the exclusive remedy to be pursued by the State (although the court appeared to hold that statutory and common law subrogation were the only theories available to the State to recover damages). In addition, the court dismissed certain of defendants' affirmative defenses under Michigan's consumer protection statute, dismissed plaintiff's antitrust claim, dismissed, with leave to amend, plaintiff's claims of breach of special duty and injunctive relief, and dismissed plaintiff's claims for punitive damages. STATE OF OKLAHOMA, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, CLEVELAND COUNTY, OKLAHOMA, FILED AUGUST 22, 1996. In January 1998, the court denied motions by the Company and other defendant parent companies to dismiss plaintiff's complaint based on the court's lack of personal jurisdiction. Trial is scheduled to begin in November 1998. PEOPLE OF THE STATE OF CALIFORNIA V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED SEPTEMBER 5, 1996. In October 1997, the court struck several of defendants' affirmative defenses including comparative fault, assumption of risk, failure to mitigate, improper class action, federal preemption (in part), lack of standing, separation of powers doctrine, lack of authority to retain contingency counsel, improper accumulation of actions and "antitrust-related defenses." Trial is scheduled for March 1999. STATE OF NEW JERSEY V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT, MIDDLESEX COUNTY, NEW JERSEY, FILED SEPTEMBER 10, 1996. COYNE, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OHIO, FILED SEPTEMBER 17, 1996. In February 1998, the court granted defendants' motion to dismiss this 6 action due to plaintiffs' lack of standing. This case had been filed by private citizens in Ohio purportedly on behalf of the State of Ohio and all Ohio taxpayers. 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. In November 1997, the court denied defendants' motions to dismiss the antitrust, negligence and conspiracy claims and granted defendants' motions to dismiss the special duty, restitution, nuisance and unjust enrichment claims. STATE OF IOWA V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, FIFTH JUDICIAL DISTRICT, POLK COUNTY, IOWA, FILED NOVEMBER 27, 1996. In August 1997, the court dismissed plaintiff's claims for deception, breach of assumed duty, disgorgement of profits, and indemnity. The court also denied defendants' motion to dismiss plaintiff's claims for violation of the Iowa Consumer Fraud Act, civil conspiracy, aiding and abetting, nuisance, and injunctive relief. 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. STATE OF HAWAII V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., CIRCUIT COURT, FIRST CIRCUIT, HAWAII, FILED JANUARY 31, 1997. 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. STATE OF ALASKA V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, FIRST JUDICIAL DISTRICT, ALASKA, FILED APRIL 14, 1997. COUNTY OF COOK V. PHILIP MORRIS, INCORPORATED, ET AL., CIRCUIT COURT, COOK COUNTY, ILLINOIS, FILED APRIL 18, 1997. WHITE, ET AL. V. PHILIP MORRIS, INC., ET AL., CHANCERY COURT, JEFFERSON COUNTY, MISSISSIPPI, 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. 7 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. BECKOM, ET AL., EX. REL. STATE OF TENNESSEE AND TENNESSEE TAXPAYERS 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. 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. In December 1997, the court certified a class consisting of "all existing jointly-administrating collectively bargained-for health and welfare trusts in Washington, and/or the trustees of such entities, that have provided or paid for health care and/or addiction treatment costs or services for employees or other beneficiaries." In February 1998, the court denied defendants' motion to certify the court's class certification decision for appeal. 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. UNIVERSITY OF SOUTH ALABAMA V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED MAY 23, 1997. In August 1997, the court granted the attorney general's motion to dismiss the action on the ground that the university, as an instrumentality of the State, did not have authority to bring this action on its own behalf. 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. THE LOWER BRULE SIOUX TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, LOWER BRULE SIOUX TRIBE, FILED ON AN UNKNOWN DATE; FIRST AMENDED COMPLAINT FILED MAY 28, 1997. In October 1997, this case was dismissed without prejudice by the tribal court on the grounds that plaintiffs failed to effect proper service of process and otherwise failed to follow tribal court rules. A new complaint was filed in January 1998. STATE OF VERMONT V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, CHITTENDEN COUNTY, VERMONT, FILED MAY 29, 1997. Trial is scheduled for November 1999. 8 UNPINGCO, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES DISTRICT COURT, AGANA, GUAM, FILED MAY 29, 1997. In January 1998, plaintiffs dismissed the complaint, voluntarily and without prejudice, in return for a tolling agreement. CENTRAL ILLINOIS CARPENTERS HEALTH & WELFARE TRUST FUND, ET AL. V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF 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. 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 February 1998, the court dismissed the special duty and conspiracy counts, dismissed (with leave to replead) the public nuisance and unjust enrichment counts, and reserved decision on the antitrust count. The court also granted defendants' motion dismissing the damages and restitution remedy for the statutory consumer protection and RICO counts. Trial is scheduled for April 1999. THE CROW TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, CROW TRIBE, FILED JUNE 10, 1997. 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. 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. 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 AND THE TRANSPORT WORKERS UNION NEW YORK CITY PRIVATE BUS LINES HEALTH BENEFIT TRUST V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JUNE 19, 1997. THE IOWA LABORERS DISTRICT COUNCIL HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF IOWA, FILED JUNE 20, 1997. This case was voluntarily dismissed by plaintiffs, without prejudice, in September 1997. MUSCOGEE CREEK NATION V. THE AMERICAN TOBACCO COMPANY, ET AL., DISTRICT COURT, MUSCOGEE CREEK NATION, OKMULGEE DISTRICT, FILED JUNE 20, 1997. In February 1998, defendants' motion to dismiss on jurisdictional grounds was denied by the court. 9 ARK-LA-MISS LABORERS WELFARE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED JUNE 20, 1997. In September 1997, this case was consolidated with ASBESTOS WORKERS LOCAL 53 HEALTH & WELFARE FUND referenced below. KENTUCKY LABORERS DISTRICT COUNCIL HEALTH AND WELFARE TRUST FUND 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. Trial is scheduled for January 1999. CHEHALIS TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., CHEHALIS TRIBAL COURT, CHEHALIS INDIAN RESERVATION, OAKVILLE, WASHINGTON, FILED JUNE 23, 1997. In October 1997, plaintiffs voluntarily dismissed this case without prejudice. 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. CONNECTICUT PIPE TRADES HEALTH FUND AND INTERNATIONAL BROTHERHOOD OF ELECTRICAL WORKERS LOCAL 90 BENEFIT PLAN V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, CONNECTICUT, FILED JULY 1, 1997. SEAFARERS WELFARE PLAN AND UNITED INDUSTRIAL WORKERS WELFARE PLAN V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, MARYLAND, SOUTHERN DIVISION, FILED JULY 2, 1997. LABORERS AND OPERATING ENGINEERS UTILITY AGREEMENT HEALTH AND WELFARE TRUST FUND FOR ARIZONA V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, ARIZONA, FILED JULY 7, 1997. WOODS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, WAKE COUNTY, NORTH CAROLINA, FILED JULY 10, 1997. This case was voluntarily dismissed by plaintiffs, without prejudice, in February 1998. WEST VIRGINIA LABORERS PENSION FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, WEST VIRGINIA, HUNTINGTON DIVISION, FILED JULY 11, 1997. 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., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JULY 28, 1997. ASBESTOS WORKERS LOCAL 53 HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED AUGUST 15, 1997. In September 1997, this case was consolidated with the case of ARK-LA-MISS LABORERS WELFARE FUND referenced above. 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. 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. ARKANSAS CARPENTERS HEALTH & WELFARE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, ARKANSAS, FILED SEPTEMBER 4, 1997. 10 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. WEST VIRGINIA--OHIO VALLEY AREA INTERNATIONAL BROTHERHOOD OF ELECTRICAL WORKERS WELFARE FUND V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, WEST VIRGINIA, FILED SEPTEMBER 11, 1997. 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., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, 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., UNITED STATES DISTRICT COURT, CENTRAL DISTRICT, CALIFORNIA, FILED SEPTEMBER 16, 1997. PUERTO RICAN ILGWU HEALTH & WELFARE FUND V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, 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. ASBESTOS WORKERS LOCAL NO. 25 WELFARE FUND AND ITS TRUSTEES, ET AL. V. PHILIP MORRIS, INC., ET AL., CIRCUIT COURT, WAYNE COUNTY, MICHIGAN, FILED OCTOBER 2, 1997. This case was dismissed without prejudice by the court for want of prosecution (I.E., plaintiffs' failure to timely serve the summons and complaint) in January 1998. NEW MEXICO AND WEST TEXAS MULTI-CRAFT HEALTH AND WELFARE TRUST FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., SECOND JUDICIAL DISTRICT COURT, BERNALILLO COUNTY, NEW MEXICO, FILED OCTOBER 10, 1997. GOODPASTURE, ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES DISTRICT COURT, KANSAS, FILED OCTOBER 15, 1997. This case was voluntarily dismissed by plaintiffs, without prejudice, in February 1998. MOORE, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, KANSAS, FILED OCTOBER 15, 1997. This case was voluntarily dismissed by plaintiffs, without prejudice, in February 1998. REPUBLIC OF THE MARSHALL ISLANDS V. THE AMERICAN TOBACCO COMPANY, ET AL., HIGH COURT, REPUBLIC OF THE MARSHALL ISLANDS, FILED OCTOBER 20, 1997. This case, originally filed in June 1997, was voluntarily dismissed by plaintiffs, without prejudice, in July 1997. A new health care cost recovery action was filed thereafter. Plaintiff's motion for default judgment was denied in January 1998. 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 UNIONS 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. In December 1997, the court entered an EX PARTE order granting conditional certification for a class of all United 11 Food and Commercial Workers Union Health and Welfare Funds in the United States, noting that the order was conditional for the purpose of protecting the court's jurisdiction and that plaintiffs would have to bear the burden of proof on all elements of class certification as the case proceeds. 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. IBEW LOCAL 25 HEALTH AND BENEFIT FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED NOVEMBER 25, 1997. IBEW LOCAL 363 WELFARE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED NOVEMBER 25, 1997. LOCAL 138, 138A AND 138B INTERNATIONAL UNION OF OPERATING ENGINEERS WELFARE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED NOVEMBER 25, 1997. LOCAL 840, INTERNATIONAL BROTHERHOOD OF TEAMSTERS HEALTH AND INSURANCE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED NOVEMBER 25, 1997. LONG ISLAND COUNCIL OF REGIONAL CARPENTERS WELFARE FUND V. PHILIP MORRIS, INC., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED NOVEMBER 25, 1997. DAY CARE COUNCIL - LOCAL 205 D.C. 1707 WELFARE FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED DECEMBER 8, 1997. LOCAL 1199 HOME CARE INDUSTRY BENEFIT FUND V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED DECEMBER 8, 1997. LOCAL 1199 NATIONAL BENEFIT FUND FOR HEALTH AND HUMAN SERVICES EMPLOYEES V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, 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. 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., CIRCUIT COURT OF MOBILE COUNTY, ALABAMA, FILED FEBRUARY 20, 1998. 12 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. CERTAIN OTHER ACTIONS The following lists certain other actions pending against the Company and/or various subsidiaries and others as of February 27, 1998. These cases are described in Note 15 to the Company's consolidated financial statements; the following describes certain developments in these cases since January 1, 1997. LAWRENCE, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT OF NEW YORK, FILED MARCH 31, 1994. KURZWEIL, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL., UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK, FILED APRIL 4, 1994. In April 1997, the district court granted a motion filed by plaintiffs to vacate the court's earlier dismissal of this action and for leave to amend their complaint. Defendants' appeal of this ruling was dismissed by the Court of Appeals in August 1997, for lack of appellate jurisdiction. SACKS, ET AL. V. PHILIP MORRIS INC., UNITED STATES DISTRICT COURT, DISTRICT OF MARYLAND, FILED JUNE 21, 1995. STUART, ET AL. V. KRAFT FOODS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT OF WISCONSIN, FILED APRIL 4, 1996. This case was voluntarily dismissed in September 1997 without prejudice. SHEEKS, ET AL. V. KRAFT FOODS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT OF WISCONSIN, FILED SEPTEMBER 24, 1996. This case was voluntarily dismissed in May 1997 without prejudice. SERVAIS, ET AL. V. KRAFT FOODS, INC. AND THE NATIONAL CHEESE EXCHANGE, INC., CIRCUIT COURT OF DANE COUNTY, WISCONSIN, FILED MAY 5, 1997. This case has been consolidated with the DODSON and NOLL cases referenced herein. DODSON, ET AL. V. KRAFT FOODS, INC., ET AL., CIRCUIT COURT OF DANE COUNTY, WISCONSIN, FILED JULY 1, 1997. This case has been consolidated with the SERVAIS and NOLL cases referenced herein. NOLL, ET AL. V. KRAFT FOODS, INC., ET AL., CIRCUIT COURT OF DANE COUNTY, WISCONSIN, FILED JULY 11, 1997. This case has been consolidated with the DODSON and SERVAIS cases referenced herein. RAYMARK INDUSTRIES, INC. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, GEORGIA, FILED SEPTEMBER 15, 1997. RAYMARK INDUSTRIES, INC. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, FLORIDA, FILED SEPTEMBER 15, 1997. MOSLEY, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF ALABAMA, FILED SEPTEMBER 24, 1997. VINCENT, ET AL. V. KRAFT FOODS, INC., CIRCUIT COURT OF COOK COUNTY, ILLINOIS, FILED OCTOBER 27, 1997. FIBREBOARD CORPORATION AND OWENS CORNING V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED NOVEMBER 6, 1997. 13 KEENE CREDITORS TRUST V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED DECEMBER 19, 1997. ROBERT A. FALISE, ET AL., TRUSTEES OF THE MANVILLE PERSONAL INJURY SETTLEMENT TRUST V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED DECEMBER 31, 1997. H.K. PORTER COMPANY, INC. V. B.A.T. INDUSTRIES, PLC, ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED DECEMBER 31, 1997. 14 -----END PRIVACY-ENHANCED MESSAGE-----