1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8940
Philip Morris Companies Inc.
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(Exact name of registrant as specified in its charter)
Virginia 13-3260245
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 Park Avenue, New York, New York 10017
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 880-5000
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Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
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At July 31, 1996, there were 818,677,324 shares outstanding of the
registrant's common stock, par value $1 per share.
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PHILIP MORRIS COMPANIES INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited).
Condensed Consolidated Balance Sheets at
June 30, 1996 and December 31, 1995 3 - 4
Condensed Consolidated Statements of Earnings for the
Six Months Ended June 30, 1996 and 1995 5
Three Months Ended June 30, 1996 and 1995 6
Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 1995 and
for the Six Months Ended June 30, 1996 7
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1996 and 1995 8 - 9
Notes to Condensed Consolidated Financial Statements 10 - 21
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 22 - 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 36
Item 6. Exhibits and Reports on Form 8-K. 36
Signature 37
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
June 30, December 31,
1996 1995
------------ ------------
ASSETS
CONSUMER PRODUCTS
Cash and cash equivalents $ 1,165 $ 1,138
Receivables, net 5,168 4,508
Inventories:
Leaf tobacco 3,305 3,332
Other raw materials 1,931 1,721
Finished product 2,965 2,809
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8,201 7,862
Other current assets 1,239 1,371
------- -------
Total current assets 15,773 14,879
Property, plant and equipment, at cost 19,221 18,601
Less accumulated depreciation 7,928 7,485
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11,293 11,116
Goodwill and other intangible assets
(less accumulated amortization of
$4,132 and $3,873) 18,882 19,319
Other assets 3,322 2,866
------- -------
Total consumer products assets 49,270 48,180
FINANCIAL SERVICES AND REAL ESTATE
Finance assets, net 5,147 4,991
Real estate held for development and sale 326 339
Other assets 283 301
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Total financial services and
real estate assets 5,756 5,631
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TOTAL ASSETS $55,026 $53,811
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
(in millions of dollars)
(Unaudited)
June 30, December 31,
1996 1995
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LIABILITIES
CONSUMER PRODUCTS
Short-term borrowings $ 187 $ 122
Current portion of long-term debt 2,537 1,926
Accounts payable 2,325 3,364
Accrued marketing 2,113 2,114
Accrued taxes, except income taxes 1,707 1,075
Other accrued liabilities 3,685 3,701
Income taxes 1,147 1,137
Dividends payable 824 834
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Total current liabilities 14,525 14,273
Long-term debt 13,066 12,324
Deferred income taxes 465 356
Accrued postretirement health care costs 2,331 2,273
Other liabilities 5,407 5,643
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Total consumer products liabilities 35,794 34,869
FINANCIAL SERVICES AND REAL ESTATE
Short-term borrowings 438 671
Long-term debt 943 783
Deferred income taxes 3,436 3,382
Other liabilities 192 121
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Total financial services and
real estate liabilities 5,009 4,957
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Total liabilities 40,803 39,826
Contingencies (Note 2)
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share
(935,320,439 shares issued) 935 935
Earnings reinvested in the business 21,297 19,779
Currency translation adjustments 282 467
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22,514 21,181
Less cost of repurchased stock
(114,896,852 and 104,150,433 shares) 8,291 7,196
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Total stockholders' equity 14,223 13,985
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TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $55,026 $53,811
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Six Months Ended
June 30,
--------------------------
1996 1995
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Operating revenues $35,000 $33,646
Cost of sales 13,405 13,780
Excise taxes on products 7,506 6,583
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Gross profit 14,089 13,283
Marketing, administration and research costs 7,853 7,622
Amortization of goodwill 293 294
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Operating income 5,943 5,367
Interest and other debt expense, net 543 626
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Earnings before income taxes
and cumulative effect of
accounting changes 5,400 4,741
Provision for income taxes 2,214 1,968
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Earnings before cumulative effect
of accounting changes 3,186 2,773
Cumulative effect of changes in method of
accounting (Note 3) (28)
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Net earnings $ 3,186 $ 2,745
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Weighted average number of shares 827 847
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Per share data:
Earnings before cumulative effect of
accounting changes $ 3.85 $ 3.27
Cumulative effect of changes in
method of accounting (.03)
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Net earnings $ 3.85 $ 3.24
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Dividends declared $ 2.00 $ 1.65
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Three Months Ended
June 30,
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1996 1995
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Operating revenues $17,509 $17,129
Cost of sales 6,660 6,947
Excise taxes on products 3,749 3,366
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Gross profit 7,100 6,816
Marketing, administration and research costs 3,940 3,949
Amortization of goodwill 146 148
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Operating income 3,014 2,719
Interest and other debt expense, net 266 308
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Earnings before income taxes 2,748 2,411
Provision for income taxes 1,127 1,001
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Net earnings $ 1,621 $ 1,410
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Weighted average number of shares 823 844
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Per share data:
Net earnings $ 1.97 $ 1.67
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Dividends declared $ 1.00 $ .825
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
for the Year Ended December 31, 1995 and for
the Six Months Ended June 30, 1996
(in millions of dollars, except per share data)
(Unaudited)
Earnings Total
Reinvested Currency Cost of Stock-
Common in the Translation Repurchased holders'
Stock Business Adjustments Stock Equity
------ ---------- ----------- ----------- --------
Balances, January 1, 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
($3.65 per share) (3,065) (3,065)
Redemption of stock rights (9) (9)
Currency translation adjustments 514 514
Stock repurchased (2,075) (2,075)
Net unrealized depreciation
on securities (9) (9)
------ ------- ------ ------- -------
Balances, December 31, 1995 935 19,779 467 (7,196) 13,985
Net earnings 3,186 3,186
Exercise of stock options
and issuance of other stock
awards (32) 290 258
Cash dividends declared
($2.00 per share) (1,651) (1,651)
Currency translation adjustments (185) (185)
Stock repurchased (1,385) (1,385)
Net unrealized appreciation
on securities 15 15
------ ------- ------ ------- -------
Balances, June 30, 1996 $ 935 $21,297 $ 282 $(8,291) $14,223
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
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1996 1995
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CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 3,128 $ 2,693
- Financial services and real estate 58 52
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Net earnings 3,186 2,745
Adjustments to reconcile net earnings to
operating cash flows:
CONSUMER PRODUCTS
Depreciation and amortization 833 856
Deferred income tax provision 160 133
Cumulative effect of accounting changes 46
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (683) (754)
Inventories (211) 470
Accounts payable (1,035) (1,031)
Income taxes 106 30
Other working capital items 209 (33)
Other 145 29
FINANCIAL SERVICES AND REAL ESTATE
Deferred income tax provision 43 107
Decrease in real estate receivables 16 16
Decrease in real estate held for development and sale 13 37
Other 52 28
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Operating cash flow before income taxes on
sales of businesses 2,834 2,679
Income taxes on sales of businesses (39) (29)
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Net cash provided by operating activities 2,795 2,650
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CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
CONSUMER PRODUCTS
Capital expenditures (688) (662)
Purchases of businesses, net of acquired cash (534) (79)
Proceeds from sales of businesses 23 800
Other 27 (120)
FINANCIAL SERVICES AND REAL ESTATE
Investments in finance assets (191) (169)
Proceeds from finance assets 96 77
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Net cash used in investing activities (1,267) (153)
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Net cash provided by operating and
investing activities $ 1,528 $ 2,497
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (continued)
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
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1996 1995
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CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
CONSUMER PRODUCTS
Net issuance (repayment) of short-term borrowings $ 1,137 $ (121)
Long-term debt proceeds 934 285
Long-term debt repaid (625) (276)
FINANCIAL SERVICES AND REAL ESTATE
Net repayment of short-term borrowings (233) (121)
Long-term debt proceeds 170
Repurchase of outstanding stock (1,361) (971)
Dividends paid (1,661) (1,406)
Issuance of shares 192 131
Stock rights redemption (9)
Other (11) (8)
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Net cash used in financing activities (1,458) (2,496)
Effect of exchange rate changes on cash and
cash equivalents (43) 6
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Cash and cash equivalents:
Increase 27 7
Balance at beginning of period 1,138 184
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Balance at end of period $ 1,165 $ 191
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See notes to condensed consolidated financial statements.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Accounting Policies:
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The interim condensed consolidated financial statements of Philip
Morris Companies Inc. (the "Company") are unaudited. It is the opinion of
the Company's management that all adjustments necessary for a fair
statement of the interim results presented have been reflected therein.
All such adjustments were of a normal recurring nature. Operating revenues
and net earnings for any interim period are not necessarily indicative of
results that may be expected for the entire year.
These statements should be read in conjunction with the consolidated
financial statements and related notes which appear in the Company's annual
report to stockholders and which are incorporated by reference into the
Company's Annual Report on Form 10-K for the year ended December 31, 1995.
Balance sheet accounts are segregated by two broad types of business.
Consumer products assets and liabilities are classified as either current
or non-current, whereas financial services and real estate assets and
liabilities are unclassified, in accordance with respective industry
practices.
Note 2. Contingencies:
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Legal proceedings covering a wide range of matters are pending in various
U.S. and foreign jurisdictions against the Company and its subsidiaries,
including Philip Morris Incorporated ("PM Inc."), a wholly-owned subsidiary of
the Company.
In certain of the proceedings pending against PM Inc. and, in some cases,
the Company and/or certain of its other subsidiaries, plaintiffs allege injury
resulting from cigarette smoking, "addiction" to cigarette smoking or exposure
to environmental tobacco smoke ("ETS") and seek compensatory and, in some cases,
punitive damages. As of June 30, 1996, there were 188 such smoking and health
cases pending in the United States. Of these cases, 131 were filed in the state
of Florida and served between April 28, 1995 and June 30, 1996. One hundred
seventy of the smoking and health cases pending as of June 30, 1996, involve
allegations of various injuries allegedly related to cigarette smoking. There
are ten purported class actions that have been served involving allegations of
various injuries allegedly related to cigarette smoking. Nine of the smoking and
health cases that have been served, including one that purports to be a class
action, involve allegations of various personal injuries allegedly related to
exposure to ETS. Thirteen cases currently pending involve state and local
governments and, in one case, a purported class consisting of a state's
taxpayers, that have commenced actions seeking reimbursement for Medicaid and/or
other expenditures to treat diseases allegedly caused by cigarette smoking. In
addition, a purported class action involving allegations of various personal
injuries allegedly related to cigarette smoking is pending in Canada against,
among others, an entity in which the Company has a 40% indirect ownership
interest, and another such action is pending in Brazil against a subsidiary of
the Company, among others. In addition, there is one purported class action
pending involving allegations of defective filtered tobacco products, which
arose out of the recall of certain of PM Inc.'s products. There are also three
lawsuits pending, including one which purports to be a class action, in which
plaintiffs have alleged that PM Inc. failed to manufacture a fire-safe
cigarette. In California individuals purportedly acting as "private attorneys
general" have filed two suits seeking, among other things, injunctive relief,
restitution and disgorgement of profits for alleged violations of California's
consumer protection statutes.
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On August 9, 1996, a jury awarded a former smoker and his spouse $750,000
in a smoking and health case against another leading United States cigarette
manufacturer (Carter v. American Tobacco Co., et al.). Neither PM Inc. nor the
Company was a party to that litigation. The defendant in that action has
announced that it will appeal the verdict. One smoking and health case brought
on behalf of an individual against the leading United States cigarette
manufacturers, including PM Inc., is currently being tried in Indiana. Several
individual smoking and health cases against the industry are scheduled to go to
trial in the third and fourth quarters of this year, including one in December
1996 against PM Inc. and other leading United States cigarette manufacturers.
A description of certain pending class action and Medicaid and health
care recovery litigation follows.
SMOKING AND HEALTH CLASS ACTION LITIGATION
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, strict liability, fraud, misrepresentation, design defect, failure
to warn, breach of express and implied warranties, conspiracy, concert of
action, and violations of deceptive trade practices and consumer protection laws
and antitrust statutes. Plaintiffs also seek punitive damages in many of these
cases. Defenses raised by defendants in these cases include lack of proximate
cause, assumption of the risk, comparative fault and/or contributory negligence,
statutes of limitations or repose, and preemption by the Federal Cigarette
Labeling and Advertising Act, as amended (the "Labeling Act"). In June 1992, the
United States Supreme Court held that the Labeling Act, as enacted in 1965, does
not preempt common law damage claims but that the Labeling Act, as amended in
1969, preempts claims arising after 1969 against cigarette manufacturers "based
on failure to warn and the neutralization of federally mandated warnings to the
extent that those claims rely on omissions or inclusions in advertising or
promotions." The Court also held that the 1969 Labeling Act does not preempt
claims based on express warranty, fraudulent misrepresentation or conspiracy.
The Court also held that claims for fraudulent concealment were preempted except
"insofar as those claims relied on a duty to disclose...facts through channels
of communication other than advertising or promotion." (The Court did not
consider whether such common law damage claims were valid under state law.) The
Court's decision was announced by a plurality opinion. The effect of the
decision on pending and future cases will be the subject of further proceedings
in the lower federal and state courts. Additional similar litigation could be
encouraged if legislation to eliminate the federal preemption defense, proposed
in Congress in recent years, were to be enacted. It is not possible to predict
whether any such legislation will be enacted.
In 1991, a purported class action was filed in Florida state court
against the leading United States cigarette manufacturers, in which certain
flight attendants, claiming to represent a class of approximately 60,000
individuals, alleged personal injury caused by exposure to ETS aboard aircraft.
Broin, et al. v. Philip Morris Incorporated, et al., Circuit of the Eleventh
Judicial Circuit in and for Dade County Florida, Case No. 91-49738-CA-20. In
December 1994, the trial court certified a class consisting of "all non-smoking
flight attendants who are or have been employed by airlines based in the United
States and are suffering from diseases and disorders caused by their exposure to
second hand cigarette smoke in airline cabins." In January 1996, the Florida
Third District Court of Appeal affirmed the trial court's class certification
decision. In June 1996, defendants' motion requesting that the Florida Supreme
Court exercise its discretionary authority to review the class certification
decision was denied. Defendants' petition that the Florida Supreme Court vacate
the opinion of the
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Third District Court of Appeal and instruct the trial court to make an
independent determination of whether all of the requirements for class
certification have been met was denied in July 1996. Plaintiffs have
notified the trial court that they believe the case is ready to be set for
trial.
In May 1994, an action was filed in Florida state court against the
leading United States cigarette manufacturers and others, by plaintiffs alleging
injury and purporting to represent a class of certain smokers, certain former
smokers and their heirs. Engle, et al. v. R.J. Reynolds Tobacco Company, et al.,
Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida,
Case No. 94-08273-CA-20. In October 1994, the trial court granted plaintiffs'
motion for class certification. The class, as certified, comprises "all United
States citizens and residents and their survivors who have...suffered,
presently suffer, or who have died from diseases and medical conditions caused
by their addiction to cigarettes that contain nicotine." In January 1996, the
Florida Third District Court of Appeal affirmed the trial court's class
certification order, with the modification that the subject class be restricted
to Florida citizens and residents rather than United States citizens and
residents. A motion by defendants requesting that the Florida Supreme Court
exercise its discretionary authority to review the lower court's class
certification decision is pending. Plaintiffs have notified the trial court
that they believe that the case is ready to be set for trial. In July 1996,
the trial court entered an order providing that, in general, potential class
members shall be advised of this action through publication in Florida
newspapers and magazines. Notification, however, has been stayed pending
disposition of defendants' petition to the Florida Supreme Court for
discretionary review.
In March 1994, an action was filed in Alabama state court against three leading
United States cigarette manufacturers, including PM Inc. Defendants
subsequently removed the case to federal court. Lacey, et al. v. Lorillard
Tobacco Company, Inc. et al., United States District Court, Northern District
of Alabama, Jasper Division, Civil Action No. CV94-B-0901-J. Plaintiffs,
claiming to represent all smokers who have smoked or are smoking cigarettes
sold by defendants in the State of Alabama, seek compensatory and punitive
damages not to exceed $48,500 per each class member as well as injunctive
relief arising from defendants' alleged failure to disclose additives used in
their cigarettes. On August 13, 1996, the judge orally granted defendants'
motion for summary judgment on the grounds that the suit is preempted by the
Labeling Act.
In March 1994, an action was filed in federal court in Louisiana against
the leading United States cigarette manufacturers and others, including the
Company, seeking certification of a purported class action on behalf of all
United States residents who allege that they are addicted, or are the legal
survivors of persons who were addicted, to tobacco products. Castano, et al. v.
The American Tobacco Company Inc., et al., United States District Court, Eastern
District of Louisiana, Case No. 94-1044. Plaintiffs alleged that the cigarette
manufacturers concealed and/or misrepresented information regarding the
addictive nature of nicotine and manipulated the levels of nicotine in their
tobacco products to make such products addictive. In May 1996, the Court of
Appeals reversed the district court's earlier certification of the class and
remanded the case with instructions that the district court dismiss the class
allegations. The case can now proceed as an individual action by the two named
plaintiffs. Oral argument on summary judgment motions against these plaintiffs
is scheduled for August 21, 1996. Since the announcement of the Court of
Appeals' decision, purported class action suits based on claims similar to those
in Castano (a "nicotine-dependence class action") and, in some cases, claims of
physical injury as well (a "physical injury class action") have been filed in
Alabama, the District of Columbia, Louisiana, Maryland, New Mexico, New York and
Pennsylvania on behalf of the particular state's (or, in the case of the
District of Columbia, the district's) residents.
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Lawyers for the plaintiffs in Castano announced that they
intend to file similar class actions and actions on behalf of individual
plaintiffs in other state courts.
Immediately prior to the Court of Appeal's decision in the Castano case,
a purported nicotine-dependence class action suit was filed in Indiana state
court against the leading United States cigarette manufacturers and others,
including the Company. In June 1996, defendants removed the case to federal
court. Plaintiffs' motion to remand the case to state court is pending. Norton,
et al. v. RJR Nabisco Holdings Corporation, et al., United States District
Court for the Southern District of Indiana, Case No. IP96-0798-C-M/S.
In May 1996, a purported physical injury class action suit was filed in
Maryland state court against the leading United States cigarette manufacturers
and others, including the Company. The case was removed by defendants to federal
court and plaintiffs have moved to remand the case to state court. Richardson,
et al., v. Philip Morris Incorporated, et al., United States District Court,
District of Maryland, Civil Action No. CCB-96-1963.
In May 1996, a purported nicotine-dependence class action suit was filed
in Louisiana state court against four leading United States cigarette
manufacturers and others, including the Company. The case was removed by
defendants to the United States District Court for the Eastern District of
Louisiana in June 1996. Scott, et al. v. The American Tobacco Company, Inc., et
al., United States District Court, Eastern District of Louisiana, Case No.
96-1946. Plaintiffs' motion to remand the case to state court has been scheduled
for oral argument on August 21, 1996.
In May 1996, a purported nicotine-dependence class action suit was filed
in New Mexico state court against four leading United States cigarette
manufacturers and others, including the Company. Connor v. The American Tobacco
Company, Inc., et al., Second Judicial District Court, County of Bernalillo,
State of New Mexico, Case No. CV-96-5497. This case was voluntarily dismissed by
plaintiff in July 1996.
In June 1996, a purported nicotine-dependence class action suit was filed
in New York state court against PM Inc., the Company, the Tobacco Institute and
the Council for Tobacco Research--U.S.A., Inc. Frosina et al. v. Philip Morris
Inc., et al., Supreme Court of the State of New York, County of New York, Case
No. 96110950.
In June 1996, a purported physical injury class action suit was filed in
the Superior Court of the District of Columbia against the leading United States
cigarette manufacturers and others, including the Company. Reed v. Philip Morris
Incorporated, et al., Superior Court of the District of Columbia, Case No.
CA-05070-96. A similar action captioned Finelli v. Philip Morris Incorporated et
al., which was filed in the Superior Court of the District of Columbia in May
1996 by lawyers for the plaintiff in the Reed case, was dismissed voluntarily by
the plaintiff in June 1996.
In August 1996, a purported nicotine-dependence class action suit was
filed in Pennsylvania state court. Arch et al., v. American Tobacco Company
Inc. et al., Court of Common Pleas of Philadelphia, Pennsylvania, August term
1996 Case No. 0495.
In August 1996, a purported nicotine-dependence class action suit was
filed in Alabama state court on behalf of Alabama and North Carolina residents.
Lyons, et al. v. PM Companies, Inc., et al., Circuit Court of Mobile County,
Alabama, Civil Action No. CV-96-00264.
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In February 1995, Rothmans, Benson & Hedges, Inc. (in which the Company,
through subsidiaries, owns a 40% interest) was served with a statement of claim
commencing a purported class action in the Ontario Court of Justice, Toronto,
Canada, against Imperial Tobacco Limited, RJR-MacDonald Inc., and Rothmans,
Benson & Hedges. LeTourneau v. Rothmans et al., Ontario Court of Justice,
Toronto, Canada. Court File No. 95-CU-82186 (now captioned Caputo v. Imperial
Tobacco Limited, et al.). The lawsuit seeks damages in the amount of $1,000,000
(Canadian) per class member and punitive and exemplary damages and an order
requiring the funding of rehabilitation centers. Plaintiffs seek certification
of a class of persons who have suffered loss as a result of their alleged
nicotine addiction and their estates and persons with related Family Law Act
claims. Defendants have requested a more particular statement of claim prior to
delivering their statement of defense. In April 1996, the Master partially
granted and partially denied the defendants' request for a more particular
statement of claim, and defendants have appealed the Master's order.
In July 1995, a purported class action on behalf of all Brazilian smokers
and former smokers was filed in State Court in Sao Paulo, Brazil, naming Philip
Morris Marketing, S.A. ("PM Marketing") as a co-defendant. The Smoker Health
Defense Association, et al. v. Souza Cruz, S.A. and Philip Morris Marketing,
S.A., 19th Lower Civil Court of the Central Courts of the Judiciary District of
Sao Paulo, Brazil. Plaintiffs allege that defendants failed to warn that smoking
is "addictive" and engaged in misleading advertising. Plaintiffs have obtained
an ex-parte order reversing the burden of proof and placing the burden on
defendants. PM Marketing has denied all material allegations in the complaint.
In December 1995, the court denied PM Marketing's request for dismissal, which
was based on plaintiffs' lack of standing and failure to follow proper filing
procedures. The court's rulings on the reversal of the burden of proof and
plaintiffs' lack of standing have been appealed. The court also denied
co-defendant Souza Cruz's request for recusal of the judge assigned to the case,
and this ruling has also been appealed.
Pro se prisoners have filed two purported class actions against the
leading United States cigarette manufacturers and others seeking, in one case,
class certification on behalf of prisoners in two Mississippi prisons based on
alleged exposure to ETS (Lyle, et al. v. Brown & Williamson Tobacco Corporation,
et al., United States District Court for the Northern District of Mississippi,
Civil Action No. 3:96-CV-268WS) and, in the other, on behalf of all allegedly
nicotine-dependent persons in the United States (Harris, et al. v. Philip Morris
Incorporated, et al., United States District Court for the Eastern District of
Pennsylvania, Civil Action No. 3:96-CV 652). PM Inc. has not been served with
the complaint in either of these actions.
MEDICAID AND HEALTH CARE RECOVERY LITIGATION
In certain of the proceedings pending against PM Inc. and, in some cases,
the Company, state and local government entities or officials and, in one case,
an insurance company, and, in one case, a purported class consisting of a
state's taxpayers, seek reimbursement for Medicaid and other related health care
expenditures allegedly caused by tobacco products. As of August 13, 1996, such
Medicaid recovery actions were pending in the states of Alabama, Connecticut,
Florida, Louisiana, Maryland, Massachusetts, Minnesota, Mississippi, Texas,
Washington and West Virginia. In addition, the City and County of San Francisco
and the County of Los Angeles have filed similar actions. Other states,
municipalities or counties have announced that they are considering similar
actions.
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The claims asserted in these Medicaid recovery actions vary. All
plaintiffs assert the equitable claim that the tobacco industry was "unjustly
enriched" by plaintiffs' payment of health care costs allegedly attributable to
smoking and seek reimbursement of those costs. Other claims made by some but not
all plaintiffs include the equitable claim of indemnity, common law claims of
negligence, strict liability, breach of express and implied warranty, violation
of a voluntary undertaking or special duty, fraud, negligent misrepresentation,
conspiracy, public nuisance, claims under state and federal statutes governing
consumer fraud, antitrust, and deceptive trade practices and false advertising
and claims under the Federal Racketeer Influenced and Corrupt Organization Act
("RICO").
Each plaintiff seeks reimbursement of Medicaid and/or other health care
costs. Other relief sought by some but not all plaintiffs includes punitive
damages, treble damages for alleged antitrust law violations, injunctions
prohibiting alleged marketing and sales to minors, disclosure of research,
disgorgement of profits, funding of anti-smoking programs, disclosure of
nicotine yields and payment of attorneys and expert witness fees.
Defenses raised by defendants include failure to state a valid claim,
lack of benefit, adequate remedy at law, "unclean hands" (namely, that
plaintiffs cannot recover because they participated in, and benefitted 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 damages to the extent a state benefits
economically from the sale of cigarettes through the receipt of excise taxes or
otherwise. Defendants also argue that all of these cases are improper because
plaintiffs must proceed under principles of subrogation and assignment. Under
traditional theories of recovery, a payor of medical costs (such as an insurer
or a state) can seek recovery of health care costs from a third party solely by
"standing in the shoes" of the injured party. Defendants argue that plaintiffs
should be required to bring an action on behalf of each individual Medicaid
recipient and should be subject to all defenses available against the injured
party. In certain of these cases, defendants have also challenged the ability of
the plaintiffs to use contingency fee counsel to prosecute these actions.
Further, certain cigarette companies, including PM Inc., have filed related
declaratory judgment actions in Maryland, Texas, Massachusetts, Connecticut and
Utah seeking to block the Medicaid recovery actions in those states and/or to
prevent the state from hiring contingency fee counsel.
The following is a summary of certain developments in each of the
Medicaid and health care recovery suits pending against PM Inc. and, in some
cases, the Company and the related declaratory judgment actions filed by tobacco
companies.
Florida -- In May 1994, the State of Florida enacted a statute which purports,
among other things, to abolish affirmative defenses in Medicaid recovery
actions. In June 1994, PM Inc. and others filed suit in Florida state court
challenging the constitutionality of the statute. Associated Industries of
Florida, Inc., et al. v. State of Florida Agency for Health Care Administration,
et al., Circuit Court of the Second Judicial Circuit in and for Leon County,
Florida, Case No. 94-3128. In June 1996, the Florida Supreme Court, by a 4 to 3
plurality opinion, ruled that the provisions of the statute that permitted the
state to pursue its action without identifying individual Medicaid recipients
violated defendants' due process rights under the Florida constitution and that
defendants may rebut the state's claims of causation and damages on a recipient
by recipient basis. The court held constitutional on its face the statutory
provision abolishing affirmative defenses normally available to a third party,
including assumption of the risk. However, the court stated that while this
provision is constitutional in the abstract, it might be unconstitutional as
applied in the state's case. The court also held that the state's independent
cause of action created by statutory
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amendment could apply only to Medicaid costs paid after the amendment became
effective in July 1994, that defendants could be held individually liable under
a market share theory, that the state could use statistical evidence to present
its case, and that the agency charged with enforcing the statute was
constitutionally established. Plaintiffs have filed a petition for rehearing on
the Florida Supreme Court's rulings on abrogation of affirmative defenses and
application of the statute to conduct occurring before July 1994.
In February 1995, the State of Florida filed a Medicaid recovery action
under the statute in Florida state court. The State of Florida, et al. v. The
American Tobacco Company, et al., Circuit Court of the Fifteenth Judicial
Circuit in and for Palm Beach County, Florida, Case No. CL 95 1466 AO. In March
1996, defendants filed motions to dismiss and oral argument on these motions is
scheduled for September 6, 1996. In June 1996, the Company withdrew its motion
to dismiss for lack of personal jurisdiction. The court, in July 1996, lifted
its earlier stay of this action. The court has ordered that the trial in this
case begin in August 1997.
Mississippi -- In May 1994, the Attorney General of Mississippi filed a Medicaid
recovery action in Mississippi state court. Moore v. The American Tobacco
Company, et al., Chancery Court of Jackson County, Mississippi, Case No.
94-1429. In February 1995, the court granted plaintiff's motion to strike
certain of defendants' challenges to the sufficiency of the complaint and denied
defendants' motion for judgment on the pleadings. The court subsequently denied
defendants' motion for partial summary judgment, which asserted that the
Attorney General lacked the authority to bring those claims seeking Medicaid
reimbursement. In July 1995, plaintiff filed a motion seeking to preclude
defendants, from asserting their "set off" defenses. That motion is pending. In
April 1996, the Mississippi Supreme Court directed the Attorney General to
respond to the Governor of Mississippi's petition requesting that the court
issue a writ requiring the Attorney General to cease and desist from actions for
recovery of Medicaid funds on the grounds the Attorney General has no authority
to pursue such an action. Pursuant to the Supreme Court's order, in June 1996,
the Attorney General responded to defendants' petition which requested that the
Mississippi Supreme Court instruct the trial judge to dismiss those portions of
the Attorney General's lawsuit that seek recovery of Medicaid funds due to lack
of authority to bring such an action. The Mississippi Supreme Court has
scheduled oral argument on both petitions for September 4, 1996. The trial has
been scheduled for March 24, 1997.
Minnesota -- In August 1994, the Attorney General of Minnesota and Blue Cross
and Blue Shield of Minnesota filed a Medicaid recovery action in Minnesota state
court. Minnesota, et al. v. Philip Morris Incorporated, et al., Minnesota
District Court, Second Judicial District, County of Ramsey, Case No. C1-94-8565.
In July 1996, the Minnesota Supreme Court ruled that Blue Cross did not have
standing to pursue its tort claims against defendants, but that it could proceed
against defendants for claims brought under antitrust and consumer protection
statutes. The Supreme Court also held that Blue Cross could pursue directly its
equitable claims but only for injunctive (not monetary) relief. The case is
tentatively scheduled to go to trial in 1998.
West Virginia -- In September 1994, the Attorney General of West Virginia filed
a Medicaid recovery action in West Virginia state court. McGraw v. The American
Tobacco Company, et al., Circuit Court of Kanawha County, West Virginia, Case
No. 94-1707. In October 1995, the court issued a final order dismissing eight of
ten counts of the complaint on the grounds that the Attorney General did not
have standing to assert the common law counts of the complaint. The court also
granted defendants' motion to prohibit prosecution of this case pursuant to a
contingent fee agreement with private counsel. In June 1996, the Attorney
General filed an amended complaint adding the Public Employees' Insurance Agency
as a party plaintiff. Also in June 1996, the Attorney General withdrew his
earlier petition
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to the West Virginia Supreme Court of Appeals which had sought to reverse the
trial court's dismissal of the common law counts of the complaint. In July 1996,
defendants filed motions to dismiss the remaining antitrust and consumer fraud
counts of the complaint. Hearings on these motions have been scheduled for
November 8 and December 13, 1996.
Texas -- In November 1995, PM Inc., the other leading United States cigarette
manufacturers and the Tobacco Institute filed a lawsuit in state court in Texas
seeking a declaration that the Attorney General cannot pursue a Medicaid
recovery action, which the Attorney General subsequently brought, as discussed
below. Philip Morris Incorporated, et al. v. Dan Morales, Attorney General of
the State of Texas, et al., District Court of Travis County, Texas, No.
94-14807. The complaint asserts that the lawsuit violates the United States
Constitution and federal law as well as the Texas Constitution and Texas
statutory and common law, and includes a request for a declaration that the
Attorney General has no authority to enter into contingent fee agreements with
private attorneys. In February 1996, plaintiffs filed a motion for partial
summary judgment seeking a declaration that the Attorney General has no
authority under Texas law to seek reimbursement of Medicaid expenditures from
plaintiffs outside of the subrogation remedy provided by statute and that
subrogation is the exclusive remedy for recovery of Medicaid expenditures from
third parties. In June 1996, the court denied the Attorney General's challenge
to the court's jurisdiction but decided to hold this state court action in
abeyance pending the action filed by the Attorney General in federal court in
March 1996. The State of Texas v. The American Tobacco Company, et al., United
States District Court, Eastern District of Texas, Civil No. 5-96CV91. In June
1996, defendants filed a number of motions, including a motion to dismiss the
RICO claims of the complaint.
Massachusetts -- In November 1995, PM Inc., along with four other tobacco
manufacturers, commenced an action in federal court in Massachusetts against the
Attorney General of Massachusetts seeking declaratory and injunctive relief in
connection with the constitutionality of two recently enacted Massachusetts
statutory provisions (as construed by the Attorney General). Philip Morris
Incorporated, et al. v. Scott Harshbarger, United States District Court,
District of Massachusetts, Case No. 95-12574-GAO. The complaint alleges that the
Attorney General of Massachusetts had threatened to bring a Medicaid recovery
action, which was subsequently brought, as discussed below. The complaint
asserts claims based upon the United States Constitution and federal law, as
well as certain Massachusetts state constitutional, statutory and common law
claims. In July 1996, oral argument was heard on the Attorney General's motion
to dismiss the complaint, which is still pending. In December 1995, the
Commonwealth of Massachusetts filed a Medicaid recovery suit in Massachusetts
state court. Defendants removed the case to federal court in Massachusetts but
the case was subsequently remanded to state court. Commonwealth of Massachusetts
v. Philip Morris Inc., et al., Superior Court, Middlesex County, Civil Action
No. 95-7378.
Maryland -- In January 1996, PM Inc., four other leading United States cigarette
manufacturers, the Tobacco Institute and a local retailer, commenced an action
in Maryland state court seeking a declaration that, under Maryland law, any
contingent fee contract between the Attorney General and private attorneys to be
appointed assistant counsel for the State and compensated in such a manner is
invalid. Philip Morris Incorporated, et al. v. Parris N. Glendening, Governor of
the State of Maryland, et al., Circuit Court for Talbot County, Maryland, Case
No. CG 2829. The action was commenced in response to threats by the Governor and
Attorney General to file a Medicaid recovery action, which was subsequently
brought, as discussed below. In August 1996, the court denied plaintiffs' motion
for summary judgment, granted defendants' motion for summary judgment and
dismissed the case. In May 1996, the State of Maryland filed a Medicaid recovery
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action in Maryland state court. Defendants subsequently removed the case to
federal court in Maryland and, in July 1996, it was remanded to state court.
State of Maryland v. Philip Morris Incorporated, et al., Circuit Court for
Baltimore County, Maryland, Case No. 96-122017/CL211017.
Louisiana -- In March 1996, the Attorney General of Louisiana filed a Medicaid
recovery action in Louisiana state court. Defendants removed the case to federal
court in Louisiana but, in July 1996, the case was remanded to state court.
Ieyoub, et al. v. The American Tobacco Company, et al., 14th Judicial District
Court, Parish of Calcasieu, Louisiana, Case No. 96-1204.
San Francisco -- This action for recovery of health care expenses was filed in
June 1996 by the City and County of San Francisco in California federal court.
City and County of San Francisco, et al., v. Philip Morris, Inc. et al., United
States District Court, Northern District of California, Civil No. C 96-2090.
Washington - This Medicaid recovery action was filed in June 1996 by the
Attorney General of the State of Washington in Washington state court. State of
Washington v. American Tobacco Co., Inc., et al., Superior Court of Washington,
King County, No. 96-2-15056-8. Trial is scheduled for October 27, 1997.
Connecticut - In June 1996, PM Inc., along with three other tobacco
manufacturers, commenced an action in federal court in Connecticut against the
Attorney General of Connecticut seeking declaratory and injunctive relief.
Philip Morris Inc., et al. v. Richard Blumenthal, United States District Court,
District of Connecticut, Case No. 396CV01221 (PCD). The complaint alleges that
the Attorney General threatened to bring a Medicaid recovery action, which was
subsequently brought, as discussed below. The complaint asserts claims based
upon the United States Constitution and federal law, as well as certain
Connecticut state constitutional, statutory and common law claims. In July 1996,
the Attorney General moved to dismiss the complaint. In July 1996, the State of
Connecticut filed a Medicaid recovery action in Connecticut state court.
Defendants subsequently removed the case to federal court. Richard Blumenthal v.
Philip Morris Inc., et al., United States District Court, District of
Connecticut, Case No. 3-96-CV-01491 (JBA).
Utah - In July 1996, PM Inc. and the other leading United States cigarette
manufacturers filed a lawsuit in state court in Utah seeking a declaration that
the Attorney General of the State of Utah is not authorized by Utah law to hire
special counsel and compensate them on a contingent fee basis for bringing a
Medicaid recovery action. Philip Morris Incorporated, et al. v. Janet C. Graham,
Attorney General of the State of Utah, et al., Third Judicial District Court of
Salt Lake County, Utah, No. 960904948CV. The suit also challenges the right of
the Attorney General to bring the threatened lawsuit as a matter of federal
constitutional law and statutes and under the Utah constitution and Utah
statutes and common law.
Los Angeles - This action for the recovery of health care expenses was filed in
August 1996 by the County of Los Angeles in California state court. County of
Los Angeles v. R.J. Reynolds Tobacco Company, et al., Superior Court of
California, Los Angeles County, Case No. BC155068.
Alabama - This Medicaid recovery action was filed in Alabama state court in
August 1996 as a putative class action on behalf of taxpayers of the State
of Alabama. Crozier, et al. v. The American Tobacco Company, et al., Circuit
Court of Montgomery County, Alabama, Civil Action No. 96-1508PR. On August 12,
1996, the court entered an order conditionally certifying the class.
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OTHER TOBACCO RELATED CLASS ACTION 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 1987." Sacks, et al. v. Philip Morris Inc., United
States District Court, District of Maryland, Case No. WMN-95-1840. Plaintiffs
allege 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. Causes of action are asserted based on federal and state consumer
protection statutes, strict liability, negligence and breach of implied
warranties. Compensatory and punitive damages are sought. In September 1995, PM
Inc. filed a motion to dismiss the complaint based on plaintiffs' failure to
state a claim. Thereafter plaintiffs filed an amended complaint. Defendant's
motion to dismiss is still pending.
In May 1995, PM Inc. announced a recall of certain of its products and in
June and July four purported class actions relating to the recall were filed.
Three of these cases have been dismissed: Netherland, et al. v. Philip Morris
USA, et al., United States District Court, Western District of Louisiana, Monroe
Division, Case No. CV95-1249-M; Sansone, et al. v. Hoechst Celanese Corporation,
et al., Superior Court of New Jersey, Hudson County, Case No. HUD-L-4342-95; and
Walton, et al. v. Philip Morris, Inc., United States District Court, Middle
District of Louisiana, Case No. 95-693. The actions alleged, among other things,
that PM Inc. sold defective products that caused injury to plaintiffs.
In September 1995, plaintiffs in the remaining action filed a second
amended complaint to change the scope of the complaint to allege that PM Inc.
has, for many years, knowingly manufactured filtered products that are defective
because they contain "defective filters." Tijerina, et al., v. Philip Morris,
Inc., et al., United States District Court, Northern District of Texas, Amarillo
Division, Case No. 2-95-CV-120. The second amended complaint purported to be
brought on behalf of a class of all persons who have used filtered products
manufactured by PM Inc. and who have suffered adverse health effects. In March
1996, plaintiffs further amended their complaint to limit the proposed class to
all people who have purchased and smoked within the State of Texas certain
filtered products manufactured by PM Inc. Plaintiffs allege that the filters in
these products contain hazardous chemicals and that cellulose acetate fibers
break away from the filters and are inhaled and ingested by the consumer when
the filtered products are used. Plaintiffs further allege that they relied on PM
Inc.'s false and fraudulent misrepresentations, made through advertising,
regarding the safety of the use of the filters. Motions to dismiss certain of
plaintiffs' claims and motions for summary judgment are pending. The trial is
scheduled to begin on September 10, 1996.
OTHER CLASS ACTION LITIGATION
In April 1993, the Company and certain officers and directors were named
as defendants in the first of a number of purported shareholder class actions
which were consolidated in the United States District Court for the Southern
District of New York. San Leandro Emergency Medical Group Profit Sharing Plan,
et al. v. Philip Morris Companies Inc., et al., United States District Court
for the Southern District of New York, Case No. 93 Civ. 2131. These lawsuits
alleged that the Company violated federal securities laws by making false and
misleading statements concerning the effects of discount cigarettes on PM
Inc.'s premium tobacco business prior to April 2, 1993, the date upon which
PM Inc. announced
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revisions in its marketing and pricing strategies for its premium and discount
brands. In May 1996, the case was dismissed.
In April 1994, the Company, PM Inc. and certain officers and directors
were named as defendants in a complaint filed as a purported class action in
federal court in New York. Lawrence, et al. v. Philip Morris Companies Inc., et
al., United States District Court, Eastern District of New York, Case No. 94
Civ. 1494 (JG). Plaintiffs allege that defendants violated the federal
securities laws by maintaining artificially high levels of profitability through
an inventory management practice pursuant to which defendants allegedly shipped
more inventory to customers than was necessary to satisfy market demand. In
December 1994, a motion to dismiss by defendants was denied. In August 1995, the
court granted plaintiffs' motion for class certification, certifying this action
as a class action on behalf of all persons (other than persons associated with
defendants) who purchased common stock of the Company during the period July 10,
1991 through April 1, 1993, inclusive, and who held such stock at the close of
business on April 1, 1993. In February 1996, the Company filed a Petition for
Writ of Mandamus with the United States Court of Appeals for the Second Circuit
requesting the Court of Appeals to direct the trial court to withdraw its order
granting class certification. In April 1996, the Court of Appeals ordered
plaintiffs to respond to the Company's Petition for Writ of Mandamus. In July
1996, an alleged class member moved to intervene in the action and to be named a
class representative.
In April 1994, the Company, PM Inc. and certain officers and directors
were named as defendants in several purported class actions that were
consolidated in the United States District Court in the Southern District of New
York. Kurzweil, et al. v. Philip Morris Companies Inc., et al., United States
District Court for the Southern District of New York, Case Nos. 94 Civ. 2373
(MBM) and 94 Civ. 2546 (MBM) and State Board of Administration of Florida, et
al. v. Philip Morris Companies Inc., et al., United States District Court for
the Southern District of New York, Case No. 94 Civ. 6399 (MBM). In those cases,
plaintiffs asserted that defendants violated federal securities laws by, among
other things, making allegedly false and misleading statements regarding the
allegedly "addictive" qualities of cigarettes. In each case, plaintiffs claimed
to have been misled by defendants' knowing and intentional failure to disclose
material information. In September 1995, the court granted defendants' motion to
dismiss the two complaints in their entirety. The court granted plaintiff in the
State Board action leave to replead one of its claims. In April 1996, the court
entered an order stipulating the dismissal of the State Board's claim.
In March 1995, an antitrust action was filed in California state court
against four leading United States cereal manufacturers, including the Post
Division of Kraft Foods, Inc. ("Kraft"), by plaintiffs purporting to represent
all California residents who purchased defendants' cereal products for
consumption during the four years preceding the date upon which the complaint
was filed. McIver, et al. v. General Mills, Inc., et al., Superior Court of the
State of California, County of Santa Barbara, Case No. 206666. Plaintiffs seek
treble damages and the return of profits resulting from defendants' alleged
conspiracy to fix and raise prices of cereal products sold to California
consumers. In April 1995, a second purported class action similar to the earlier
action was filed in the same court. In August 1995, the two cases were
consolidated. In September 1995, the court granted defendants' motions for
summary judgment. In December 1995, plaintiffs filed an appeal of that decision
with the California Court of Appeals.
In April 1996, an antitrust action was filed in federal court in
Wisconsin against Kraft as a purported class action. Stuart et
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al. v. Kraft Foods, Inc., et al., United States District Court, Eastern
District of Wisconsin, Case No. 96-C-391. An amended complaint filed in July
1996, named two other leading dairy products manufacturers and the National
Cheese Exchange as defendants. Plaintiff purports to represent all persons
and entities in the United States (excluding governmental entities and
political subdivisions) that sold milk and/or bulk cheese directly to Kraft or
any of its alleged co-conspirators at any time since January 1, 1988. Plaintiff
alleges that defendants engaged in a conspiracy to fix and depress the prices
of bulk cheese and milk through their trading activity on the National Cheese
Exchange and failed to deal in good faith with their bulk cheese and milk
suppliers by paying them prices based on the National Cheese Exchange opinion.
Plaintiff seeks injunctive and equitable relief and treble damages.
The Company and each of its subsidiaries named as a defendant believes,
and each has been so advised by counsel handling the respective cases, that it
has a number of valid defenses to all litigation pending against it. All such
cases are, and will continue to be, vigorously defended. It is not possible to
predict the outcome of this litigation. Litigation is subject to many
uncertainties, and it is possible that some of these actions could be decided
unfavorably. An unfavorable outcome of a pending smoking and health case, such
as the Carter case discussed above, could encourage the commencement of
additional similar litigation. There have also been a number of adverse
legislative, regulatory, political and other developments concerning cigarette
smoking and the tobacco industry. These developments generally receive
widespread media attention. The Company is not able to evaluate the effect of
these developing matters on pending litigation and the possible commencement of
additional litigation.
Management is unable to make a meaningful estimate of the amount or range
of loss that could result from an unfavorable outcome of all pending litigation.
It is possible that the Company's results of operations or cash flows in a
particular quarterly or annual period or its financial position could be
materially affected by an ultimate unfavorable outcome of certain pending
litigation. Management believes, however, that the ultimate outcome of all
pending litigation should not have a material adverse effect on the Company's
financial position.
Note 3. Recently Adopted Financial Accounting Pronouncements:
- --------------------------------------------------------------
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." This
statement requires that certain assets be reviewed for impairment and, if
necessary, remeasured at fair value, whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. The adoption and application of SFAS No. 121 as of January 1,
1996 had no impact on the Company's financial position or results of
operations for the three and six months ended June 30, 1996.
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 employee stock compensation
plans using a fair value based method or to continue to use an intrinsic
value based method. The Company will continue to use the intrinsic value
based method, which generally does not result in compensation cost.
Effective January 1, 1995, the Company adopted SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions," for
its non-U.S. retiree benefit plans and SFAS No. 116, "Accounting for
Contributions Received and Contributions Made." The adoption of these
Statements reduced 1995 net earnings by $21 million ($.02 per share) and $7
million ($.01 per share), respectively.
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
- ------------------------------------------------------------------------
CONSOLIDATED OPERATING RESULTS
- ------------------------------
For the Six Months Ended June 30,
------------------------------------------------------------
Operating Revenues Operating Income
---------------------------- ------------------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
Tobacco $18,340 $16,271 $ 4,130 $ 3,602
Food 14,178 14,949 1,968 1,913
Beer 2,300 2,233 275 279
Financial services
and real estate 182 193 90 81
Amortization of goodwill (293) (294)
Unallocated
corporate expenses (227) (214)
------- ------- ------- -------
Total $35,000 $33,646 $ 5,943 $ 5,367
======= ======= ======= =======
For the Three Months Ended June 30,
------------------------------------------------------------
Operating Revenues Operating Income
---------------------------- ------------------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
Tobacco $ 9,194 $ 8,330 $ 2,046 $ 1,778
Food 7,034 7,490 1,020 980
Beer 1,200 1,187 159 165
Financial services
and real estate 81 122 49 49
Amortization of goodwill (146) (148)
Unallocated
corporate expenses (114) (105)
------- ------- ------- -------
Total $17,509 $17,129 $ 3,014 $ 2,719
======= ======= ======= =======
1996 COMPARED WITH 1995
Operating revenues for the first six months of 1996 increased $1.4
billion (4.0%) and operating income for the first six months increased $576
million (10.7%) over the comparable 1995 period. Operating revenues for the
second quarter increased $380 million (2.2%) and operating income for the
second quarter increased $295 million (10.8%) over the comparable 1995 period.
Operating revenues increased in the first six months and second quarter over
the comparable 1995 periods due primarily to increases in tobacco revenues
partially offset by the impact of divestitures of food businesses. Operating
income increased in the first six months and second quarter over the comparable
1995 periods due primarily to increases in the tobacco and food segments.
Continued
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23
Excluding the results of divested North American food businesses
(discussed below in Food--Business Environment), operating revenues and
operating income increased $2.8 billion (8.8%) and $636 million (12.0%),
respectively, in the first six months over the comparable 1995 period and
increased $880 million (5.3%) and $327 million (12.2%), respectively, in the
second quarter over the comparable 1995 period.
Currency movements, primarily the Japanese yen, decreased operating
income by $35 million and $18 million in the first six months and second
quarter of 1996, respectively, versus the comparable 1995 periods. Although
the Company cannot predict future movements in currency rates, it currently
estimates that currency movements may continue to have an unfavorable impact
on operating income in 1996.
Excluding the cumulative effect of accounting changes discussed below,
net earnings increased by $413 million (14.9%) in the first six months of
1996 over the comparable 1995 period due to increased operating income ($576
million) and lower interest expense ($83 million), partially offset by a
higher income tax provision ($246 million). Net earnings increased $211
million (15.0%) in the second quarter of 1996 over the comparable 1995
period due to increased operating income ($295 million) and lower interest
expense ($42 million), partially offset by a higher income tax provision
($126 million).
Excluding the cumulative effect of accounting changes discussed below,
earnings per share of $3.85 in the first six months of 1996 increased by
17.7% over the comparable 1995 period, due to an increase in earnings and
fewer shares outstanding. Similarly, net earnings per share of $1.97 in the
second quarter of 1996 increased 18.0% as compared to the prior year. As a
result of the Company's share repurchase program, the weighted average
number of shares outstanding decreased to 827 million in the first six
months of 1996 from 847 million in the first six months of 1995. The
weighted average number of shares outstanding decreased to 823 million in
the second quarter of 1996 from 844 million in the second quarter of 1995.
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," for its non-U.S. retiree
benefit plans and SFAS No. 116, "Accounting for Contributions Received and
Contributions Made." The adoption of these Statements reduced 1995 net
earnings by $21 million ($.02 per share) and $7 million ($.01 per share),
respectively.
As described in Note 3 to the Condensed Consolidated Financial
Statements, 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" and SFAS No. 123, "Accounting for Stock-Based
Compensation." The adoption and application of SFAS No. 121 and SFAS No.
123 as of January 1, 1996 had no impact on the Company's financial position
or results of operations for the three and six months ended June 30, 1996.
OPERATING RESULTS BY BUSINESS SEGMENT
- -------------------------------------
TOBACCO
- -------
BUSINESS ENVIRONMENT
As discussed below, the tobacco industry, including PM Inc., the Company's
domestic tobacco subsidiary, and Philip Morris International Inc. ("PMI"), the
Company's international tobacco subsidiary, have faced, and continue to face, a
number of issues which may adversely affect volume, operating revenues and
operating income.
Continued
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In the United States, these issues include proposed federal regulatory
controls (including, as discussed below, the publication of proposed
regulations by the United States Food and Drug Administration (the "FDA")
which purport to regulate tobacco products as "drugs" or "medical devices");
actual and proposed excise tax increases; federal, state and local
governmental and private restrictions on smoking (including restrictions
imposed by airlines); new and proposed restrictions on tobacco
manufacturing, marketing, advertising (including decisions by certain
companies to limit or not accept tobacco advertising) and sales; new and
proposed regulations to ban or severely restrict smoking in workplaces and
in buildings permitting public access, to require substantial additional
health warning and product content information on cigarette packages and in
advertising, and to eliminate the tax deductibility of a portion of the cost
of tobacco advertising; increased assertions of adverse health effects
associated with both smoking and exposure to environmental tobacco smoke
(and legislation or other governmental action seeking to ascribe to the
industry responsibility and liability therefor); the diminishing social
acceptance of smoking; increased pressure from anti-smoking groups;
unfavorable press reports; governmental and grand jury investigations;
private plaintiff class action litigation; and actions by states and local
governments seeking Medicaid and health care reimbursement and existing and
proposed laws to help facilitate such recoveries. See Note 2 to the
Condensed Consolidated Financial Statements regarding certain litigation in
which the Company and/or its subsidiaries (including PM Inc.) are
defendants.
In August 1995, President Clinton announced, and the FDA initiated, a
rule-making proceeding purportedly designed to prevent minors from smoking. In
the proposed regulations, the FDA asserted that it has jurisdiction over
nicotine as a "drug" and over cigarettes as a "medical device" (a nicotine
delivery system) under the provisions of the Food, Drug and Cosmetic Act. The
proposed regulations include severe restrictions on the distribution, marketing
and advertising of cigarettes and would require cigarette manufacturers to
fund, in the aggregate, a $150 million-a-year campaign to discourage minors
from using tobacco products. In March 1996, the FDA placed in its rulemaking
docket statements from three former employees of PM Inc. concerning, according
to the FDA Commissioner, "the role of nicotine in the design and manufacture of
cigarettes." The period for public comment on the FDA's proposal ended on
April 19, 1996. It has been reported that the final regulations have been
submitted to the Office of Management and Budget for review and may be issued
before the November 5, 1996 elections. The FDA's assertion 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
current proposed regulations and could adversely affect the volume, operating
revenues and operating income of PM Inc. in amounts that cannot be determined.
PM Inc. and other domestic cigarette manufacturers and an advertising firm have
sued the FDA, seeking a judicial declaration that the FDA has no authority to
regulate cigarettes and asking the court to issue an injunction requiring the
FDA to withdraw its proposed regulations. Similar suits have been filed
against the FDA by manufacturers of smokeless tobacco products, by a trade
association of cigarette retailers, and by advertising agency associations. It
is not possible to determine the outcome of the FDA regulatory initiative
announced by President Clinton or the related litigation.
On August 2, 1996, the Governor of Massachusetts signed legislation that
would require cigarette manufacturers, beginning in 1997, to disclose the
flavorings and other ingredients used in individual brands, and to provide
"nicotine-yield ratings" for their products based on standards to be
established by the Massachusetts Department of Public Health. PM Inc. and three
other domestic cigarette manufacturers have filed suit in federal district
court in Boston challenging the ingredient-disclosure provision of the
legislation as preempted by the Federal Cigarette Labeling and Advertising Act
and as violating the commerce, full faith and credit, due process and takings
clauses of the U.S. Constitution. The outcome of this lawsuit cannot be
predicted. The enactment of this legislation may encourage efforts in other
states to enact similar legislation.
Continued
-24-
25
Some foreign countries have also taken steps to restrict or prohibit
cigarette advertising and promotion, to increase taxes on cigarettes, to
control prices, to restrict imports and to discourage cigarette smoking.
It is not possible to predict what, if any, other foreign or domestic
governmental legislation or regulations will be adopted relating to the
advertising, sale or use of cigarettes or to the tobacco industry generally.
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 May 1996, PM Inc. proposed that comprehensive federal legislation be
enacted to respond to concerns by the President and others regarding the use
of tobacco products by minors. The proposed legislation would establish a
federal minimum age of 18 for the sale of tobacco products and would ban,
restrict or otherwise limit the following among other things: cigarette
vending machines; tobacco product brand names, logos, characters and selling
messages on non-tobacco-related items such as hats or T-shirts; tobacco
product sponsorship of events with significant youth audiences; outdoor
advertisements for tobacco products within 1,000 feet of any playground or
elementary or secondary school, including outward-facing window display
advertising; advertisements for tobacco products in or on trains, buses,
subways and taxis, and in terminals, stations, platforms or stops for these
vehicles; and advertisements for tobacco products in youth-oriented
publications. The proposed legislation would restrict youth access to
tobacco products by calling for a ban on the sale of single cigarettes or
packs with fewer than 20 cigarettes; requiring all tobacco sales to be
face-to-face, where proof of age can be verified for anyone appearing to be
under age 21; mandating that tobacco products in retail establishments be
displayed within the control or line of sight of an employee; banning
sampling except in locations where minors are denied access; and requiring
retailers and their employees to certify that they understand and will
comply with minimum-age laws. To ensure compliance, the proposed
legislation calls for penalties of up to $50,000 for violations by a tobacco
manufacturer. The proposed legislation also calls for a $250 million
contribution from the tobacco industry (based on market share) over a
five-year period to assist the government and others in implementation and
enforcement. The proposed legislation would preclude the FDA from
regulating tobacco products. As of the date of this filing, this legislation
has not been introduced in either house of Congress.
PM Inc. has received requests for information (including, in some
cases, grand jury subpoenas or Civil Investigative Demands) in connection
with governmental investigations of the tobacco industry. 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:
An investigation by the United States Department of Justice relating to
the possibility of alleged joint activity to restrain competition in the
manufacture and sale of cigarettes, including possible joint activity to
restrict research and development or product innovations;
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;
An investigation by the United States Attorney for the Eastern District
of Virginia relating to Healthy Buildings International, Inc.; and
Continued
-25-
26
An investigation by the United States Department of Justice relating to
issues raised in testimony provided by tobacco industry executives before
Congress.
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 above.
While the outcomes of these investigations cannot be predicted, PM Inc.
believes it has acted lawfully.
In July 1996, PMI learned of a criminal investigation initiated in February
1996, by the Criminal Prosecutors Office in Naples, Italy, regarding an alleged
conspiracy to avoid the payment by PMI and certain of its affiliates of
presently unassessed, but potentially substantial, amounts of income taxes in
Italy. PMI and its affiliates believe that they have complied with applicable
Italian tax laws.
Also in July 1996, an affiliate of PMI received a request for information
from the Competition Directorate of the European Commission concerning the
relationship of certain affiliates of PMI with Monopoli di Stato, the Italian
state cigarette monopoly. PMI and its affiliates believe that they have acted in
accordance with European Community law.
In March 1996, Liggett Group, Inc., a United States manufacturer and
seller of cigarettes ("Liggett"), announced an agreement to settle the
Castano case described in Note 2 to the Condensed Consolidated Financial
Statements. The agreement is subject to court approval. Liggett also
announced an agreement to settle the Medicaid reimbursement actions brought
by the states of Florida, Louisiana, Massachusetts, Mississippi and West
Virginia. As part of each settlement, Liggett agreed to comply with certain
aspects of the regulations proposed by the FDA, to make certain payments and
to cooperate in limited ways with otherwise adverse parties in certain
investigations and lawsuits. The terms of the settlements would be
available to any other defendant that has a share of the United States
domestic cigarette market of less than 30% if it acquires or is acquired by
Liggett, and each settlement can be terminated by Liggett upon the
occurrence of specified events. Liggett's sales account for approximately
2% of the United States domestic cigarette market. The major cigarette
manufacturers in the United States, including PM Inc., have stated that they
do not intend to settle any smoking and health litigation and that they will
continue to defend all such actions vigorously.
In addition to the foregoing, there is litigation pending against the
Company and its subsidiaries which is discussed in Note 2 to the Condensed
Consolidated Financial Statements. The Company's position with regard to this
litigation is set forth therein.
Continued
-26-
27
1996 COMPARED WITH 1995
For the Six Months Ended June 30,
----------------------------------------
Operating Revenues Operating Income
-------------------- ------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
Domestic tobacco $ 5,967 $ 5,576 $2,033 $1,825
International tobacco 12,373 10,695 2,097 1,777
------- ------- ------ ------
Total $18,340 $16,271 $4,130 $3,602
======= ======= ====== ======
DOMESTIC TOBACCO. During the first six months of 1996, PM Inc.'s
operating revenues increased 7.0% over the comparable 1995 period, due to
pricing ($195 million), higher volume ($160 million) and improved product
mix ($36 million). Operating income for the first six months of 1996
increased 11.4% over 1995, due to price increases, net of product cost
increases ($164 million), higher volume ($99 million), improved product mix
($32 million) and lower fixed manufacturing expense ($103 million, due
primarily to the costs of a product recall in the second quarter of 1995),
partially offset by higher marketing, administration and research expense
($190 million).
The premium and discount segments (based on shipments) accounted for
approximately 71.3% and 28.7%, respectively, of domestic cigarette industry
volume in the first six months of 1996, versus approximately 69.6% for the
premium segment and 30.4% for the discount segment in the first six months
of 1995.
PM Inc.'s volume (based on shipments) for the first six months of 1996
was 111.8 billion units, an increase of 2.9% over 1995, compared with an
industry decrease of 0.3%, from the comparable period in 1995.
PM Inc.'s market share (based on shipments) for the first six months of
1996 was 47.3%, an increase of 1.5 share points from the first six months of
1995. In the premium segment, volume in PM Inc.'s brands increased 4.7%,
compared with a 2.0% increase for the industry, resulting in a premium
segment share of 55.7%, an increase of 1.4 share points from the first six
months of 1995. Marlboro volume was up 4.6 billion units (6.5%) for a 31.8%
share of the total industry, an increase of 2.0 share points from 1995. In
the discount segment, PM Inc.'s shipments decreased 5.4%, to 18.0 billion
units, in the first six months of 1996 compared with an industry decline of
5.7%, resulting in a discount segment share of 26.5%, an increase of 0.1
share points from the first six months of 1995.
Retail sales data (compiled by the A.C. Nielsen Company) indicate PM
Inc. and Marlboro market shares of 49.2% and 32.9%, respectively, in the
first six months of 1996, compared with 47.0% and 30.3%, respectively, in
the first six months of 1995. The market share for PM Inc.'s other premium
brands as a group was 9.0% in 1996, up slightly from the comparable period
in 1995. In the discount segment, Basic increased its segment share to
17.1%, an increase of 1.8 share points from the first six months of 1995.
PM Inc. cannot predict change or rates of change in the relative sizes
of the premium and discount segments or in PM Inc.'s shipments, market share
(based on shipments) or retail market share.
During the second quarter of 1996, PM Inc. implemented a $2.00 per
thousand increase in the price of its domestic premium and discount brands.
PM Inc.
Continued
-27-
28
previously increased the price of its domestic brands by $1.50 per thousand in
the second quarter of 1995.
INTERNATIONAL TOBACCO. During the first six months of 1996, tobacco
operating revenues of PMI increased 15.7%, due to higher foreign excise
taxes ($887 million, including those for previously unconsolidated and newly
acquired subsidiaries), favorable volume/mix ($531 million), price increases
($146 million) and the impact of previously unconsolidated and newly
acquired subsidiaries ($165 million, excluding excise taxes), partially
offset by unfavorable currency movements ($51 million). Operating income
increased 18.0%, due primarily to favorable volume/mix ($276 million) and
price increases ($146 million), partially offset by unfavorable currency
movements ($49 million) and higher marketing costs ($55 million).
Total international volume grew 38.2 billion units (12.6%) in the first
six months of 1996 over the comparable 1995 period to 340.7 billion units.
Volume advanced in most major markets, including Germany, Italy, Spain,
Central and Eastern Europe, Turkey, Saudi Arabia, Japan, Korea and
Singapore. Volume continued to decline in Mexico, due to poor economic
conditions, and was down in Australia due to an unfavorable comparison with
last year, when a price war resulted in strong volume and share growth for PMI,
as well as lower industry volume trends this year. Volume in Central Europe
includes local brands manufactured by ZPT-Krakow, Poland's largest cigarette
manufacturer, in which PMI acquired a controlling interest during the first
quarter. Excluding sales of ZPT-Krakow's local brands, PMI's overall volume
during the first six months of 1996 was 10.0% higher than the comparable 1995
period.
PMI's market shares also rose in most major markets, with gains
recorded in Germany, Italy, Spain, the Benelux countries, Switzerland, the
Czech Republic, Turkey, Japan, Korea, Singapore, Hong Kong and Argentina.
For the Three Months Ended June 30,
----------------------------------------
Operating Revenues Operating Income
-------------------- ------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
Domestic tobacco $3,133 $2,998 $1,062 $ 951
International tobacco 6,061 5,332 984 827
------- ------ ------ ------
Total $9,194 $8,330 $2,046 $1,778
======= ====== ====== ======
DOMESTIC TOBACCO. During the second quarter of 1996, PM Inc.'s
operating revenues increased 4.5% over the comparable 1995 period, due to
pricing ($120 million) and improved product mix ($24 million), partially
offset by lower volume ($9 million). Operating income for the 1996 second
quarter increased 11.7% from 1995, due to price increases, net of product cost
increases ($104 million), improved product mix ($20 million) and lower fixed
manufacturing expense ($91 million, due to the costs of a product recall in the
second quarter of 1995), partially offset by lower volume ($6 million), and
higher marketing, administration and research costs ($98 million).
The premium and discount segments (based on shipments) accounted for
approximately 71.3% and 28.7%, respectively, of domestic cigarette industry
volume in the second quarter of 1996, versus approximately 69.8% for the
premium segment and 30.2% for the discount segment in the second quarter of
1995.
Continued
-28-
29
PM Inc.'s volume (based on shipments) for the second quarter of 1996
was 57.9 billion units, a decrease of 0.4% over 1995, compared with an
industry decrease of 2.9%, from the comparable period in 1995. PM Inc.'s
volume decline was attributable to an unfavorable comparison with 1995. In
the second quarter of 1995, shipments were affected by the timing of orders
as distributors replenished inventories and moved up what would have been
third quarter shipments to the end of June, to stock warehouses in advance
of an extended July 4th holiday weekend.
PM Inc.'s market share (based on shipments) for the second quarter of
1996 was 46.9%, an increase of 1.2 share points from the second quarter of
1995. In the premium segment, volume in PM Inc.'s brands increased 1.3%,
compared with a 0.9% decrease for the industry, resulting in a premium
segment share of 55.4%, an increase of 1.2 share points from the second
quarter of 1995. Marlboro volume was up 1.0 billion units (2.5%) for a
31.5% share of the total industry, an increase of 1.7 share points from
1995. In the discount segment, PM Inc.'s shipments decreased 8.7%, to 9.1
billion units, in the second quarter of 1996 compared with an industry
decline of 7.6%, resulting in a discount segment share of 25.8%, a decrease
of 0.3 share points from the second quarter of 1995.
Retail sales data (compiled by the A.C. Nielsen Company) indicate PM
Inc. and Marlboro market shares of 49.6% and 33.4%, respectively, in the
second quarter of 1996, compared with 46.6% and 30.0%, respectively, in the
second quarter of 1995. The market share for PM Inc.'s other premium brands
as a group was 9.0% in 1996, up slightly from the comparable period in 1995.
In the discount segment, Basic increased its segment share 2.1 points, to
17.5%, in the second quarter of 1996.
PM Inc. cannot predict change or rates of change in the relative sizes
of the premium and discount segments or in PM Inc.'s shipments, market share
(based on shipments) or retail market share.
INTERNATIONAL TOBACCO. During the second quarter of 1996, tobacco
operating revenues of PMI increased 13.7%, due to higher foreign excise
taxes ($390 million, including those for previously unconsolidated and newly
acquired subsidiaries), favorable volume/mix ($271 million), price increases
($74 million) and the impact of previously unconsolidated and newly acquired
subsidiaries ($107 million, excluding excise taxes), partially offset by
currency movements ($113 million). Operating income increased 19.0% due
primarily to favorable volume/mix ($130 million) and price increases ($74
million), partially offset by unfavorable currency movements ($22 million)
and higher marketing costs ($22 million).
Total international volume grew 18.1 billion units (12.4%) in the
second quarter of 1996 over the comparable 1995 period to 164.8 billion
units. Volume advanced in most major markets, including Germany, Italy,
Spain, Central and Eastern Europe, Turkey, Saudi Arabia, Japan, Korea and
Singapore. Volume continued to decline in Mexico, due to poor economic
conditions and was down in Australia due to an unfavorable comparison with
last year, when a price war resulted in strong volume and share growth for PMI,
as well as lower industry volume trends this year. Volume in Central Europe
includes local brands manufactured by ZPT-Krakow, Poland's largest cigarette
manufacturer, in which PMI acquired a controlling interest during the first
quarter of 1996. Excluding sales of ZPT-Krakow's local brands, PMI's overall
volume during the second quarter of 1996 was 9.2% higher than the comparable
1995 period.
PMI's market shares rose in most major markets, with gains recorded in
Germany, Italy, Spain, the Benelux countries, Switzerland, the Czech
Republic, Turkey, Japan, Korea, Singapore, Hong Kong and Argentina.
Continued
-29-
30
FOOD
- ----
BUSINESS ENVIRONMENT
Several steps have been taken to build the value of premium brands,
reduce costs and increase profitability in the food businesses. Effective
January 1995, the North American food business was reorganized to fully
integrate the operations of Kraft USA and General Foods USA. The combined
organization, named Kraft Foods, Inc. ("Kraft"), has streamlined operations
and improved effectiveness and customer response. In December 1995, the
international food business, Kraft Foods International, Inc. ("KFI"), was
realigned to capitalize on future growth opportunities and reorganized into
separate regional units: Western Europe; Northern Europe; Central and
Eastern Europe, Middle East and Africa; and Asia/Pacific. In Latin America,
where certain subsidiaries and affiliates of PMI manufacture and market a
wide variety of food products, PMI acquired nearly all of the remaining
voting shares of Industrias de Chocolate Lacta S.A., Brazil's leading
chocolate company.
Kraft and KFI have sold certain non-strategic businesses. In 1995,
Kraft sold its bakery and margarine businesses during the fourth quarter,
its specialty oils, marshmallows and caramels businesses during the third
quarter and substantially all of the distribution businesses of Kraft
Foodservice during the first quarter. In addition, KFI sold several smaller
international food businesses in 1995 and 1996.
During 1996, KFI plans to continue initiatives to realign its portfolio
of businesses, focus on higher-margin premium products, reduce costs and
grow in new markets. KFI has reached agreements to sell several
non-strategic operations in the third quarter of 1996, including the Malaco
sugar confectionery business in Scandinavia and margarine and spreads
businesses in the U.K. and Italy. These divestitures are not expected to
have a material effect on international food's 1996 or future results of
operations.
Both the North American and international food businesses have been
affected by green coffee bean cost volatility, which began with frosts in
Brazil in the second quarter of 1994. Throughout 1995, green coffee bean
prices remained volatile, and continued to fluctuate in the first half of
1996. Volatile green coffee bean prices significantly affected consumer
buying patterns and in some markets, such as Germany, led to intense price
competition among coffee companies. In the second quarter of 1996, green
coffee bean prices declined, resulting in lower operating revenues as prices
charged to consumers were reduced.
1996 COMPARED WITH 1995
For the Six Months Ended June 30,
----------------------------------------
Operating Revenues Operating Income
-------------------- ------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
North American food $ 8,447 $ 9,547 $1,420 $1,387
International food 5,731 5,402 548 526
------- ------- ------ ------
Total $14,178 $14,949 $1,968 $1,913
======= ======= ====== ======
Continued
-30-
31
NORTH AMERICAN FOOD. During the first six months of 1996, operating
revenues decreased 11.5% from the comparable 1995 period, due primarily to
the impact of divestitures ($1.5 billion), product mix ($52 million) and
pricing ($50 million), partially offset by volume increases in on-going
operations ($436 million). Operating income increased 2.4% over the
comparable 1995 period, due primarily to volume increases in on-going
operations ($242 million), partially offset by higher marketing,
administration and research costs ($63 million), the impact of divestitures
($60 million), product mix ($49 million) and pricing ($45 million).
Excluding operating results of the divested businesses discussed above,
North American food operating revenues and operating income increased 4.7%
and 7.0%, respectively, in the first six months of 1996 compared with the
comparable 1995 period.
Volume grew in beverages, on the strength of powdered and
ready-to-drink products; cheese, due to volume gains in natural and process
cheese; desserts, due to strength in ready-to-eat and packaged products, as
well as the acquisition of a shelf-stable pudding product line in the fourth
quarter of 1995; coffee on the strength of premium brands; frozen pizza,
helped by new product introductions; and processed meats, driven by new
product introductions in lunch combinations and cold cuts. Volume increased
in cereals in the first six months of 1996, due primarily to Kraft's
implementation of price reductions and simplified couponing in the second
quarter. These steps were initiated after a first quarter volume
decline, which reflected intense price competition and pressure from low-price
brands.
INTERNATIONAL FOOD. Operating revenues for the first six months of
1996 increased 6.1% over the first six months of 1995, due to higher volume
($76 million, reflecting an additional selling week in 1996), the
consolidation of previously unconsolidated operations in emerging markets
($362 million) and currency movements ($45 million), partially offset by
pricing ($121 million, primarily coffee) and the impact of divestitures ($39
million). Operating income during the first six months of 1996, which
included the results from an extra selling week, increased 4.2% over the
comparable 1995 period reflecting higher volume ($32 million), the
consolidation of previously unconsolidated operations in emerging markets
($31 million), cost decreases, net of price reductions ($28 million) and
currency movements ($11 million), partially offset by higher marketing,
administration and research costs ($81 million).
Higher international food volume was due primarily to the consolidation
of previously unconsolidated businesses, an extra selling week in the first
quarter and growth in a number of developing markets. KFI's coffee volume
increased in all regions during the first six months of 1996 over the first
six months of 1995, particularly in several key markets such as Sweden and
France. However, coffee volume was down in Germany, international food's
largest coffee market. Although volume gains in coffee were realized during the
first six months of 1996, volume related earnings gains were not realized due to
lower margins reflecting continued competition. KFI's confectionery volume
increased, especially in the emerging markets of Central and Eastern Europe.
KFI's cheese and grocery volumes were down, due to divestitures of businesses
and lower sliced beef sales in Italy. Price competition remains intense in all
international food categories and may continue to have an unfavorable impact on
volume and operating income during 1996. Latin America volume was higher on
strong sales of powdered soft drinks throughout the region.
Continued
-31-
32
For the Three Months Ended June 30,
----------------------------------------
Operating Revenues Operating Income
-------------------- ------------------
(in millions)
1996 1995 1996 1995
---- ---- ---- ----
North American food $4,258 $4,646 $ 735 $716
International food 2,776 2,844 285 264
------ ------ ------ ------
Total $7,034 $7,490 $1,020 $980
====== ====== ====== ======
NORTH AMERICAN FOOD. During the second quarter of 1996, operating
revenues decreased 8.4% from the comparable 1995 period, due primarily to
the impact of divestitures ($500 million), pricing ($71 million, due
primarily to the price reductions in cereals) and product mix ($19 million),
partially offset by volume increases in on-going operations ($177 million)
and currency movements ($12 million). Operating income increased 2.7% over
the comparable 1995 period, due primarily to volume increases in on-going
operations ($103 million) and lower marketing, administrative and research
expenses ($32 million), partially offset by pricing ($66 million), the
impact of divestitures ($32 million) and product mix ($23 million).
Excluding operating results of divested businesses, discussed above,
North American food operating revenues and operating income increased 2.7%
and 7.5%, respectively, in the second quarter of 1996 compared with the
comparable 1995 period.
Volume grew in beverages, on the strength of powdered and
ready-to-drink products; desserts, due to the acquisition of a shelf-stable
pudding product line in the fourth quarter of 1995; frozen pizza, helped by
new product introductions; cheese, driven by gains in process and natural
cheese, as well as new product introductions; and processed meats, driven by
lunch combinations and cold cuts, both of which were aided by new product
introductions. Volume also increased in the cereals business, as consumers
responded to price reductions and new product introductions.
INTERNATIONAL FOOD. Operating revenues for the second quarter of 1996
decreased 2.4% compared to the second quarter of 1995, due to lower volume
($82 million), pricing ($79 million, reflecting lower coffee prices and
continued intense price competition in Western Europe), currency movements
($39 million) and the impact of divestitures ($24 million), partially offset
by the consolidation of previously unconsolidated operations in emerging
markets ($155 million). Operating income increased 8.0% over the comparable
1995 period reflecting cost decreases, net of price reductions ($70 million) and
the consolidation of previously unconsolidated subsidiaries ($3 million),
partially offset by lower volume ($37 million) and higher marketing,
administration and research costs ($17 million). During the second quarter of
1995, an interest in an Italian grocery operation was sold at a gain, and a
lower-of-cost-or-market charge was recorded for coffee inventories. The net
impact of these items was not material to second quarter 1995 operating income.
KFI's coffee volumes declined in the second quarter of 1996 due
primarily to continued price competition in Germany and the timing of
shipments in Sweden, partially offset by growth of premium coffee products
in France. KFI's confectionery volumes were down in the second quarter of
1996 reflecting intense price competition throughout Western and Northern
Europe, partially offset by growth in developing markets. KFI's cheese and
grocery volume decreased in the second quarter reflecting the sale of
several small international food businesses
Continued
-32-
33
in 1995, price competition and lower sliced beef volume in Italy, partially
offset by higher volume in the developing markets of China, the Philippines
and the Middle East. Volume in Latin America increased in the second quarter
of 1996 on the strength of powdered soft drinks in Argentina, Brazil and
Puerto Rico, partially offset by lower confectionery volume in Argentina.
BEER
- ----
Six Months ended June 30
Operating revenues of Miller Brewing Company ("Miller") for the first
six months of 1996 increased $67 million (3.0%) from the comparable 1995
period, due primarily to price/mix improvements ($79 million), partially
offset by lower volume ($16 million). Operating income decreased $4 million
(1.4%) from the comparable 1995 period, due primarily to lower volume ($7
million), higher marketing, administration and research costs ($11 million)
and unfavorable fixed manufacturing expenses ($11 million), partially offset
by price/mix improvements ($25 million). During the first quarter of 1996,
Miller recorded its share of a one-time restructuring charge at 20% owned
Molson Canada. In the second quarter of 1996, Miller realized the benefit
of lower than anticipated costs for integrating Molson USA's operations.
The net impact of these items was not material to Miller's operating income
for the six months ended June 30, 1996.
Miller's 1996 first six months total worldwide volume of 23.5 million
barrels decreased 0.6% from the comparable 1995 period, reflecting decreased
shipments of budget-priced brands, partially offset by increased shipments
of premium-priced brands. Shipments of premium-priced beers accounted for
82.4% of shipments in the first six months of 1996 compared with 81.3% in the
first six months of 1995. Premium brand growth was led by the introduction of
Miller Beer, a new lager, and increased shipments of Miller Lite, while
shipments of Red Dog declined from last year's first six months.
Quarter Ended June 30
Operating revenues of Miller for the second quarter of 1996 increased
$13 million (1.1%) from the comparable 1995 period, due primarily to price/mix
improvements ($48 million), partially offset by volume decreases ($36
million). Operating income decreased by $6 million (3.6%) from the
comparable 1995 period, due primarily to lower volume ($15 million) and
unfavorable fixed manufacturing expenses ($8 million), partially offset by
price/mix improvements ($14 million) and lower than anticipated costs for
integrating Molson USA's operations.
Miller's 1996 second quarter total worldwide volume of 12.2 million
barrels decreased 3.0% from the comparable 1995 period, reflecting decreased
shipments of premium and budget-priced brands. The decrease in premium beer
shipments was due to lower volume in Red Dog, Miller Lite Ice and the
Genuine Draft brand family, which more than offset the introduction of
Miller Beer and higher volume from Miller Lite, Icehouse and hand-crafted
specialty beers. Lower volume in the second quarter is attributable in part
to unseasonably cool weather in Miller's key northern United States markets
and intense competition. Miller currently estimates that, if second quarter
trends continue, shipments for the full year may be lower than 1995.
FINANCIAL SERVICES AND REAL ESTATE
- ----------------------------------
Six Months ended June 30
For the first six months of 1996, operating revenues from financial
services and real estate operations decreased 5.7%, and operating income
increased 11.1% from the first six months of 1995, reflecting growth from
the financial services
Continued
-33-
34
operations of Philip Morris Capital Corporation ("PMCC") and lower results
from the real estate operations of Mission Viejo Company ("MVC"). Higher
financial services operating revenues and income reflect the continued growth
and profitability of PMCC's leasing and structured finance portfolio.
Operating revenues and income from real estate operations decreased from 1995
levels, due primarily to an unfavorable comparison caused by a large land sale
in Southern California in the second quarter of last year, partially offset by
higher 1996 Colorado land sales.
Quarter Ended June 30
For the second quarter of 1996, operating revenues from financial
services and real estate operations decreased 33.6% from the second quarter
of 1995, and operating income was flat, reflecting growth from PMCC's
financial services and lower results from MVC's real estate operations.
Higher financial services operating revenues and income reflect income from
continuing and new investments in PMCC's leasing and structured finance
portfolio. Operating revenues and income from real estate operations
decreased from 1995 levels, due primarily to an unfavorable comparison
caused by a large 1995 land sale in Southern California, partially offset by
higher residential land sales volume in Colorado this year.
FINANCIAL REVIEW
- ----------------
Net Cash Provided by Operating Activities
- -----------------------------------------
During the first six months of 1996, cash provided by operating
activities was $2.8 billion, $145 million higher than during the first six
months of 1995. The increase was due primarily to higher net earnings,
partially offset by increased investments in working capital.
Net Cash Used in Investing Activities
- -------------------------------------
During the first six months of 1996, cash used in investing activities
was $1.3 billion, compared with $153 million used during the comparable 1995
period. The change is due primarily to cash used for the acquisitions of a
controlling interest in ZPT-Krakow, Poland's largest tobacco company, and
Lacta, Brazil's leading confectionery company in 1996 compared with cash
proceeds from the sale of the Kraft Foodservice distribution business in
1995.
Net Cash Used in Financing Activities
- -------------------------------------
During the first six months of 1996, the Company's net cash used in
financing activities was $1.5 billion, compared with $2.5 billion used
during the comparable 1995 period. The change reflects receipts of proceeds
from higher net borrowings in 1996, partially offset by an increase in cash
paid for stock repurchases and dividends in 1996.
Debt
- ----
The Company's total debt was $17.2 billion and $15.8 billion at June
30, 1996 and December 31, 1995, respectively. Total consumer products debt
increased $1.4 billion in the first six months of 1996, due primarily to the
net issuance of short-term borrowings of $1.1 billion, most of which was
reclassified as long-term debt based upon the Company's intent and ability
to refinance such debt under an $8 billion revolving bank credit agreement
that expires in 2000. The Company may continue to refinance 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.
Continued
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35
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, Swedish krona, Canadian dollar and Norwegian krone)
based on current market conditions and business strategies. 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
aggregate notional principal amounts of these agreements outstanding was
$2.0 billion, at June 30, 1996 and December 31, 1995, of which $1.4 billion
and $1.5 billion related to consumer products debt at June 30, 1996 and
December 31, 1995, respectively.
The Company enters into forward exchange contracts, for purposes other
than trading, to reduce the effects of fluctuating foreign currency on
foreign currency denominated assets, liabilities, commitments and short-term
intercompany transactions. At June 30, 1996 and December 31, 1995, the Company
had forward exchange contracts, with maturities of less than one year, of $1.9
billion and $1.2 billion, respectively.
Equity and Dividends
- --------------------
During the first six months of 1996, the Company repurchased 14.5
million shares of its common stock at an aggregate cost of $1.4 billion.
These purchases were made pursuant to the Company's repurchase program,
announced in 1994, to purchase up to $6 billion of its common stock in the
open market. Through June 30, 1996, cumulative purchases under the program
totaled 50.0 million shares at a cost of $3.9 billion.
At June 30, 1996, the ratio of consumer products debt to total equity
was 1.11, compared with 1.03 at December 31, 1995. The Company's ratio of
total debt to total equity at June 30, 1996 was 1.21 compared with 1.13 at
December 31, 1995. The increase in these ratios primarily reflects net
issuance of short-term borrowings and long-term debt, partially offset by an
increase in stockholders' equity, due primarily to net earnings offset by
share repurchases, dividends declared and currency translation adjustments.
Dividends paid in the first six months of 1996 were 18.1% higher than
in the first six months of 1995, reflecting an increase in dividends
declared, partially offset by fewer shares outstanding. On August 30, 1995,
the Board of Directors increased the Company's quarterly dividend rate to
$1.00 per share, a 21.2% increase, resulting in an annualized dividend rate
of $4.00 per share.
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents, primarily representing cash earned and
retained outside of North America, was $1.2 billion at June 30, 1996,
compared with $1.1 billion at December 31, 1995. Cash earned and retained
outside of North America is used for new investments, normal working capital
requirements, the payment of foreign excise taxes and dividend repatriation.
Contingencies
- -------------
See Note 2 to the Condensed Consolidated Financial Statements for
discussion of contingencies. Reference is made to Item 1 (c) "Other Matters
- - Forward-Looking and Cautionary Statements" of the Company's 1995 Annual
Report on Form 10-K regarding important factors that could cause actual
results to differ materially from those contained in any forward-looking
statement made by or on behalf of the Company.
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36
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
Reference is made to Note 2, "Contingencies," of the Notes to the
Condensed Consolidated Financial Statements included in Part I, Item 1 of this
report, and to "Tobacco--Business Environment," of the Management's Discussion
and Analysis of Financial Condition and Results of Operations included in Part
I, Item 2 of this report.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
12 Statement regarding computation of ratios of earnings to fixed
charges.
27 Financial Data Schedule.
(b) Reports on Form 8-K. Registrant filed no reports on Form 8-K during
the quarter for which this report is filed.
- -----------
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37
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
BY /s/ HANS G. STORR
Hans G. Storr, Executive Vice President and
Chief Financial Officer
DATE August 13, 1996
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38
EXHIBIT INDEX
-------------
Exhibit No. Description
- ----------- -----------
12 Statement regarding computation of ratios of earnings to fixed
charges.
27 Financial Data Schedule.