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UNITED STATES
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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8940
Philip Morris Companies Inc.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 13-3260245
- ------------------------------ ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 Park Avenue, New York, New York 10017
- --------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (917) 663-5000
--------------
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
At July 31, 2002, there were 2,113,855,531 shares outstanding of the
registrant's common stock, par value $0.33 1/3 per share.
PHILIP MORRIS COMPANIES INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at
June 30, 2002 and December 31, 2001 3 - 4
Condensed Consolidated Statements of Earnings for the
Six Months Ended June 30, 2002 and 2001 5
Three Months Ended June 30, 2002 and 2001 6
Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 2001 and the
Six Months Ended June 30, 2002 7
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001 8 - 9
Notes to Condensed Consolidated Financial Statements 10 - 27
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 28 - 50
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 51
Item 6. Exhibits and Reports on Form 8-K 51
Signature 52
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
June 30, December 31,
2002 2001
-------- ------------
ASSETS
Consumer products
Cash and cash equivalents $ 1,380 $ 453
Receivables (less allowances of
$159 and $193) 5,567 5,148
Inventories:
Leaf tobacco 3,517 3,827
Other raw materials 2,154 1,909
Finished product 3,416 3,187
------- -------
9,087 8,923
Other current assets 2,119 2,751
------- -------
Total current assets 18,153 17,275
Property, plant and equipment, at cost 26,456 25,625
Less accumulated depreciation 11,066 10,488
------- -------
15,390 15,137
Goodwill and other intangible assets, net 37,879 37,548
Other assets 6,192 6,144
------- -------
Total consumer products assets 77,614 76,104
Financial services
Finance assets, net 8,381 8,691
Other assets 188 173
------- -------
Total financial services assets 8,569 8,864
------- -------
TOTAL ASSETS $86,183 $84,968
======= =======
See notes to condensed consolidated financial statements.
Continued
-3-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars, except per share data)
(Unaudited)
June 30, December 31,
2002 2001
-------- ------------
LIABILITIES
Consumer products
Short-term borrowings $ 468 $ 997
Current portion of long-term debt 3,213 1,942
Accounts payable 2,878 3,600
Accrued liabilities:
Marketing 2,681 2,794
Taxes, except income taxes 1,958 1,654
Employment costs 916 1,192
Settlement charges 2,853 3,210
Other 2,480 2,480
Income taxes 1,829 1,021
Dividends payable 1,237 1,251
-------- --------
Total current liabilities 20,513 20,141
Long-term debt 16,576 17,159
Deferred income taxes 5,168 5,238
Accrued postretirement health care costs 3,393 3,315
Minority interest 4,198 4,013
Other liabilities 7,941 7,796
-------- --------
Total consumer products liabilities 57,789 57,662
Financial services
Short-term borrowings 512
Long-term debt 2,091 1,492
Deferred income taxes 5,312 5,246
Other liabilities 450 436
-------- --------
Total financial services liabilities 7,853 7,686
-------- --------
Total liabilities 65,642 65,348
Contingencies (Note 8)
STOCKHOLDERS' EQUITY
Common stock, par value $0.33 1/3 per
share (2,805,961,317 shares issued) 935 935
Additional paid-in capital 4,646 4,503
Earnings reinvested in the business 39,773 37,269
Accumulated other comprehensive losses
(including currency translation of
$2,998 and $3,238) (3,265) (3,373)
-------- --------
42,089 39,334
Less cost of repurchased stock
(679,266,327 and 653,458,100 shares) (21,548) (19,714)
-------- --------
Total stockholders' equity 20,541 19,620
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 86,183 $ 84,968
======== ========
See notes to condensed consolidated financial statements.
-4-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
2002 2001
------- -------
Net revenues $41,638 $40,748
Cost of sales 17,033 17,131
Excise taxes on products 9,158 8,810
------- -------
Gross profit 15,447 14,807
Marketing, administration and research costs 6,645 6,230
Litigation related expense 500
Amortization of intangibles 4 506
------- -------
Operating income 8,798 7,571
Interest and other debt expense, net 602 889
------- -------
Earnings before income taxes, minority interest and
cumulative effect of accounting change 8,196 6,682
Provision for income taxes 2,909 2,526
------- -------
Earnings before minority interest and cumulative effect of
accounting change 5,287 4,156
Minority interest in earnings 312 82
------- -------
Earnings before cumulative effect of accounting change 4,975 4,074
Cumulative effect of accounting change (6)
------- -------
Net earnings $ 4,975 $ 4,068
======= =======
Per share data:
Basic earnings per share before cumulative effect of
accounting change $ 2.32 $ 1.86
Cumulative effect of accounting change (0.01)
------- -------
Basic earnings per share $ 2.32 $ 1.85
======= =======
Diluted earnings per share before cumulative effect of
accounting change $ 2.30 $ 1.83
Cumulative effect of accounting change
------- -------
Diluted earnings per share $ 2.30 $ 1.83
======= =======
Dividends declared $ 1.16 $ 1.06
======= =======
See notes to condensed consolidated financial statements.
-5-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
For the Three Months Ended
June 30,
--------------------------
2002 2001
------- -------
Net revenues $21,103 $20,789
Cost of sales 8,501 8,761
Excise taxes on products 4,583 4,377
------- -------
Gross profit 8,019 7,651
Marketing, administration and research costs 3,390 3,194
Amortization of intangibles 2 253
------- -------
Operating income 4,627 4,204
Interest and other debt expense, net 309 438
------- -------
Earnings before income taxes and minority interest 4,318 3,766
Provision for income taxes 1,533 1,431
------- -------
Earnings before minority interest 2,785 2,335
Minority interest in earnings 175 47
------- -------
Net earnings $ 2,610 $ 2,288
======= =======
Per share data:
Basic earnings per share $ 1.22 $ 1.04
======= =======
Diluted earnings per share $ 1.21 $ 1.03
======= =======
Dividends declared $ 0.58 $ 0.53
======= =======
See notes to condensed consolidated financial statements.
-6-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
for the Year Ended December 31, 2001 and
the Six Months Ended June 30, 2002
(in millions of dollars, except per share data)
(Unaudited)
Accumulated Other
Comprehensive Losses
-----------------------------
Addi- Earnings Total
tional Reinvested Currency Cost of Stock-
Common Paid-in in the Translation Repurchased holders'
Stock Capital Business Adjustments Other Total Stock Equity
------ ------- ---------- ----------- ----- ------- ----------- -------
Balances, January 1, 2001 $935 $ -- $33,481 $(2,864) $ (86) $(2,950) $(16,461) $15,005
Comprehensive earnings:
Net earnings 8,560 8,560
Other comprehensive losses,
net of income taxes:
Currency translation adjustments (753) (753) (753)
Additional minimum pension liability (89) (89) (89)
Change in fair value of derivatives
accounted for as hedges 33 33 33
-------
Total other comprehensive losses (809)
-------
Total comprehensive earnings 7,751
-------
Exercise of stock options and
issuance of other stock awards 138 70 747 955
Cash dividends
declared ($2.22 per share) (4,842) (4,842)
Stock repurchased (4,000) (4,000)
Sale of Kraft Foods Inc. common stock 4,365 379 7 386 4,751
---- ------ ------- ------- ----- ------- -------- -------
Balances, December 31, 2001 935 4,503 37,269 (3,238) (135) (3,373) (19,714) 19,620
Comprehensive earnings:
Net earnings 4,975 4,975
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments 240 240 240
Additional minimum pension liability (5) (5) (5)
Change in fair value of derivatives
accounted for as hedges (127) (127) (127)
-------
Total other comprehensive earnings 108
-------
Total comprehensive earnings 5,083
-------
Exercise of stock options and
issuance of other stock awards 143 8 513 664
Cash dividends
declared ($1.16 per share) (2,479) (2,479)
Stock repurchased (2,347) (2,347)
---- ------ ------- ------- ----- ------- -------- -------
Balances, June 30, 2002 $935 $4,646 $39,773 $(2,998) $(267) $(3,265) $(21,548) $20,541
==== ====== ======= ======= ===== ======= ======== =======
Total comprehensive earnings, which represent net earnings and the change in
fair value of derivatives accounted for as hedges, partially offset by currency
translation adjustments, were $2,930 million and $1,896 million, respectively,
for the quarters ended June 30, 2002 and 2001, and $3,531 million for the first
six months of 2001.
See notes to condensed consolidated financial statements.
-7-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
2002 2001
------- -------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings - Consumer products $ 4,869 $ 3,984
- Financial services 106 84
------- -------
Net earnings 4,975 4,068
Adjustments to reconcile net earnings to
operating cash flows:
Consumer products
Cumulative effect of accounting change 6
Depreciation and amortization 664 1,163
Deferred income tax provision 590 296
Loss on sale of a North American food factory and
integration costs 119 29
Voluntary retirement programs 175
Gains on sales of businesses (3) (8)
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (534) (439)
Inventories 118 (54)
Accounts payable (867) (999)
Income taxes 953 884
Accrued liabilities and other current assets (639) (357)
Other (51) (169)
Financial services
Deferred income tax provision 66 103
Other 170 103
------- -------
Net cash provided by operating activities 5,736 4,626
------- -------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures (834) (790)
Purchases of businesses, net of acquired cash (72) (354)
Proceeds from sales of businesses 86 9
Other 48 41
Financial services
Investments in finance assets (113) (305)
Proceeds from finance assets 249 105
------- -------
Net cash used in investing activities (636) (1,294)
------- -------
See notes to condensed consolidated financial statements.
Continued
-8-
Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)
For the Six Months Ended
June 30,
------------------------
2002 2001
------- -------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net repayment of short-term borrowings $(3,100) $(7,148)
Long-term debt proceeds 4,536 47
Long-term debt repaid (1,466) (1,287)
Financial services
Net repayment of short-term borrowings (512) (673)
Long-term debt proceeds 440 557
Repurchase of Philip Morris common stock (2,220) (1,971)
Dividends paid on Philip Morris common stock (2,493) (2,342)
Issuance of Philip Morris common stock 651 592
Issuance of Kraft Foods Inc. common stock 8,443
Other (99) (85)
------- -------
Net cash used in financing activities (4,263) (3,867)
------- -------
Effect of exchange rate changes on cash and
cash equivalents 90 (7)
------- -------
Cash and cash equivalents:
Increase (decrease) 927 (542)
Balance at beginning of period 453 937
------- -------
Balance at end of period $ 1,380 $ 395
======= =======
See notes to condensed consolidated financial statements.
-9-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Company Name Change:
In April 2002, the stockholders of Philip Morris Companies Inc. (the "Company")
approved changing the Company's name from Philip Morris Companies Inc. to Altria
Group, Inc. The Company's Board of Directors retains the discretion to effect
the name change, pending the resolution of legal challenges.
Note 2. Accounting Policies:
The interim condensed consolidated financial statements of 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. Net
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, and management's discussion and analysis of
financial condition and results of operations, 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, 2001 (the
"2001 Form 10-K").
Balance sheet accounts are segregated by two broad types of businesses. Consumer
products assets and liabilities are classified as either current or non-current,
whereas financial services assets and liabilities are unclassified, in
accordance with respective industry practices.
Certain prior year amounts have been reclassified to conform with the current
year's presentation.
Note 3. Recently Adopted Accounting Standards:
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets." As a result, the Company stopped recording the
amortization of goodwill and indefinite life intangible assets as a charge to
earnings as of January 1, 2002. The Company estimates that net earnings and
diluted earnings per share ("EPS") would have been approximately $4.6 billion
and $2.05, respectively, for the six months ended June 30, 2001, and
approximately $2.5 billion and $1.14, respectively, for the three months ended
June 30, 2001, had the provisions of the new standards been applied as of
January 1, 2001. In addition, the Company is required to conduct an annual
review of goodwill and intangible assets for potential impairment. The Company
completed its review and did not have to record a charge to earnings for an
impairment of goodwill or other intangible assets as a result of these new
standards.
At June 30, 2002, goodwill by segment was as follows (in millions):
International tobacco $ 899
North American food 20,655
International food 4,255
Beer 186
-------
Total goodwill $25,995
=======
-10-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Intangible assets as of June 30, 2002 were as follows:
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
(in millions)
Non-amortizable intangible assets $11,855
Amortizable intangible assets 55 $26
------- ---
Total intangible assets $11,910 $26
======= ===
Non-amortizable intangible assets substantially comprise brand names purchased
through the Nabisco acquisition. Amortizable intangible assets consist primarily
of certain trademark licenses and non-compete agreements. The pre-tax
amortization expense for intangible assets during the six months and quarter
ended June 30, 2002 was $4 million and $2 million, respectively. Based upon the
amortizable intangible assets recorded on the balance sheet as of June 30, 2002,
amortization expense for each of the next five years is estimated to be $8
million or less.
The increase in goodwill and other intangible assets, net, at June 30, 2002 from
December 31, 2001 of $331 million is primarily related to currency translation.
Effective January 1, 2002, the Company also adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed Of." SFAS No. 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets, expands the scope of a discontinued operation to include a
component of an entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. The adoption of this new
standard did not have a material impact on the Company's financial position,
results of operations or cash flows.
Effective January 1, 2002, the Company adopted Emerging Issues Task Force
("EITF") Issue No. 00-14, "Accounting for Certain Sales Incentives" and EITF
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendor's Products." The adoption of EITF Issues No. 00-14
and No. 00-25 resulted in a reduction of revenues of approximately $4.8 billion
and $2.4 billion in the first six months and the second quarter of 2001,
respectively. In addition, the adoption reduced marketing, administration and
research costs in the first six months and the second quarter of 2001 by
approximately $5.2 billion and $2.6 billion, respectively. Cost of sales
increased in the first six months and the second quarter of 2001 by
approximately $307 million and $162 million, respectively, and excise taxes on
products increased by approximately $114 million and $58 million, respectively.
The adoption of these EITF Issues had no impact on net earnings or basic and
diluted EPS.
Note 4. Financial Instruments:
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," and its related amendment, SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities" (collectively referred to as "SFAS No. 133"). As of January 1, 2001,
the adoption of these new standards resulted in a cumulative effect of an
accounting change that reduced net earnings by $6 million, net of income taxes
of $3 million, and decreased accumulated other comprehensive losses by $15
million, net of income taxes of $8 million.
During the six months and three months ended June 30, 2002 and 2001,
ineffectiveness related to fair value hedges and cash flow hedges was not
material. The Company is hedging forecasted transactions for periods not
exceeding the next nineteen months. At June 30, 2002, the Company estimates
derivative gains of $56 million,
-11-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
net of income taxes, reported in accumulated other comprehensive losses will be
reclassified to the consolidated statement of earnings within the next twelve
months.
Within currency translation adjustments at June 30, 2002 and 2001, the
Company recorded a loss of $113 million, net of income taxes of $60 million,
and a gain of $8 million, net of income taxes of $4 million, respectively,
which represented effective hedges of net investments.
Hedging activity affected accumulated other comprehensive losses, net of income
taxes, as follows:
For the Six Months Ended For the Three Months Ended
June 30, June 30,
------------------------ --------------------------
2002 2001 2002 2001
----- ---- ----- ----
(in millions) (in millions)
Balance at beginning of period $ 33 $ -- $ 75 $ 32
Impact of SFAS No. 133 adoption 15
Derivative losses (gains) transferred to earnings 79 (52) (13) (22)
Change in fair value (206) 33 (156) (14)
----- ---- ----- ----
Balance as of June 30 $ (94) $ (4) $ (94) $ (4)
===== ==== ===== ====
Note 5. Acquisitions and Divestitures:
On May 30, 2002, the Company announced an agreement with South African Breweries
plc ("SAB") to merge Miller Brewing Company ("Miller") into SAB. The transaction
closed on July 9, 2002 and SAB changed its name to SABMiller plc ("SABMiller").
At closing, the Company received 430 million shares of SABMiller valued at
approximately $3.4 billion, based upon a share price of 5.12 British pounds per
share, in exchange for Miller, which had $2.0 billion of existing debt. The
shares in SABMiller owned by the Company resulted in an initial 36% economic
interest in SABMiller and a 24.9% voting interest. The transaction resulted in
a pre-tax gain of approximately $2.6 billion or approximately $1.7 billion
after-tax. The gain will be recorded in the third quarter of 2002. Subsequent
to the sale, the Company's ownership interest in SABMiller will be accounted
for under the equity method, according to which the Company will record its
percentage of SABMiller's net earnings going forward.
During the first quarter of 2002, Kraft Foods International, Inc. ("KFI")
acquired a biscuits company in Australia for an aggregate cost of $62 million.
In addition, during 2002, Kraft Foods North America, Inc. ("KFNA") sold several
small North American food businesses, most of which were previously classified
as businesses held for sale. The net revenues and operating results of the
businesses held for sale, which were not significant, were excluded from the
Company's consolidated statements of earnings and no gain or loss was recognized
on these sales. The aggregate proceeds received from sales of businesses during
the first six months of 2002 were $86 million.
During 2001, Philip Morris International Inc. ("PMI") increased its interest in
an Argentine tobacco company for an aggregate cost of $255 million. In addition,
KFI purchased coffee businesses in Romania, Morocco and Bulgaria.
The operating results of businesses acquired and sold were not material to the
consolidated operating results of the Company in any of the periods presented.
-12-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 6. Earnings Per Share:
Basic and diluted EPS were calculated using the following:
For the Six Months Ended
June 30,
------------------------
2002 2001
------ ------
(in millions)
Earnings before cumulative effect of accounting change $4,975 $4,074
Cumulative effect of accounting change (6)
------ ------
Net earnings $4,975 $4,068
====== ======
Weighted average shares for basic EPS 2,140 2,196
Plus incremental shares from assumed conversions:
Restricted stock and stock rights 2 6
Stock options 23 24
------ ------
Weighted average shares for diluted EPS 2,165 2,226
====== ======
For the Three Months Ended
June 30,
--------------------------
2002 2001
------ ------
(in millions)
Net earnings $2,610 $2,288
====== ======
Weighted average shares for basic EPS 2,135 2,191
Plus incremental shares from assumed conversions:
Restricted stock and stock rights 1 6
Stock options 23 24
------ ------
Weighted average shares for diluted EPS 2,159 2,221
====== ======
The number of shares of common stock excluded from the calculation of weighted
average shares for diluted EPS because their effects were antidilutive was
immaterial for all periods presented.
Note 7. Segment Reporting:
The products of the Company's subsidiaries include cigarettes, food (consisting
principally of a wide variety of snacks, beverages, cheese, grocery products and
convenient meals) and, prior to the merger of Miller into SAB on July 9, 2002,
beer. Another subsidiary of the Company, Philip Morris Capital Corporation, is
primarily engaged in leasing activities. The products and services of these
subsidiaries constitute the Company's reportable segments of domestic tobacco,
international tobacco, North American food, international food, beer and
financial services.
The Company's management reviews operating companies income to evaluate segment
performance and allocate resources. Operating companies income for the segments
excludes general corporate expenses and amortization of intangibles. Interest
and other debt expense, net, and provision for income taxes are centrally
-13-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
managed at the corporate level and, accordingly, such items are not presented by
segment since they are excluded from the measure of segment profitability
reviewed by the Company's management. Segment data were as follows:
For the Six Months Ended
June 30,
------------------------
2002 2001
------- -------
(in millions)
Net revenues:
Domestic tobacco $ 9,899 $ 9,682
International tobacco 14,173 13,721
North American food 10,862 10,662
International food 3,798 4,008
Beer 2,641 2,464
Financial services 265 211
------- -------
Total net revenues $41,638 $40,748
======= =======
Operating companies income:
Domestic tobacco $ 2,704 $ 2,085
International tobacco 2,967 2,906
North American food 2,467 2,496
International food 551 537
Beer 276 292
Financial services 175 140
------- -------
Total operating companies income 9,140 8,456
Amortization of intangibles (4) (506)
General corporate expenses (338) (379)
------- -------
Total operating income 8,798 7,571
Interest and other debt expense, net (602) (889)
------- -------
Total earnings before income taxes, minority interest
and cumulative effect of accounting change $ 8,196 $ 6,682
======= =======
For the Three Months Ended
June 30,
--------------------------
2002 2001
------- -------
(in millions)
Net revenues:
Domestic tobacco $ 4,881 $ 5,105
International tobacco 7,139 6,750
North American food 5,568 5,428
International food 1,945 2,045
Beer 1,422 1,350
Financial services 148 111
------- -------
Total net revenues $21,103 $20,789
======= =======
-14-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
For the Three Months Ended
June 30,
--------------------------
2002 2001
------ ------
(in millions)
Operating companies income:
Domestic tobacco $1,454 $1,383
International tobacco 1,403 1,348
North American food 1,369 1,353
International food 299 298
Beer 169 168
Financial services 104 76
------ ------
Total operating companies income 4,798 4,626
Amortization of intangibles (2) (253)
General corporate expenses (169) (169)
------ ------
Total operating income 4,627 4,204
Interest and other debt expense, net (309) (438)
------ ------
Total earnings before income taxes and minority interest $4,318 $3,766
====== ======
During 2002, operating companies income for the North American food and
international food segments included pre-tax charges related to the
consolidation of production lines, the closing of a facility and other
consolidation programs. Pre-tax charges of $102 million and $75 million were
recorded in marketing, administration and research costs of the North American
food segment for the six months and three months ended June 30, 2002,
respectively, and $17 million was recorded in the international food segment for
the six months and three months ended June 30, 2002. The 2002 integration
related charges of $119 million included $21 million relating to severance,
$82 million relating to asset write-offs and $16 million relating to other cash
exit costs. Cash payments relating to this charge will approximate $37 million
of which $1 million has been paid through June 30, 2002. The majority of the
remaining payments are expected to be made by December 31, 2002.
During the first quarter of 2002, a pre-tax charge of $15 million was recorded
in marketing, administration and research costs for a beer asset impairment.
During the second quarter of 2002, the international tobacco business announced
a voluntary early retirement program in Germany and approximately 160 employees
accepted the benefits offered by this program. As a result, in the second
quarter of 2002, a pre-tax charge of $25 million, which includes enhanced
pension and postretirement benefits, was recorded in marketing, administration
and research costs of the international tobacco segment.
During 2001, voluntary early retirement programs were announced for certain
eligible salaried employees in the food and beer businesses. During the first
quarter of 2002, approximately 800 employees accepted the benefits offered by
these programs and elected to retire or terminate employment. Pre-tax charges of
$135 million, $7 million and $8 million were recorded in marketing,
administration and research costs of the North American food, international food
and beer segments, respectively, in the first quarter of 2002 for these
voluntary retirement programs.
As discussed in Note 8. Contingencies, on May 7, 2001, the trial court in the
Engle class action approved a stipulation and agreed order among Philip Morris
Incorporated ("PM Inc."), certain other defendants and the plaintiffs providing
that the execution or enforcement of the punitive damages component of the
judgment in that case will remain stayed through the completion of all judicial
review. As a result of the stipulation, PM Inc. placed $500 million into a
separate interest-bearing escrow account that, regardless of the outcome of the
appeal, will be paid to the court and the court will determine how to allocate
or distribute it consistent with the Florida Rules of Civil Procedure. As a
result, a $500 million pre-tax charge was recorded by the domestic
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
tobacco business during the first quarter of 2001. In July 2001, PM Inc. also
placed $1.2 billion into an interest-bearing escrow account, which will be
returned to PM Inc. should it prevail in its appeal of the case. The $1.2
billion escrow account is included in the June 30, 2002 and December 31, 2001
consolidated balance sheets as other assets. Interest income on the $1.2 billion
escrow account is paid to PM Inc. quarterly and is being recorded as earned in
interest and other debt expense, net, in the consolidated statements of
earnings.
During the first quarter of 2001, KFNA sold a North American food factory, which
resulted in a pre-tax loss of $29 million.
Note 8. Contingencies:
Legal proceedings covering a wide range of matters are pending or threatened in
various United States and foreign jurisdictions against the Company, its
subsidiaries and affiliates, including PM Inc. and Philip Morris International
Inc. ("PMI"), the Company's international tobacco subsidiary, as well as their
respective indemnitees. Various types of claims are raised in these proceedings,
including product liability, consumer protection, antitrust, tax, contraband
shipments, patent infringement, employment matters, claims for contribution and
claims of competitors and distributors.
Overview of Tobacco-Related Litigation
Types and Number of Cases
Pending claims related to tobacco products generally fall within the following
categories: (i) smoking and health cases alleging personal injury brought on
behalf of individual plaintiffs, (ii) smoking and health cases primarily
alleging personal injury and purporting to be brought on behalf of a class of
individual plaintiffs, (iii) health care cost recovery cases brought by
governmental (both domestic and foreign) and non-governmental plaintiffs seeking
reimbursement for health care expenditures allegedly caused by cigarette smoking
and/or disgorgement of profits, and (iv) other tobacco-related litigation. Other
tobacco-related litigation includes class action suits alleging that the use of
the terms "Lights" and "Ultra Lights" constitutes deceptive and unfair trade
practices, suits by foreign governments seeking to recover damages resulting
from the allegedly illegal importation of cigarettes into various jurisdictions,
suits by former asbestos manufacturers seeking contribution or reimbursement for
amounts expended in connection with the defense and payment of asbestos claims
that were allegedly caused in whole or in part by cigarette smoking, and various
antitrust suits. Damages claimed in some of the smoking and health class
actions, health care cost recovery cases and other tobacco-related litigation
range into the billions of dollars. In July 2000, a jury in a Florida smoking
and health class action returned a punitive damages award of approximately $74
billion against PM Inc. (see discussion of the Engle case below). Plaintiffs'
theories of recovery and the defenses raised in the smoking and health and
health care cost recovery cases are discussed below. Exhibit 99.1 hereto lists
the smoking and health class actions, health care cost recovery and certain
other actions pending as of August 1, 2002, and discusses certain developments
in such cases since May 10, 2002.
As of August 1, 2002 there were approximately 1,500 smoking and health cases
filed and served on behalf of individual plaintiffs in the United States against
PM Inc. and, in some instances, the Company, compared with approximately 1,500
such cases on August 1, 2001, and approximately 390 such cases on August 1,
2000. In certain jurisdictions, individual smoking and health cases have been
aggregated for trial in a single proceeding; the largest such proceeding
aggregates 1,250 cases in West Virginia and is currently scheduled for trial in
June 2003. An estimated 14 of the individual cases involve allegations of
various personal injuries allegedly related to exposure to environmental tobacco
smoke ("ETS"). In addition, approximately 2,800 additional individual cases are
pending in Florida by current and former flight attendants claiming personal
injuries allegedly related to ETS. The flight attendants allege that they are
members of an ETS smoking and health class action, which was settled in 1997.
The terms of the court-approved settlement in that case allow class members to
file
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
individual lawsuits seeking compensatory damages, but prohibit them from seeking
punitive damages.
As of August 1, 2002, there were an estimated 21 smoking and health purported
class actions pending in the United States against PM Inc. and, in some cases,
the Company (including two that involve allegations of various personal
injuries related to exposure to ETS), compared with approximately 28 such cases
on August 1, 2001, and approximately 35 such cases on August 1, 2000. Some of
these actions purport to constitute statewide class actions and were filed after
May 1996, when the United States Court of Appeals for the Fifth Circuit reversed
a federal district court's certification of a purported nationwide class action
on behalf of persons who were allegedly "addicted" to tobacco products.
As of August 1, 2002, there were an estimated 43 health care cost recovery
actions, including the suit discussed below under "Federal Government's
Lawsuit," filed by the United States government, pending in the United States
against PM Inc. and, in some instances, the Company, compared with approximately
52 such cases pending on August 1, 2001, and 50 such cases on August 1, 2000. In
addition, health care cost recovery actions are pending in Israel, the Province
of British Columbia, Canada, France (in a case brought by a local agency of the
French social security health insurance system) and Spain.
There are also a number of other tobacco-related actions pending outside the
United States against PMI and its affiliates and subsidiaries, including an
estimated 73 smoking and health cases brought on behalf of individuals
(Argentina (40), Australia (1), Brazil (19), Czech Republic (1), Ireland (1),
Israel (2), Italy (4), Japan (1), the Philippines (1), Scotland (1), and Spain
(2)), compared with approximately 69 such cases on August 1, 2001, and 45 such
cases on August 1, 2000. In addition, as of August 1, 2002, there were eight
smoking and health putative class actions pending outside the United States
(Brazil (1), Canada (3), and Spain (4)), compared with 12 such cases on August
1, 2001 and ten such cases on August 1, 2000.
Pending and Upcoming Trials
Jury selection is proceeding in a smoking and health class action in Louisiana
in which PM Inc. is a defendant and in which plaintiffs seek the creation of
funds to pay for medical monitoring and smoking cessation programs. Jury
selection is also proceeding in an individual smoking and health case against PM
Inc. in California. In addition, later in August, trials are scheduled to begin
in two cases in Florida brought by flight attendants seeking compensatory
damages for personal injuries allegedly caused by ETS; PM Inc. is a defendant in
both cases.
As set forth in Exhibit 99.2 hereto, additional cases against PM Inc. and, in
some instances, the Company, are scheduled for trial through the end of 2003.
They include two class actions in California in which plaintiffs seek damages
under the California Business and Professions Code for the costs of cigarettes
purchased by class members during the class period, a case in West Virginia that
aggregates 1,250 individual smoking and health cases, a Lights/Ultra Lights
class action in Illinois and the health care cost recovery case brought by the
United States government as well as an estimated 26 individual smoking and
health cases and 14 additional cases brought by flight attendants seeking
compensatory damages for personal injuries allegedly caused by ETS. Five of the
trials in the individual smoking and health cases are scheduled to begin in
October 2002 and one of the trials is scheduled to begin in November 2002.
Trials are scheduled to begin in six of the cases brought by flight attendants
in the next three months. Cases against other tobacco companies are also
scheduled for trial through the end of 2003. Trial dates, however, are subject
to change.
Recent Trial Results
Since January 1999, jury verdicts have been returned in 21 smoking and health
and health care cost recovery cases in which PM Inc. was a defendant. Verdicts
in favor of PM Inc. and other defendants were returned in 12 of the 21 cases.
These 12 cases were tried in Rhode Island, West Virginia, Ohio (2), New Jersey,
Florida (2), New York (2), Mississippi and Tennessee (2). Plaintiffs' appeals or
post-trial motions challenging the verdicts are pending in West Virginia, Ohio
and Florida. In May 2002, a mistrial was declared in a case brought by a flight
attendant claiming personal injuries allegedly caused by ETS, and the case was
subsequently dismissed. In
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
addition, in 2001, a mistrial was declared in New York in an asbestos
contribution case, and plaintiffs subsequently voluntarily dismissed the case.
The chart below lists the verdicts and post-trial developments in the nine cases
that have gone to trial since January 1999 in which verdicts were returned in
favor of plaintiffs.
Location Type of Post-Trial
Date of Court Case Verdict Developments
- -------- ---------- ------------- --------------------------------- -----------------------------------
June Florida Flight $5.5 million in compensatory Defendants have filed post-trial
2002 Attendant ETS damages against all motions challenging the verdict.
Litigation defendants, including PM Inc.
June Florida Individual $37.5 million in compensatory Defendants have filed post-trial
2002 Smoking and damages against all defendants, motions challenging the verdict.
Health including PM Inc.
March Oregon Individual $168,500 in compensatory damages In May 2002, the trial court reduced
2002 Smoking and and $150 million in punitive the punitive damages award to
Health damages against PM Inc. $100 million, and in July 2002,
the trial court denied PM Inc.'s
post-trial motions challenging the
verdict. PM Inc. has appealed.
June California Individual $5.5 million in compensatory In August 2001, the trial court
2001 Smoking and damages, and $3 billion in reduced the punitive damages award
Health punitive damages against PM Inc. to $100 million; PM Inc. has
appealed.
June New York Health Care $17.8 million in compensatory In February 2002, the trial court
2001 Cost damages, against all defendants awarded plaintiffs $38 million in
Recovery including $6.8 million against attorneys' fees. Defendants have
PM Inc. appealed.
July Florida Smoking and $145 billion in punitive damages See "Engle Class Action," below.
2000 Health against all defendants, including
Class Action $74 billion against PM Inc.
March California Individual $1.72 million in compensatory Defendants have appealed.
2000 Smoking and damages against PM Inc. and
Health another defendant, and $10
million in punitive damages
against PM Inc. and $10
million in punitive damages
against the other defendant.
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Location Type of Post-Trial
Date of Court Case Verdict Developments
- -------- ---------- ------------- --------------------------------- -----------------------------------
March Oregon Individual $800,000 in compensatory The trial court reduced the
1999 Smoking and damages, $21,500 in medical punitive damages award to $32
Health expenses and $79.5 million in million, and PM Inc. appealed. In
punitive damages against PM Inc. June 2002, the Oregon Court of
Appeals reinstated the $79.5
million punitive damages award; PM
Inc. has appealed to the Oregon
Supreme Court.
February California Individual $1.5 million in compensatory The trial court reduced the
1999 Smoking and damages and $50 million in punitive damages award to $25
Health punitive damages against PM Inc. million and PM Inc. appealed. In
November 2001, a California
District Court of Appeals affirmed
the trial court's ruling, and PM
Inc. has appealed to the California
Supreme Court.
In addition, since January 1999, jury verdicts have been returned in 12
tobacco-related cases in which neither the Company nor any of its subsidiaries
were defendants. Verdicts in favor of defendants were returned in eight of the
12 cases in cases tried in Connecticut, Texas, South Carolina, Mississippi,
Louisiana, Missouri and Tennessee (2). Plaintiffs' appeal is pending in
Mississippi. Verdicts in favor of plaintiffs were returned in four of the 12
cases in cases tried in Australia, Kansas and Florida (2). Defendants' appeals
or post-trial motions are pending. In addition, in a case in France the trial
court found in favor of plaintiff, however, the appellate court reversed the
trial court's ruling and dismissed plaintiff's claim.
Engle Class Action
Verdicts have been returned and judgment has been entered against PM Inc. and
other defendants in the first two phases of this three-phase smoking and health
class action trial in Florida. The class consists of all Florida residents and
citizens, and their survivors, "who have suffered, presently suffer or have died
from diseases and medical conditions caused by their addiction to cigarettes
that contain nicotine."
In July 1999, the jury returned a verdict against defendants in phase one of the
trial concerning certain issues determined by the trial court to be "common" to
the causes of action of the plaintiff class. Among other things, the jury found
that smoking cigarettes causes 20 diseases or medical conditions, that
cigarettes are addictive or dependence-producing, defective and unreasonably
dangerous, that defendants made materially false statements with the intention
of misleading smokers, that defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking cigarettes,
and that defendants were negligent and engaged in extreme and outrageous conduct
or acted with reckless disregard with the intent to inflict emotional distress.
During phase two of the trial, the claims of three of the named plaintiffs were
adjudicated in a consolidated trial before the same jury that returned the
verdict in phase one. In April 2000, the jury determined liability against the
defendants and awarded $12.7 million in compensatory damages to the three named
plaintiffs.
In July 2000, the same jury returned a verdict assessing punitive damages on a
lump sum basis for the entire class totaling approximately $145 billion against
the various defendants in the case, including approximately $74 billion
severally against PM Inc. PM Inc. believes that the punitive damages award was
determined improperly and that it should ultimately be set aside on any one of
numerous grounds. Included among these grounds are the following: under
applicable law, (i) defendants are entitled to have liability and damages for
each plaintiff tried by the same jury, an impossibility due to the jury's
dismissal; (ii) punitive damages cannot
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
be assessed before the jury determines entitlement to, and the amount of,
compensatory damages for all class members; (iii) punitive damages must bear a
reasonable relationship to compensatory damages, a determination that cannot be
made before compensatory damages are assessed for all class members; and (iv)
punitive damages can "punish" but cannot "destroy" the defendant. In March 2000,
at the request of the Florida legislature, the Attorney General of Florida
issued an advisory legal opinion stating that "Florida law is clear that
compensatory damages must be determined prior to an award of punitive damages"
in cases such as Engle. As noted above, compensatory damages for all but three
members of the class have not been determined.
Following the verdict in the second phase of the trial, the jury was dismissed,
notwithstanding that liability and compensatory damages for all but three class
members have not yet been determined. According to the trial plan, phase three
of the trial will address other class members' claims, including issues of
specific causation, reliance, affirmative defenses and other individual-specific
issues regarding entitlement to damages, in individual trials before separate
juries.
It is unclear how the trial plan will be further implemented. The trial plan
provides that the punitive damages award should be standard as to each class
member and acknowledges that the actual size of the class will not be known
until the last class member's case has withstood appeal, i.e., the punitive
damages amount would be divided equally among those plaintiffs who, in addition
to the successful phase two plaintiffs, are ultimately successful in phase three
of the trial and in any appeal.
Following the jury's punitive damages verdict in July 2000, defendants removed
the case to federal district court following the intervention application of a
union health fund that raised federal issues in the case. In November 2000, the
federal district court remanded the case to state court on the grounds that the
removal was premature.
The trial judge in the state court, without a hearing, then immediately denied
the defendants' post-trial motions and entered judgment on the compensatory and
punitive damages awarded by the jury. PM Inc. and the Company believe that the
entry of judgment by the trial court is unconstitutional and violates Florida
law. PM Inc. has filed an appeal with respect to the entry of judgment, class
certification and numerous other reversible errors that have occurred during the
trial. PM Inc. has also posted a $100 million bond to stay execution of the
judgment with respect to the $74 billion in punitive damages that has been
awarded against it. The bond was posted pursuant to legislation that was enacted
in Florida in May 2000 that limits the size of the bond that must be posted in
order to stay execution of a judgment for punitive damages in a certified class
action to no more than $100 million, regardless of the amount of punitive
damages ("bond cap legislation").
Plaintiffs had previously indicated that they believe the bond cap legislation
is unconstitutional and might seek to challenge the $100 million bond. If the
bond were found to be invalid, it would be commercially impossible for PM Inc.
to post a bond in the full amount of the judgment and, absent appellate relief,
PM Inc. would not be able to stay any attempted execution of the judgment in
Florida. PM Inc. and the Company will take all appropriate steps to seek to
prevent this worst-case scenario from occurring. In May 2001, the trial court
approved a stipulation (the "Stipulation") among PM Inc., certain other
defendants, plaintiffs and the plaintiff class that provides that execution or
enforcement of the punitive damages component of the Engle judgment will remain
stayed against PM Inc. and the other participating defendants through the
completion of all judicial review. As a result of the Stipulation and in
addition to the $100 million bond it previously posted, PM Inc. placed $1.2
billion into an interest-bearing escrow account for the benefit of the Engle
class. Should PM Inc. prevail in its appeal of the case, both amounts are to be
returned to PM Inc. PM Inc. also placed an additional $500 million into a
separate interest-bearing escrow account for the benefit of the Engle class. If
PM Inc. prevails in its appeal, this amount will be paid to the court, and the
court will determine how to allocate or distribute it consistent with the
Florida Rules of Civil Procedure. In connection with the Stipulation, the
Company recorded a $500 million pre-tax charge in its consolidated statement of
earnings for the quarter ended March 31, 2001.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
PM Inc. and the Company remain of the view that the Engle case should not have
been certified as a class action. The certification is inconsistent with the
overwhelming majority of federal and state court decisions that have held that
mass smoking and health claims are inappropriate for class treatment. PM Inc.
has filed an appeal challenging the class certification and the compensatory and
punitive damages awards, as well as numerous other reversible errors that it
believes occurred during the trial to date.
Smoking and Health Litigation
Plaintiffs' allegations of liability in smoking and health cases are based on
various theories of recovery, including negligence, gross negligence, strict
liability, fraud, misrepresentation, design defect, failure to warn, breach of
express and implied warranties, breach of special duty, conspiracy, concert of
action, violations of deceptive trade practice laws and consumer protection
statutes, and claims under the federal and state RICO statutes. In certain of
these cases, plaintiffs claim that cigarette smoking exacerbated the injuries
caused by their exposure to asbestos. Plaintiffs in the smoking and health
actions seek various forms of relief, including compensatory and punitive
damages, treble/multiple damages and other statutory damages and penalties,
creation of medical monitoring and smoking cessation funds, disgorgement of
profits, and injunctive and equitable relief. Defenses raised in these cases
include lack of proximate cause, assumption of the risk, comparative fault
and/or contributory negligence, statutes of limitations and preemption by the
Federal Cigarette Labeling and Advertising Act. In May 1996, the United States
Court of Appeals for the Fifth Circuit held in the Castano case that a class
consisting of all "addicted" smokers nationwide did not meet the standards and
requirements of the federal rules governing class actions. Since this class
decertification, lawyers for plaintiffs have filed numerous putative smoking and
health class action suits in various state and federal courts. In general, these
cases purport to be brought on behalf of residents of a particular state or
states (although a few cases purport to be nationwide in scope) and raise
"addiction" claims and, in many cases, claims of physical injury as well. As of
August 1, 2002, smoking and health putative class actions were pending in
Alabama, Florida, Illinois, Louisiana, Michigan, Missouri, New York, Ohio,
Oregon, Tennessee, Utah, West Virginia and the District of Columbia, as well
as in Brazil, Canada, Israel and Spain. Class certification has been denied
or reversed by courts in 29 smoking and health class actions involving PM Inc.
in Arkansas, the District of Columbia, Illinois (2), Iowa, Kansas, Louisiana,
Maryland, Michigan, Minnesota, Nevada (4), New Jersey (6), New York (2), Ohio,
Oklahoma, Pennsylvania, Puerto Rico, South Carolina, Texas and Wisconsin, while
classes remain certified in the Engle case in Florida (discussed above) and a
case in Louisiana in which plaintiffs seek the creation of funds to pay for
medical monitoring and smoking cessation programs for class members. In May
1999, the United States Supreme Court declined to review the decision of the
United States Court of Appeals for the Third Circuit affirming a lower court's
decertification of a class. In November 2001, in the first medical monitoring
class action case to go to trial, a West Virginia jury returned a verdict in
favor of all defendants, including PM Inc. In January 2002, the trial court
denied plaintiffs' motion for a new trial, and plaintiffs have appealed.
Health Care Cost Recovery Litigation
Overview
In certain pending proceedings, domestic and foreign governmental entities and
non-governmental plaintiffs, including union health and welfare funds
("unions"), Native American tribes, insurers and self-insurers such as Blue
Cross and Blue Shield plans, hospitals, taxpayers and others, are seeking
reimbursement of health care cost expenditures allegedly caused by tobacco
products and, in some cases, of future expenditures and damages as well. Relief
sought by some but not all plaintiffs includes punitive damages, multiple
damages and other
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
statutory damages and penalties, injunctions prohibiting alleged marketing and
sales to minors, disclosure of research, disgorgement of profits, funding of
anti-smoking programs, additional disclosure of nicotine yields, and payment of
attorney and expert witness fees. Certain of the health care cost recovery cases
purport to be brought on behalf of a class of plaintiffs.
The claims asserted in the health care cost recovery actions include the
equitable claim that the tobacco industry was "unjustly enriched" by plaintiffs'
payment of health care costs allegedly attributable to smoking, the equitable
claim of indemnity, common law claims of negligence, strict liability, breach of
express and implied warranty, violation of a voluntary undertaking or special
duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims
under federal and state statutes governing consumer fraud, antitrust, deceptive
trade practices and false advertising, and claims under federal and state RICO
statutes.
Defenses raised include lack of proximate cause, remoteness of injury, failure
to state a valid claim, lack of benefit, adequate remedy at law, "unclean hands"
(namely, that plaintiffs cannot obtain equitable relief because they
participated in, and benefited from, the sale of cigarettes), lack of antitrust
standing and injury, federal preemption, lack of statutory authority to bring
suit, and statutes of limitations. In addition, defendants argue that they
should be entitled to "set off" any alleged damages to the extent the plaintiff
benefits economically from the sale of cigarettes through the receipt of excise
taxes or otherwise. Defendants also argue that these cases are improper because
plaintiffs must proceed under principles of subrogation and assignment. Under
traditional theories of recovery, a payor of medical costs (such as an insurer)
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 any actions as subrogees of individual health care recipients
and should be subject to all defenses available against the injured party.
Although there have been some decisions to the contrary, most courts that have
decided motions in these cases have dismissed all or most of the claims against
the industry. In addition, eight federal circuit courts of appeals, the Second,
Third, Fifth, Seventh, Eighth, Ninth, Eleventh and District of Columbia
circuits, as well as California and Tennessee intermediate appellate courts,
relying primarily on grounds that plaintiffs' claims were too remote, have
affirmed dismissals of, or reversed trial courts that had refused to dismiss,
health care cost recovery actions. The United States Supreme Court has refused
to consider plaintiffs' appeals from the cases decided by the courts of appeals
for the Second, Third, Ninth and District of Columbia circuits.
As of August 1, 2002, there were an estimated 43 health care cost recovery cases
pending in the United States against PM Inc., and in some instances, the
Company, including the case filed by the United States government, which is
discussed below under "Federal Government's Lawsuit."
The cases brought in the United States include actions brought by Belize,
Bolivia, Ecuador, Guatemala, Honduras, Nicaragua, the Province of Ontario,
Canada, Panama, the Russian Federation, Tajikistan, Ukraine, Venezuela, 11
Brazilian states, 11 Brazilian cities and a group of Argentine unions. The
actions brought by Belize, Bolivia, Ecuador, Guatemala, Honduras, Nicaragua, the
Province of Ontario, Panama, the Russian Federation, Tajikistan, Ukraine,
Venezuela, 10 Brazilian states and 11 Brazilian cities were consolidated for
pre-trial purposes and transferred to the United States District Court for the
District of Columbia. The district court dismissed the cases brought by
Guatemala, Nicaragua, Ukraine and the Province of Ontario, and the dismissals
are now final. The district court has remanded to state courts the remaining
cases except for the cases brought by Bolivia and Panama. Subsequent to remand,
the Ecuador case was voluntarily dismissed. In November 2001, the cases brought
by Venezuela and the Brazilian state of Espirito Santo were dismissed by the
state court, and Venezuela has appealed. In January 2001, the Superior Court of
the District of Columbia dismissed the suit brought by the Argentine unions, and
the dismissal is now final. In addition to cases brought in the United States,
health care cost recovery actions have also been brought in Israel, the Marshall
Islands (dismissed), the Province of British Columbia, Canada, France and Spain,
and other entities have stated that they are considering filing such actions.
In March 1999, in the first health care cost recovery case to go to trial, an
Ohio jury returned a verdict in favor of defendants on all counts. In June 2001,
a New York jury returned a verdict awarding $6.83 million in
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
compensatory damages against PM Inc. and a total of $11 million against four
other defendants in a health care cost recovery action brought by a Blue Cross
and Blue Shield plan. In February 2002, the court awarded plaintiff
approximately $38 million for attorneys' fees. Defendants, including PM Inc.,
have appealed.
Settlements of Health Care Cost Recovery Litigation
In November 1998, PM Inc. and certain other United States tobacco product
manufacturers entered into the Master Settlement Agreement (the "MSA") with 46
states, the District of Columbia, Puerto Rico, Guam, the United States Virgin
Islands, American Samoa and the Northern Marianas to settle asserted and
unasserted health care cost recovery and other claims. PM Inc. and certain other
United States tobacco product manufacturers had previously settled similar
claims brought by Mississippi, Florida, Texas and Minnesota (together with the
MSA, the "State Settlement Agreements"). The MSA has received final judicial
approval in all 52 settling jurisdictions.
The State Settlement Agreements require that the domestic tobacco industry make
substantial annual payments in the following amounts (excluding future annual
payments contemplated by the agreement with tobacco growers discussed below),
subject to adjustment for several factors, including inflation, market share and
industry volume: 2002, $11.3 billion; 2003, $10.9 billion; 2004 through 2007,
$8.4 billion each year; and, thereafter, $9.4 billion each year. In addition,
the domestic tobacco industry is required to pay settling plaintiffs' attorneys'
fees, subject to an annual cap of $500 million, as well as additional annual
payments of $250 million through 2003. These payment obligations are the several
and not joint obligations of each settling defendant. PM Inc.'s portion of
ongoing adjusted payments and legal fees is based on its relative share of the
settling manufacturers' domestic cigarette shipments, including roll-your-own
cigarettes, in the year preceding that in which the payment is due. PM Inc.
records its portions of ongoing settlement payments as part of cost of sales as
product is shipped.
The State Settlement Agreements also include provisions, discussed below in
Management's Discussion and Analysis of Financial Condition and Results of
Operations, relating to advertising and marketing restrictions, public
disclosure of certain industry documents, limitations on challenges to certain
tobacco control and underage use laws, restrictions on lobbying activities and
other provisions.
As part of the MSA, the settling defendants committed to work cooperatively with
the tobacco-growing states to address concerns about the potential adverse
economic impact of the MSA on tobacco growers and quota-holders. To that end,
four of the major domestic tobacco product manufacturers, including PM Inc., and
the grower states, have established a trust fund to provide aid to tobacco
growers and quota-holders. The trust will be funded by these four manufacturers
over 12 years with payments, prior to application of various adjustments,
scheduled to total $5.15 billion. Future industry payments (2002 through 2008,
$500 million each year; 2009 and 2010, $295 million each year) are subject to
adjustment for several factors, including inflation, United States cigarette
volume and certain other contingent events, and, in general, are to be allocated
based on each manufacturer's relative market share. PM Inc. records its portion
of these payments as part of cost of sales as product is shipped.
The State Settlement Agreements have materially adversely affected the volumes
of PM Inc. and the Company; the Company believes that they may materially
adversely affect the business, volumes, results of operations, cash flows or
financial position of PM Inc. and the Company in future periods. The degree of
the adverse impact will depend, among other things, on the rate of decline in
United States cigarette sales in the premium and discount segments, PM Inc.'s
share of the domestic premium and discount cigarette segments, and the effect of
any resulting cost advantage of manufacturers not subject to the MSA and the
other State Settlement Agreements.
Certain litigation, described in Exhibit 99.1, has arisen challenging the
validity of the MSA and alleging violations of antitrust laws.
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Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Federal Government's Lawsuit
In 1999, the United States government filed a lawsuit in the United States
District Court for the District of Columbia against various cigarette
manufacturers and others, including PM Inc. and the Company, asserting claims
under three federal statutes, the Medical Care Recovery Act ("MCRA"), the
Medicare Secondary Payer ("MSP") provisions of the Social Security Act and the
Racketeer Influenced and Corrupt Organizations Act ("RICO"). The lawsuit seeks
to recover an unspecified amount of health care costs for tobacco-related
illnesses allegedly caused by defendants' fraudulent and tortious conduct and
paid for by the government under various federal health care programs, including
Medicare, military and veterans' health benefits programs, and the Federal
Employees Health Benefits Program. The complaint alleges that such costs total
more than $20 billion annually. It also seeks various types of what it alleges
to be equitable and declaratory relief, including disgorgement, an injunction
prohibiting certain actions by the defendants, and a declaration that the
defendants are liable for the federal government's future costs of providing
health care resulting from defendants' alleged past tortious and wrongful
conduct. PM Inc. and the Company moved to dismiss this lawsuit on numerous
grounds, including that the statutes invoked by the government do not provide a
basis for the relief sought. In September 2000, the trial court dismissed the
government's MCRA and MSP claims, but permitted discovery to proceed on the
government's claims for relief under RICO. In October 2000, the government moved
for reconsideration of the trial court's order to the extent that it dismissed
the MCRA claims for health care costs paid pursuant to government health benefit
programs other than Medicare and the Federal Employees Health Benefits Act. In
February 2001, the government filed an amended complaint attempting to replead
the MSP claims. In July 2001, the court denied the government's motion for
reconsideration of the dismissal of the MCRA claims and dismissed the
government's amended MSP claims. Trial of the case is currently scheduled for
July 2003.
In June 2001, representatives of the Department of Justice invited the
defendants, including PM Inc. and the Company, to participate in settlement
discussions. A meeting with representatives of the Department of Justice was
held in July 2001. PM Inc. and the Company cannot predict whether discussions
will continue or the outcome of any such discussions.
Certain Other Tobacco-Related Litigation
Lights/Ultra Lights Cases: As of August 1, 2002, there were 13 putative class
actions pending against PM Inc. and, in some instances, the Company in
California, Florida, Illinois, Massachusetts, Minnesota, Missouri, New
Hampshire, New Jersey, Ohio (2), Oregon, Tennessee and West Virginia on behalf
of individuals who purchased and consumed various brands of cigarettes,
including Marlboro Lights, Marlboro Ultra Lights, Virginia Slims Lights and
Superslims, Merit Lights and Cambridge Lights. Plaintiffs in these cases allege,
among other things, that the use of the terms "Lights" and/or "Ultra Lights"
constitutes deceptive and unfair trade practices, and seek injunctive and
equitable relief, including restitution. Classes have been certified in
Illinois, Massachusetts and Florida. Trial in the Illinois case is scheduled for
January 2003.
Cigarette Contraband Cases: As of August 1, 2002, the European Community and ten
member states, various Departments of Colombia, Ecuador, Belize and Honduras had
filed suits in the United States against the Company and certain of its
subsidiaries, including PM Inc. and PMI, and other cigarette manufacturers and
their affiliates, alleging that defendants sold to distributors cigarettes that
would be illegally imported into various jurisdictions. The claims asserted in
these cases include negligence, negligent misrepresentation, fraud, unjust
enrichment, violations of RICO and its state-law equivalents and conspiracy.
Plaintiffs in these cases seek actual damages, treble damages and undisclosed
injunctive relief. In February 2002, the courts granted defendants' motions to
dismiss all of the actions. In the Colombia and European Community actions,
however, the RICO and fraud claims predicated on allegations of money laundering
claims were dismissed without prejudice. Plaintiffs in each of the cases have
appealed. In October 2001, the United States Court of Appeals for the Second
Circuit affirmed the dismissal of a cigarette contraband case filed against
another cigarette manufacturer and in March 2002, plaintiff in that case
petitioned the United States Supreme Court for further review.
-24-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Asbestos Contribution Cases: As of August 1, 2002, an estimated 9 suits were
pending on behalf of former asbestos manufacturers and affiliated entities
against domestic tobacco manufacturers, including PM Inc. These cases seek,
among other things, contribution or reimbursement for amounts expended in
connection with the defense and payment of asbestos claims that were allegedly
caused in whole or in part by cigarette smoking. Plaintiffs in most of these
cases also seek punitive damages.
Retail Leaders Case: Three domestic tobacco manufacturers filed suit against PM
Inc. seeking to enjoin the PM Inc. "Retail Leaders" program that became
available to retailers in October 1998. The complaint alleged that this retail
merchandising program is exclusionary, creates an unreasonable restraint of
trade and constitutes unlawful monopolization. In addition to an injunction,
plaintiffs sought unspecified treble damages, attorneys' fees, costs and
interest. In May 2002, the court granted PM Inc.'s motion for summary judgment
and dismissed all of plaintiffs' claims with prejudice. Plaintiffs have
appealed.
Vending Machine Case: Plaintiffs, who began their case as a purported nationwide
class of cigarette vending machine operators, allege that PM Inc. has violated
the Robinson-Patman Act in connection with its promotional and merchandising
programs available to retail stores and not available to cigarette vending
machine operators. The initial complaint was amended to bring the total number
of plaintiffs to 211, but by stipulated orders, all claims were stayed, except
those of ten plaintiffs that proceeded to pre-trial discovery. Plaintiffs
request actual damages, treble damages, injunctive relief, attorneys' fees and
costs, and other unspecified relief. In June 1999, the court denied plaintiffs'
motion for a preliminary injunction. Plaintiffs have withdrawn their request for
class action status. In August 2001, the court granted PM Inc.'s motion for
summary judgment and dismissed, with prejudice, the claims of the ten
plaintiffs. In October 2001, the court certified its decision for appeal to the
United States Court of Appeals for the Sixth Circuit following the stipulation
of all plaintiffs that the district court's dismissal would, if affirmed, be
binding on all plaintiffs.
Tobacco Price Cases: As of August 1, 2002, there were 36 putative class actions
pending against PM Inc. and other domestic tobacco manufacturers, as well as, in
certain instances, the Company and PMI, alleging that defendants conspired to
fix cigarette prices in violation of antitrust laws. Seven of the putative class
actions were filed in various federal district courts by direct purchasers of
tobacco products, and the remaining 29 were filed in 14 states and the District
of Columbia by retail purchasers of tobacco products. In November 2001,
plaintiffs' motion for class certification was granted in a case pending in
state court in Kansas, and trial in this case is scheduled for September 2003.
In November 2001, plaintiffs' motion for class certification was denied in a
case pending in state court in Minnesota. In June 2002, plaintiffs' motion for
class certification was denied in a case pending in the State of Michigan.
Plaintiffs' motion for reconsideration of this ruling and defendants' motions
for summary judgment are pending. In May 2002, the Arizona Court of Appeals
reversed the trial court's decision to dismiss an action, and defendants have
appealed. The seven federal class actions have been consolidated in the United
States District Court for the Northern District of Georgia. In July 2002, the
court granted defendants' motion for summary judgment dismissing the case in its
entirety, and plaintiffs have appealed. The cases are listed in Exhibit 99.1.
Cases Under the California Business and Professions Code: In June 1997 and July
1998, two suits were filed in California courts alleging that domestic cigarette
manufacturers, including PM Inc. and others, have violated California Business
and Professions Code Sections 17200 and 17500 regarding unfair, unlawful and
fraudulent business practices. Class certification was granted as to plaintiffs'
claims that defendants violated sections 17200 and/or 17500 of California
Business and Professions Code pursuant to which plaintiffs allege that class
members are entitled to reimbursement of the costs of cigarettes purchased
during the class periods and injunctive relief. Trials in the cases are
scheduled for October 2002 and April 2003.
Tobacco Growers' Case: In February 2000, a suit was filed on behalf of a
purported class of tobacco growers and quota-holders, and amended complaints
were filed in May 2000 and in August 2000. The second amended complaint alleges
that defendants, including PM Inc., violated antitrust laws by bid-rigging and
allocating purchases at tobacco auctions and by conspiring to undermine the
tobacco quota and price-support program administered by the federal government.
In October 2000, defendants filed motions to dismiss the amended
-25-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
complaint and to transfer the case, and plaintiffs filed a motion for class
certification. In November 2000, the court granted defendants' motion to
transfer the case to the United States District Court for the Middle District of
North Carolina. In December 2000, plaintiffs served a motion for leave to file a
third amended complaint to add tobacco leaf buyers as defendants. This motion
was granted, and the additional parties were served in February 2001. In March
2001, the leaf buyer defendants filed a motion to dismiss the case. In July
2001, the court denied the manufacturer and leaf buyer defendants' motions to
dismiss the case, and in April 2002 granted plaintiffs' motion for class
certification. Defendants' petition for interlocutory review of the class
certification order was denied in June 2002.
Consolidated Putative Punitive Damages Cases: In September 2000, a putative
class action was filed in the federal district court in the Eastern District of
New York that purports to consolidate punitive damages claims in ten
tobacco-related actions then pending in federal districts court New York and
Pennsylvania. In July 2002, plaintiffs filed an amended consolidated class
action complaint and a motion for class certification. The complaint seeks
certification of a punitive damages class of persons residing in the United
States who smoke or smoked defendants' cigarettes, and who have been diagnosed
by a physician with an enumerated disease from April 1993 through the date
notice of the certification of this class is disseminated.
Certain Other Actions
National Cheese Exchange Cases: Since 1996, seven putative class actions have
been filed by various dairy farmers alleging that Kraft and others engaged in a
conspiracy to fix and depress the prices of bulk cheese and milk through their
trading activity on the National Cheese Exchange. Plaintiffs seek injunctive and
equitable relief and unspecified treble damages. Plaintiffs voluntarily
dismissed two of the actions after class certification was denied. Three cases
were consolidated in state court in Wisconsin, and in November 1999, the court
granted Kraft's motion for summary judgment. In June 2001, the Wisconsin Court
of Appeals affirmed the trial court's ruling dismissing the cases. In April
2002, the Wisconsin Supreme Court affirmed the intermediate appellate court's
ruling. In April 2002, Kraft's motion for summary judgment dismissing the case
was granted in a case pending in the United States District Court for the
Central District of California. In June 2002, the parties settled this dispute
on an individual (non-class) basis, and plaintiffs dismissed their appeal. A
case in Illinois state court has been settled and dismissed.
Italian Tax Matters: One hundred ninety-four tax assessments alleging the
nonpayment of taxes in Italy (value-added taxes for the years 1988 to 1996 and
income taxes for the years 1987 to 1996) have been served upon certain
affiliates of the Company, including six new assessments (for the year 1996),
which were served in October and December 2001. The aggregate amount of alleged
unpaid taxes assessed to date is the euro equivalent of $2.3 billion. In
addition, the euro equivalent of $3.5 billion in interest and penalties has been
assessed. The Company anticipates that value-added and income tax assessments
may also be received with respect to subsequent years. All of the assessments
are being vigorously contested. To date, the Italian administrative tax court in
Milan has overturned 188 of the assessments, and the tax authorities have
appealed to the regional appellate court in Milan. To date, the regional
appellate court has rejected 81 of the appeals filed by the tax authorities. The
tax authorities have appealed 45 of the 81 decisions of the regional appellate
court to the Italian Supreme Court, and a hearing on these cases was held in
December 2001. Six of the 81 decisions were not appealed and are now final. In
March and May 2002, the Italian Supreme Court issued its decision in 42 of the
45 appeals. The Italian Supreme Court rejected 12 of the 45 appeals and these 12
cases are now final. The Italian Supreme Court vacated the decisions of the
regional appellate court in 30 of the cases and remanded these cases back to the
regional appellate court for further hearings on the merits. Three decisions
have not been issued. In a separate proceeding in October 1997, a Naples court
dismissed charges of criminal association against certain present and former
officers and directors of affiliates of the Company, but permitted tax evasion
and related charges to remain pending. In February 1998, the criminal court in
Naples determined that jurisdiction was not proper, and the case file was
transmitted to the public prosecutor in Milan. In March 2002, after the Milan
prosecutor's investigation into the matter, these present and former officers
and directors received notices that an initial hearing would take place in June
2002 at which time the "preliminary judge" hearing the case would evaluate
whether the Milan prosecutor's charges should be sent to a criminal judge for a
full trial. At the June 2002 hearing, the "preliminary judge" ruled that there
was no legal basis for the
-26-
Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
prosecutor's charges and acquitted all of the defendants; the prosecutor has
appealed. The Company, its affiliates and the officers and directors who are
subject to the proceedings believe they have complied with applicable Italian
tax laws and are vigorously contesting the pending assessments and proceedings.
----------
It is not possible to predict the outcome of the litigation pending against the
Company and its subsidiaries. Litigation is subject to many uncertainties.
Unfavorable verdicts awarding compensatory and/or punitive damages against
PM Inc. have been returned in the Engle smoking and health class action, several
individual smoking and health cases, a flight attendant ETS lawsuit, and a
health care cost recovery case and are being appealed. It is possible that there
could be further adverse developments in these cases and that additional cases
could be decided unfavorably. An unfavorable outcome or settlement of a pending
tobacco-related litigation could encourage the commencement of additional
litigation. There have also been a number of adverse legislative, regulatory,
political and other developments concerning cigarette smoking and the tobacco
industry that have received widespread media attention. These developments may
negatively affect the perception of potential triers of fact with respect to the
tobacco industry, possibly to the detriment of certain pending litigation, and
may prompt the commencement of additional similar litigation.
Management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending tobacco-related
litigation, and the Company has not provided any amounts in the consolidated
financial statements for unfavorable outcomes, if any. The present legislative
and litigation environment is substantially uncertain, and it is possible that
the Company's business, volume, results of operations, cash flows or financial
position could be materially affected by an unfavorable outcome or settlement of
certain pending litigation or by the enactment of federal or state tobacco
legislation. The Company and each of its subsidiaries named as a defendant
believe, and each has been so advised by counsel handling the respective cases,
that it has a number of valid defenses to the litigation pending against it, as
well as valid bases for appeal of adverse verdicts against it. All such cases
are, and will continue to be, vigorously defended. However, the Company and its
subsidiaries may enter into discussions in an attempt to settle particular cases
if they believe it is in the best interests of the Company's stockholders to do
so.
Note 9. Recently Issued Accounting Pronouncements:
On July 30, 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Costs covered by SFAS No. 146 include lease termination
costs and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing or other exit or disposal
activity. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. Accordingly, the Company will apply the
provisions of SFAS No. 146 prospectively to exit or disposal activities
initiated after December 31, 2002.
-27-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Consolidated Operating Results
For the Six Months Ended June 30,
Net Revenues
-----------------
(in millions)
2002 2001
------- -------
Domestic tobacco $ 9,899 $ 9,682
International tobacco 14,173 13,721
North American food 10,862 10,662
International food 3,798 4,008
Beer 2,641 2,464
Financial services 265 211
------- -------
Net revenues $41,638 $40,748
======= =======
Operating Income
-----------------
(in millions)
2002 2001
------- -------
Domestic tobacco $2,704 $2,085
International tobacco 2,967 2,906
North American food 2,467 2,496
International food 551 537
Beer 276 292
Financial services 175 140
------ ------
Operating companies income 9,140 8,456
Amortization of intangibles (4) (506)
General corporate expenses (338) (379)
------ ------
Operating income $8,798 $7,571
====== ======
For the Three Months Ended June 30,
Net Revenues
-----------------
(in millions)
2002 2001
------- -------
Domestic tobacco $ 4,881 $ 5,105
International tobacco 7,139 6,750
North American food 5,568 5,428
International food 1,945 2,045
Beer 1,422 1,350
Financial services 148 111
------- -------
Net revenues $21,103 $20,789
======= =======
-28-
For the Three Months Ended June 30,
Operating Income
----------------
(in millions)
2002 2001
------ ------
Domestic tobacco $1,454 $1,383
International tobacco 1,403 1,348
North American food 1,369 1,353
International food 299 298
Beer 169 168
Financial services 104 76
------ ------
Operating companies income 4,798 4,626
Amortization of intangibles (2) (253)
General corporate expenses (169) (169)
------ ------
Operating income $4,627 $4,204
====== ======
Several events occurred during the first six months of 2002 and 2001 that
affected the comparability of statement of earnings amounts. In order to isolate
the impact of these events and discuss underlying business trends, comparisons
will be given both including and excluding these events, which were as follows:
o Sale of Food Factory and Integration Costs - During the first six months
and second quarter of 2002, Kraft Foods North America, Inc. ("KFNA")
recorded pre-tax charges of $102 million and $75 million, respectively,
related to the closing of a facility and other consolidation programs in
North America. In addition, during the second quarter of 2002, Kraft Foods
International, Inc. ("KFI") recorded pre-tax charges of $17 million to
consolidate production lines and distribution networks in Latin America.
These charges were part of the previously announced $200 million to $300
million original estimate to close or reconfigure existing Kraft facilities
and integrate Nabisco. As of June 30, 2002, the aggregate pre-tax charges
to the consolidated statement of earnings to close or reconfigure Kraft
facilities and integrate Nabisco, including Kraft's voluntary early
retirement programs discussed below, were $314 million, slightly above the
original estimate. The 2002 integration related charges of $119 million
included $21 million relating to severance, $82 million relating to asset
write-offs and $16 million relating to other cash exit costs. Cash payments
relating to this charge will approximate $37 million of which $1 million
has been paid through June 30, 2002. The majority of the remaining payments
are expected to be made by December 31, 2002. In addition, during the first
quarter of 2001, KFNA recorded a pre-tax charge of $29 million on the sale
of a North American food factory. These pre-tax charges were included in
marketing, administration and research costs of the North American food and
international food segments in their respective periods.
o Voluntary Retirement Programs - In the second quarter of 2002, a voluntary
early retirement program in the international tobacco business in Germany
was announced and approximately 160 employees accepted the benefits offered
by this program. As a result, in the second quarter of 2002, a pre-tax
charge of $25 million was recorded in marketing, administration and
research costs of the international tobacco segment. In the fourth quarter
of 2001, voluntary early retirement programs were offered to certain
salaried employees in the beer and food businesses. During the first
quarter of 2002, approximately 800 employees accepted the benefits offered
by these programs. Pre-tax charges of $135 million, $7 million and $8
million were recorded in marketing, administration and research costs of
the North American food, international food and beer segments,
respectively, in the first quarter of 2002 for these voluntary retirement
programs.
o Amortization of Intangibles - On January 1, 2002, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." As
a result, the Company stopped recording the amortization of goodwill and
indefinite life intangible assets as a charge to earnings as of January 1,
2002. The Company estimates that net earnings would have been approximately
$4.6 billion and $2.5 billion in the first six months and second quarter of
2001, respectively, and diluted earnings per share ("EPS") would have been
$2.05 and $1.14, respectively, had the provisions of the new standards been
applied as of January 1, 2001.
-29-
o Businesses Previously Held for Sale - During 2001, certain Nabisco
businesses were reclassified to businesses held for sale, including
their estimated results of operations through anticipated sale dates.
These businesses have subsequently been sold with the exception of one
business that had been held for sale since the acquisition of Nabisco.
This business, which is no longer held for sale, has been included in the
2002 consolidated operating results of KFNA.
o Asset Impairment - During the first quarter of 2002, a pre-tax charge of
$15 million was recorded in marketing, administration and research costs
for a beer asset impairment.
o Litigation Related Expense - As discussed in Note 8. Contingencies, on May
7, 2001, the trial court in the Engle class action approved a stipulation
and agreed order among Philip Morris Incorporated ("PM Inc."), certain
other defendants and the plaintiffs providing that the execution or
enforcement of the punitive damages component of the judgment in that case
will remain stayed through the completion of all judicial review. As a
result of the stipulation, PM Inc. placed $500 million into a separate
interest-bearing escrow account that, regardless of the outcome of the
appeal, will be paid to the court and the court will determine how to
allocate or distribute it consistent with the Florida Rules of Civil
Procedure. As a result, a $500 million pre-tax charge was recorded by the
domestic tobacco business during the first quarter of 2001. In July 2001,
PM Inc. also placed $1.2 billion into an interest-bearing escrow account,
which will be returned to PM Inc. should it prevail in its appeal of the
case. The $1.2 billion escrow account is included in the June 30, 2002 and
December 31, 2001 consolidated balance sheets as other assets. Interest
income on the $1.2 billion escrow account is paid to PM Inc. quarterly and
is being recorded as earned in interest and other debt expense, net, in the
consolidated statements of earnings.
o Kraft Foods Inc. ("Kraft") IPO - On June 13, 2001, Kraft completed an
initial public offering ("IPO") of 280,000,000 shares of its Class A common
stock at a price of $31.00 per share. The Company used the IPO proceeds,
net of underwriting discount and expenses, of $8.4 billion to retire a
portion of the debt incurred to finance the acquisition of Nabisco. After
the completion of the IPO, the Company owns approximately 83.9% of the
outstanding shares of Kraft's capital stock through the Company's ownership
of 49.5% of Kraft's Class A common stock and 100% of Kraft's Class B common
stock. Kraft's Class A common stock has one vote per share while Kraft's
Class B common stock has ten votes per share. Therefore, the Company holds
97.7% of the combined voting power of Kraft's outstanding common stock.
Results of Operations for the Six Months Ended June 30, 2002
Net revenues for the first six months of 2002 increased $890 million (2.2%) over
2001, due primarily to higher tobacco net revenues. Excluding the unusual items
from each period and the results of operations divested since the beginning of
2001, net revenues for the first six months of 2002 increased $786 million
(1.9%) over 2001.
Operating income for the first six months of 2002 increased $1.2 billion (16.2%)
over the comparable 2001 period. Excluding the unusual items from each period
and the results of operations divested since the beginning of 2001, operating
income for the first six months of 2002 increased $493 million (5.7%) over the
first six months of 2001, due to increases from all business segments.
Operating companies income, which is defined as operating income before general
corporate expenses and amortization of intangibles, increased $684 million
(8.1%) over the first six months of 2001, due primarily to higher operating
income from the Company's tobacco operations and the 2001 litigation related
expense. Excluding the unusual items from each period and the results of
operations divested since the beginning of 2001, operating companies income
increased $452 million (5.0%), due to higher operating income from all business
segments.
Currency movements have decreased net revenues by $1.0 billion ($583 million,
after excluding the impact of currency movements on excise taxes) and operating
companies income by $250 million from the first six months of 2001. Declines in
net revenues and operating companies income are due primarily to the strength of
the U.S. dollar against the euro, the Japanese yen, the Russian ruble and
certain Latin American currencies.
-30-
Although the Company cannot predict future movements in currency rates, the
recent weakening of the U.S. dollar, if sustained during the remainder of 2002,
could have a favorable impact on net revenues and operating companies income
comparisons in the second half of the year; although full-year net revenues and
operating companies income comparisons with 2001 are expected to reflect an
unfavorable impact due to currency.
Interest and other debt expense, net, of $602 million for the first six months
of 2002 decreased $287 million from the first six months of 2001. This decrease
was due primarily to higher average debt outstanding in 2001 as a result of the
Nabisco acquisition. The Kraft IPO proceeds, net of underwriting discount and
expenses, of $8.4 billion were used to retire a portion of the Nabisco
acquisition debt during June 2001.
During the first six months of 2002, the Company's effective tax rate decreased
by 2.3 percentage points to 35.5%. This decrease is due primarily to the
adoption of SFAS No. 141 and SFAS No. 142, under which the Company is no longer
required to amortize goodwill and indefinite life intangible assets as a charge
to earnings.
Diluted and basic EPS of $2.30 and $2.32, respectively, for the first six months
of 2002, increased by 25.7% and 25.4%, respectively, over the first six months
of 2001. Net earnings of $5.0 billion for the first six months of 2002 increased
$907 million (22.3%) over the comparable period of 2001. These results include
the unusual items previously discussed. Excluding the after-tax impact of the
unusual items, net earnings increased 7.0% to $5.1 billion, diluted EPS
increased 10.2% to $2.38 and basic EPS increased 10.0% to $2.41.
Results of Operations for the Three Months Ended June 30, 2002
Net revenues for the second quarter of 2002 increased $314 million (1.5%) over
2001, due primarily to higher international tobacco, North American food and
beer net revenues, partially offset by lower domestic tobacco and international
food net revenues. Excluding the unusual items from each period and the results
of operations divested since the beginning of 2001, net revenues for the second
quarter of 2002 increased $190 million (0.9%) over 2001.
Operating income for the second quarter of 2002 increased $423 million (10.1%)
over the comparable 2001 period. Excluding the unusual items from each period
and the results of operations divested since the beginning of 2001, operating
income for the second quarter of 2002 increased $280 million (6.3%) over the
second quarter of 2001, due to increases from all business segments.
Operating companies income increased $172 million (3.7%) over the second quarter
of 2001, due primarily to the Company's tobacco segments. Excluding the unusual
items from each period and the results of operations divested since the
beginning of 2001, operating companies income increased $280 million (6.0%), due
to increases from all business segments.
Currency movements have decreased net revenues by $349 million ($207 million,
after excluding the impact of currency movements on excise taxes) and operating
companies income by $66 million from the second quarter of 2001. Declines in net
revenues and operating companies income are due primarily to the strength of the
U.S. dollar against the Russian ruble, the Japanese yen and certain Latin
American currencies. Although the Company cannot predict future movements in
currency rates, the recent weakening of the U.S. dollar, if sustained during the
remainder of 2002, could have a favorable impact on net revenues and operating
companies income comparisons in the second half of the year; although full-year
net revenues and operating companies income comparisons with 2001 are expected
to reflect an unfavorable impact due to currency.
Interest and other debt expense, net, of $309 million for the second quarter of
2002 decreased $129 million from the second quarter of 2001. This decrease was
due primarily to higher average debt outstanding in 2001 as a result of the
Nabisco acquisition. The Kraft IPO proceeds, net of underwriting discount and
expenses, of $8.4 billion were used to retire a portion of the Nabisco
acquisition debt during June 2001.
Diluted and basic EPS of $1.21 and $1.22, respectively, for the second quarter
of 2002, increased by 17.5% and 17.3%, respectively, over the second quarter of
2001. Net earnings of $2.6 billion for the second quarter of
-31-
2002 increased $322 million (14.1%) over the comparable period of 2001. These
results include the unusual items previously discussed. Excluding the after-tax
impact of the unusual items, net earnings increased 8.0% to $2.7 billion,
diluted EPS increased 11.7% to $1.24 and basic EPS increased 10.6% to $1.25.
Operating Results by Business Segment
Tobacco
Business Environment
The tobacco industry, both in the United States and abroad, has faced, and
continues to face, a number of issues that may adversely affect the business,
volume, results of operations, cash flows and financial position of PM Inc.,
Philip Morris International Inc. ("PMI") and the Company.
These issues, some of which are more fully discussed below, include pending and
threatened smoking and health litigation and certain jury verdicts against PM
Inc., including a $74 billion punitive damages verdict in the Engle smoking and
health class action case discussed in Note 8 and punitive damages awards in
individual smoking and health cases discussed in Note 8; the civil lawsuit filed
by the United States federal government against various cigarette manufacturers,
including PM Inc., and others discussed in Note 8; legislation or other
governmental action seeking to ascribe to the industry responsibility and
liability for the adverse health effects associated with both smoking and
exposure to environmental tobacco smoke ("ETS"); price increases in the United
States related to the settlement of certain tobacco litigation, and the effect
of any resulting cost advantage of manufacturers not subject to these
settlements; actual and proposed excise tax increases in the United States and
foreign markets; diversion into the United States market of products intended
for sale outside the United States; the sale of counterfeit cigarettes by third
parties; price disparities and changes in price disparities between premium
and lowest price brands; the outcome of proceedings and investigations involving
contraband shipments of cigarettes; governmental investigations; actual and
proposed requirements regarding the use and disclosure of cigarette ingredients
and other proprietary information; governmental and private bans and
restrictions on smoking; actual and proposed price controls and restrictions on
imports in certain jurisdictions outside the United States; actual and proposed
restrictions affecting tobacco manufacturing, marketing, advertising and sales
outside the United States; actual and proposed legislation in Congress, the
State of New York and other jurisdictions inside and outside the United States
to require the establishment of fire-safety standards for cigarettes; the
diminishing social acceptance of smoking and increased pressure from tobacco
control advocates and unfavorable press reports; and other tobacco legislation
that may be considered by Congress, the states and other jurisdictions inside
and outside the United States.
Excise Taxes: Cigarettes are subject to substantial federal, state and local
excise taxes in the United States and to similar taxes in most foreign markets.
In general, such taxes have been increasing. The United States federal excise
tax on cigarettes is currently $0.39 per pack of 20 cigarettes. In the United
States, state and local sales and excise taxes vary considerably and, when
combined with sales taxes, local taxes and the current federal excise tax, may
currently be as high as $4.03. Proposed further tax increases in various
jurisdictions are currently under consideration or pending. Thus far in 2002, 18
states have passed excise tax increases, ranging from $0.07 per pack of 20 in
Tennessee to as much as $1.81 per pack of 20 in New York City and New York State
combined. Congress has considered significant increases in the federal excise
tax or other payments from tobacco manufacturers, and significant increases in
excise and other cigarette-related taxes have been proposed or enacted at the
state and local levels within the United States and in many jurisdictions
outside the United States. In the European Union (the "EU"), taxes on cigarettes
vary considerably and currently may be as high as the equivalent of $5.58 per
pack on the most popular brands (using the exchange rate at July 24, 2002). In
Germany, where total tax on cigarettes is currently equivalent to $2.27 per pack
on the most popular brands, the excise tax is scheduled to increase by
approximately the equivalent of $0.20 ((euro)0.20 at the exchange rate on July
24, 2002) per pack by January 2003. In the opinion of PM Inc. and PMI, increases
in excise and similar taxes have had an adverse impact on sales of cigarettes.
Any future increases, the extent of which cannot be predicted, may result in
volume declines for the cigarette industry, including PM Inc. and PMI, and
might cause sales to shift from the premium segment to the discount segment.
-32-
Tar and Nicotine Test Methods and Brand Descriptors: Jurisdictions around the
world have questioned the utility of standardized test methods to measure tar
and nicotine yields of cigarettes. In September 1997, the United States Federal
Trade Commission ("FTC") issued a request for public comment on its proposed
revision of its tar and nicotine test methodology and reporting procedures
established by a 1970 voluntary agreement among domestic cigarette
manufacturers. In February 1998, PM Inc. and three other domestic cigarette
manufacturers filed comments on the proposed revisions. In November 1998, the
FTC wrote to the Department of Health and Human Services ("HHS") requesting its
assistance in developing specific recommendations on the future of the FTC's
program for testing the tar, nicotine, and carbon monoxide content of
cigarettes. In November 2001, the National Cancer Institute issued a report as a
part of HHS' response to the FTC's request. The report concluded, among other
things, that because there was no meaningful difference in smoke exposure or
risk to smokers between cigarettes with different machine-measured tar and
nicotine yields, the marketing of low yield cigarettes was deceptive. Similarly,
public health officials in other countries and the EU have found that the
marketing of low yield cigarettes is deceptive and have questioned the relevance
of the related International Organization for Standardization test method for
measuring tar, nicotine, and carbon monoxide yields. The EU Commission has been
directed to establish a committee to address, among other things, alternative
methods for measuring tar, nicotine and carbon monoxide yields. In addition,
public health authorities in the United States, the EU, Brazil and other
countries have called for the prohibition of or passed legislation prohibiting
the use of brand descriptors such as "Lights" and "Ultra Lights." Brazil banned
the use of descriptors in January 2002. In the United States, as of August 1,
there were 11 putative class actions pending against PM Inc. and the Company in
which plaintiffs allege, among other things, that the use of the terms "Lights"
and/or "Ultra Lights" constitutes deceptive and unfair trade practices.
Food and Drug Administration ("FDA") Regulations: In August 1996, the FDA
promulgated regulations asserting jurisdiction over cigarettes as "drugs" or
"medical devices" under the provisions of the Food, Drug and Cosmetic Act
("FDCA"). The regulations, which included severe restrictions on the
distribution, marketing and advertising of cigarettes, and would have required
the industry to comply with a wide range of labeling, reporting, record keeping,
manufacturing and other requirements, were declared invalid by the United States
Supreme Court in March 2000. The Company has stated that while it continues to
oppose FDA regulation over cigarettes as "drugs" or "medical devices" under the
provisions of the FDCA, it would support new legislation that would provide for
reasonable regulation by the FDA of cigarettes as cigarettes. Currently, there
are several bills pending in Congress that, if enacted, would give the FDA
authority to regulate tobacco products; PM Inc. has expressed support for one of
the bills. The bills take a variety of approaches to the issue of the FDA's
proposed regulation of tobacco products ranging from codification of the
original FDA regulations under the "drug" and "medical device" provisions of the
FDCA to the creation of provisions that would apply uniquely to tobacco
products. All of the pending legislation could result in substantial federal
regulation of the design, performance, manufacture and marketing of cigarettes.
The ultimate outcome of the pending bills cannot be predicted.
Ingredient Disclosure Laws: Jurisdictions inside and outside the United States
have enacted or proposed legislation or regulations that would require cigarette
manufacturers to disclose the ingredients used in the manufacture of cigarettes,
and in certain cases, to provide toxicological information regarding the
ingredients. In the United States, the Commonwealth of Massachusetts has enacted
legislation to require cigarette manufacturers to report the flavorings and
other ingredients used in each brand-style of cigarettes sold in the
Commonwealth. Cigarette manufacturers sued to have the statute declared
unconstitutional, arguing that it could result in the public disclosure of
valuable proprietary information. In September 2000, the district court granted
the plaintiffs' motion for summary judgment and permanently enjoined the
defendants from requiring cigarette manufacturers to disclose brand-specific
information on ingredients in their products, and defendants appealed. In
October 2001, the United States Court of Appeals for the First Circuit reversed
the district court's decision, holding that the Massachusetts disclosure statute
does not constitute an impermissible taking of private property. In November
2001, the First Circuit granted the cigarette manufacturers' petition for
rehearing en banc and withdrew the prior opinion. The First Circuit, sitting en
banc, heard oral argument in January 2002. The ultimate outcome of this lawsuit
cannot be predicted. Similar legislation has been enacted or proposed in other
states and in jurisdictions outside the United States, including the EU. Under
the EU tobacco product directive described below, tobacco companies must
disclose the use of, and provide toxicological information
-33-
about, all ingredients by October 2002. PMI has voluntarily disclosed the
ingredients in its brands in a number of EU member states and in other
countries. Other jurisdictions have also enacted or proposed legislation that
would require the submission of toxicological information about ingredients
and would permit governments to prohibit their use.
Health Effects of Smoking and Exposure to ETS: Reports with respect to the
health risks of cigarette smoking have been publicized for many years, and the
sale, promotion, and use of cigarettes continue to be subject to increasing
governmental regulation. Since 1964, the Surgeon General of the United States
and the Secretary of Health and Human Services have released a number of reports
linking cigarette smoking with a broad range of health hazards, including
various types of cancer, coronary heart disease and chronic lung disease, and
recommended various governmental measures to reduce the incidence of smoking.
The 1988, 1990, 1992 and 1994 reports focus on the addictive nature of
cigarettes, the effects of smoking cessation, the decrease in smoking in the
United States, the economic and regulatory aspects of smoking in the Western
Hemisphere, and cigarette smoking by adolescents, particularly the addictive
nature of cigarette smoking during adolescence.
Studies with respect to the health risks of ETS to nonsmokers (including lung
cancer, respiratory and coronary illnesses, and other conditions) have also
received significant publicity. In 1986, the Surgeon General of the United
States and the National Academy of Sciences reported that nonsmokers were at
increased risk of lung cancer and respiratory illness due to ETS. Since then, a
number of government agencies around the world have concluded that ETS causes
diseases--including lung cancer and heart disease--in nonsmokers. In 2002, the
International Agency for Research on Cancer concluded that ETS is
carcinogenic and that exposure to ETS causes disease in non-smokers.
It is the policy of each of PM Inc. and PMI to support a single, consistent
public health message on the health effects of cigarette smoking in the
development of diseases in smokers, and on smoking and addiction. It is also
their policy to defer to the judgment of public health authorities as to the
text of warnings regarding the health effects of smoking, addiction and
exposure to ETS.
In 1999, PM Inc. and PMI established web sites that include, among other things,
views of public health authorities on smoking, disease causation in smokers,
addiction and ETS. In October 2000, the sites were updated to reflect PM
Inc.'s and PMI's agreement with the overwhelming medical and scientific
consensus that cigarette smoking is addictive, and causes lung cancer, heart
disease, emphysema and other serious diseases in smokers. The web sites advise
smokers, and those considering smoking, to rely on the messages of public
health authorities in making all smoking-related decisions.
The sites also state that public health officials have concluded that ETS causes
or increases the risk of diseases--including lung cancer and heart disease--in
non-smoking adults, as well as conditions in children such as asthma,
respiratory infections, cough wheeze, otitis media (middle ear infection) and
Sudden Infant Death Syndrome. The sites also state that public health officials
have concluded that secondhand smoke can exacerbate adult asthma and cause eye,
throat and nasal irritation. In addition, PM Inc. and PMI also state on their
web sites that they believe that particular care should be exercised where
children are concerned, and that smokers who have children--particularly young
ones--should avoid smoking around them.
The World Health Organization's Framework Convention for Tobacco Control: The
World Health Organization and its member states are negotiating a proposed
Framework Convention for Tobacco Control. The proposed treaty recommends (and in
certain instances, requires) signatory nations to enact legislation that would,
among other things, establish specific actions to prevent youth smoking;
restrict and gradually eliminate tobacco product marketing; inform the public
about the health consequences of smoking and the benefits of quitting; regulate
the ingredients of tobacco products; impose new package warning requirements
that would include the use of pictures or graphic images; eliminate cigarette
smuggling and counterfeit cigarettes; restrict smoking in public places;
increase cigarette taxes; prohibit the use of terms that suggest one brand of
cigarettes is safer than another; abolish duty-free tobacco sales; and encourage
litigation against tobacco product manufacturers. PM Inc. and PMI have stated
that they would support a
-34-
treaty that member states could consider for ratification, based on the
following four principles: (1) smoking-related decisions should be made on the
basis of a consistent public health message; (2) effective measures should be
taken to prevent minors from smoking; (3) the right of adults to choose to smoke
should be preserved; and (4) all manufacturers of tobacco products should
compete on a level playing field. The outcome of the treaty negotiations cannot
be predicted.
Other Legislative Initiatives: In recent years, various members of the United
States Congress have introduced legislation, some of which has been the subject
of hearings or floor debate, that would subject cigarettes to various
regulations under the HHS or regulation under the Consumer Products Safety Act,
establish educational campaigns relating to tobacco consumption or tobacco
control programs, or provide additional funding for governmental tobacco control
activities, further restrict the advertising of cigarettes, require additional
warnings, including graphic warnings, on packages and in advertising, eliminate
or reduce the tax deductibility of tobacco advertising, provide that the Federal
Cigarette Labeling and Advertising Act and the Smoking Education Act not be used
as a defense against liability under state statutory or common law, and allow
state and local governments to restrict the sale and distribution of cigarettes.
Legislative initiatives affecting the regulation of the tobacco industry have
also been considered in a number of jurisdictions outside the United States. In
2001, the EU issued a directive on tobacco product regulation that, among other
things, reduces maximum permitted levels of tar, nicotine and carbon monoxide
yields to 10, 1 and 10 milligrams, respectively, requires manufacturers to
disclose ingredients and toxicological data on ingredients, requires health
warnings on the front of a pack that cover at least 30% of the front panel and
14 rotational warnings that cover no less than 40% of the back panel, requires
the health warnings to be surrounded by a black border, requires the printing of
tar, nicotine and carbon monoxide numbers on the side panel of the pack at a
minimum size of 10% of the side panel, and as described above, prohibits the use
of texts, names, trademarks and figurative or other signs suggesting that a
particular tobacco product is less harmful than others. The EU member states are
in the process of drafting and adopting legislation that implements the
provisions of the directive. The European Commission is also considering a new
directive that would further restrict tobacco marketing and advertising in the
EU. Tobacco control legislation addressing the manufacture, marketing and sale
of tobacco products has been proposed in numerous other jurisdictions.
In August 2000, New York State enacted legislation that requires the State's
Office of Fire Prevention and Control to promulgate by January 1, 2003,
fire-safety standards for cigarettes sold in New York. The legislation requires
that cigarettes sold in New York stop burning within a time period to be
specified by the standards or meet other performance standards set by the Office
of Fire Prevention and Control. All cigarettes sold in New York will be required
to meet the established standards within 180 days after the standards are
promulgated. It is not possible to predict the impact of this law on PM Inc.
until the standards are published. Similar legislation is being considered in
other states and localities and at the federal level, as well as in
jurisdictions outside the United States.
It is not possible to predict what, if any, additional foreign or domestic
governmental legislation or regulations will be adopted relating to the
manufacturing, advertising, sale or use of cigarettes, or to the tobacco
industry generally. However, if any or all of the foregoing were to be
implemented, the business, volume, results of operations, cash flows and
financial position of PM Inc., PMI and the Company could be materially
adversely affected.
Governmental Investigations: The Company and its subsidiaries are subject to
governmental investigations on a range of matters, including the following:
based on recent developments, the Company believes that Canadian authorities are
contemplating a legal proceeding based on a previously disclosed investigation
of PMI and its subsidiary, Philip Morris Duty Free, Inc., relating to
allegations of contraband shipments of cigarettes into Canada in the early to
mid 1990s. During 2001, the competition authorities in Italy and Turkey
initiated separate previously disclosed investigations into the pricing
activities among participants in the cigarette markets of those countries. The
order initiating the Italian investigation named the Company and certain of its
affiliates as well as all other parties purportedly engaged in the sale of
cigarettes in Italy, including the Italian state tobacco monopoly. The Turkish
investigation is directed at one of the Company's Turkish affiliates and another
cigarette manufacturer. In 2002, the Italian authorities, at the request of a
consumer group, initiated a
-35-
previously disclosed investigation into the use of descriptors for Marlboro
Lights. The investigation is directed at the Company's German and Dutch
affiliates, which manufacture product for sale in Italy. Similarly, in 2001,
authorities in Australia initiated a previously disclosed investigation into the
use of descriptors, alleging that their use was false and misleading. The
investigation is directed at one of the Company's Australian affiliates and
other cigarette manufacturers. The Company cannot predict the outcome of these
investigations or whether additional investigations may be commenced.
Tobacco-Related Litigation: There is substantial litigation pending related to
tobacco products in the United States and certain foreign jurisdictions,
including the Engle class action case in Florida, in which PM Inc. is a
defendant, and a civil health care cost recovery action filed by the United
States Department of Justice in September 1999 against domestic tobacco
manufacturers and others, including PM Inc. and, in some instances, the Company.
(See Note 8 for a discussion of such litigation.)
State Settlement Agreements: As discussed in Note 8, during 1997 and 1998, PM
Inc. and other major domestic tobacco product manufacturers entered into
agreements with states and various United States jurisdictions settling asserted
and unasserted health care cost recovery and other claims. These settlements
provide for substantial annual payments. They also place numerous restrictions
on the tobacco industry's conduct of its business operations, including
restrictions on the advertising and marketing of cigarettes. Among these are
restrictions or prohibitions on the following: targeting youth; use of cartoon
characters; use of brand name sponsorships and brand name non-tobacco products;
outdoor and transit brand advertising; payments for product placement; and free
sampling. In addition, the settlement agreements require companies to affirm
corporate principles to reduce underage use of cigarettes; impose requirements
regarding lobbying activities; mandate public disclosure of certain industry
documents; limit the industry's ability to challenge certain tobacco control and
underage use laws; and provide for the dissolution of certain tobacco-related
organizations and place restrictions on the establishment of any replacement
organizations.
Operating Results
For the Six Months Ended June 30,
------------------------------------
Operating
Net Revenues Companies Income
----------------- ----------------
(in millions)
2002 2001 2002 2001
------- ------- ------ ------
Domestic tobacco $ 9,899 $ 9,682 $2,704 $2,085
International tobacco 14,173 13,721 2,967 2,906
------- ------- ------ ------
Total tobacco $24,072 $23,403 $5,671 $4,991
======= ======= ====== ======
Domestic tobacco. During the first six months of 2002, PM Inc.'s net revenues,
which include excise taxes billed to customers, increased $217 million (2.2%)
over the comparable 2001 period. Excluding excise taxes, net revenues increased
$86 million (1.1%), due primarily to higher pricing ($729 million), partially
offset by lower volume ($649 million).
Operating companies income for the first six months of 2002 increased $619
million (29.7%) over the comparable 2001 period, due primarily to the 2001
litigation related expense ($500 million) and price increases as well as lower
product costs (aggregating $772 million), partially offset by lower volume ($429
million) and higher marketing, administration and research costs ($235 million,
primarily promotions). Excluding the impact of the 2001 litigation related
expense, operating companies income increased 4.6%.
As reported by Management Science Associates, shipment volume for the domestic
tobacco industry during the first six months of 2002 decreased to 199.5 billion
units, a 2.2% decrease from the first six months of 2001. PM Inc.'s shipment
volume for the first six months of 2002 was 98.5 billion units, a decrease of
6.4% from the comparable 2001 period, due primarily to the timing of promotions
and increased price competition. During July 2002, plans were announced
to invest approximately $350 million to promote the premium brands and retail
presence of PM Inc. and Philip Morris International Inc. ("PMI") to enhance
future volumes and market shares. This additional investment by PM Inc. and PMI
will be made during the remainder of 2002.
-36-
It should be noted that Management Science Associates' current measurements of
the domestic cigarette industry's total shipments and related share data do not
include all shipments of some smaller manufacturers that Management Science
Associates is presently unable to monitor effectively. Accordingly, it should
also be noted that the discussion herein of PM Inc.'s performance within the
industry is based upon Management Science Associates' estimates of total
industry volume.
For the first six months of 2002, PM Inc.'s shipment share was 49.4%, a decrease
of 2.2 share points from the comparable period of 2001. Marlboro shipment volume
decreased 4.3 billion units (5.4%) from the first six months of 2001 to 76.0
billion units for a 38.1% share of the total industry, a decrease of 1.2 share
points from the comparable period of 2001. This volume and share performance was
due primarily to the timing of promotions and increased price competition.
Based on shipments, the premium segment accounted for approximately 73.3% of the
domestic cigarette industry volume in the first six months of 2002, a decrease
of 1.0 share point from the comparable period of 2001. In the premium segment,
PM Inc.'s volume decreased 5.9% during the first six months of 2002, compared
with a 3.6% decrease for the industry, resulting in a premium segment share of
60.6%, a decrease of 1.5 share points from the first six months of 2001, due
primarily to the factors mentioned above.
In the discount segment, PM Inc.'s shipments decreased 10.8% to 9.9 billion
units in the first six months of 2002, compared with an industry increase of
1.8%, resulting in a discount segment share of 18.6%, a decrease of 2.6 share
points from the comparable period of 2001. Basic shipment volume for the first
six months of 2002 was down 6.6% to 9.4 billion units, for a 17.5% share of the
discount segment, down 1.6 share points compared to the first six months of
2001, due primarily to increased price competition.
According to consumer purchase data from Information Resources Inc./Capstone, PM
Inc.'s share of cigarettes sold at retail decreased 0.4 share points to 50.5%
for the first six months of 2002. Marlboro's retail share for the first six
months of 2002 increased 0.3 share points to 38.4% and PM Inc.'s retail share of
the premium segment grew 0.7 share points to 62.2%. Retail share for Basic, PM
Inc.'s major discount brand, decreased 0.1 share points to 5.0%.
Information Resources Inc./Capstone is a proprietary retail tracking service
that uses a sample of stores to extrapolate market share performance in the
universe of stores PM Inc.'s sales representatives regularly visit. PM Inc.
currently estimates that this universe represents approximately 87% of estimated
industry volume.
In March 2002, PM Inc. announced a price increase of $6.00 per thousand
cigarettes on its domestic premium and discount brands. The price increase was
effective April 1, 2002. This followed a price increase of $2.50 per thousand in
October 2001 and a price increase of $7.00 per thousand in April 2001. Each
$1.00 per thousand increase by PM Inc. equates to a $0.02 increase in the price
to wholesalers of each pack of twenty cigarettes.
PM Inc. cannot predict future changes or rates of change in domestic tobacco
industry volume, the relative sizes of the premium and discount segments or in
PM Inc.'s shipments, shipment market share or retail market share; however, it
believes that PM Inc.'s results may be materially adversely affected by price
increases related to increased excise taxes and tobacco litigation settlements,
as well as by the other items discussed under the caption "Tobacco--Business
Environment."
International tobacco. During the first six months of 2002, international
tobacco net revenues, which include excise taxes billed to customers, increased
$452 million (3.3%) over the first six months of 2001. Excluding excise taxes,
net revenues increased $246 million (3.4%), due primarily to higher volume/mix
($312 million) and price increases ($180 million), partially offset by
unfavorable currency movements.
Operating companies income for the first six months of 2002 increased $61
million (2.1%) over the comparable 2001 period, due primarily to price increases
($180 million) and higher volume/mix ($126 million), partially offset by
unfavorable currency movements ($236 million) and a pre-tax charge for a
voluntary retirement
-37-
program ($25 million) in 2002. Excluding the 2002 pre-tax charge for the
voluntary retirement program, operating companies income increased 3.0%.
PMI's volume for the first six months of 2002 of 369.5 billion units increased
9.9 billion units (2.8%) over the first six months of 2001, due primarily to
volume increases in Eastern Europe, Asia and Turkey, partially offset by the
timing of shipments and lower overall markets in Italy and Spain, economic
weakness in Egypt and continued price competition in Poland. Volume advanced in
a number of important markets, including Austria, Belgium, the Netherlands, the
United Kingdom, Turkey, Russia, Indonesia, Japan (due primarily to favorable
timing of shipments), Taiwan, Thailand, Brazil and Mexico. International volume
for Marlboro decreased 1.5%, due to the timing of shipments in Spain, consumer
downtrading to lower-priced brands in the Czech Republic, Turkey, Egypt, the
Philippines and Argentina, and intense price competition in Poland, partially
offset by higher volumes in Austria, the United Kingdom, Japan, Indonesia,
Mexico and worldwide duty-free. In most markets exhibiting downtrading from
Marlboro, volume increased for other brands in PMI's portfolio. PMI recorded
market share gains in many of its major markets.
For the Three Months Ended June 30,
------------------------------------
Operating
Net Revenues Companies Income
----------------- ----------------
(in millions)
2002 2001 2002 2001
------- ------- ------ ------
Domestic tobacco $ 4,881 $ 5,105 $1,454 $1,383
International tobacco 7,139 6,750 1,403 1,348
------- ------- ------ ------
Total tobacco $12,020 $11,855 $2,857 $2,731
======= ======= ====== ======
Domestic tobacco. During the second quarter of 2002, PM Inc.'s net revenues,
which include excise taxes billed to customers, decreased $224 million (4.4%)
from the comparable 2001 period. Excluding excise taxes, net revenues decreased
$213 million (5.1%), due primarily to lower volume ($718 million), partially
offset by higher pricing ($504 million).
Operating companies income for the second quarter of 2002 increased $71 million
(5.1%) over the comparable 2001 period, due primarily to higher pricing and
lower product costs (aggregating $570 million), partially offset by lower volume
($493 million).
As reported by Management Science Associates, shipment volume for the domestic
tobacco industry during the second quarter of 2002 decreased to 98.2 billion
units, a 7.0% decrease from the second quarter of 2001. PM Inc.'s shipment
volume for the second quarter of 2002 was 46.2 billion units, a decrease of
13.8% from the comparable 2001 period. PM Inc.'s shipment volumes for the second
quarter of 2002 were negatively affected by trade inventory depletions following
the April 2002 price increase, the timing of promotions in the second quarter of
2002 versus the second quarter of 2001 and increased price competition.
It should be noted that Management Science Associates' current measurements of
the domestic cigarette industry's total shipments and related share data do not
include all shipments of some smaller manufacturers that Management Science
Associates is presently unable to monitor effectively. Accordingly, it should
also be noted that the discussion herein of PM Inc.'s performance within the
industry is based upon Management Science Associates' estimates of total
industry volume.
For the second quarter of 2002, PM Inc.'s shipment share was 47.1%, a decrease
of 3.7 share points from the comparable period of 2001. Marlboro shipment volume
decreased 5.8 billion units (14.1%) from the second quarter of 2001 to 35.2
billion units for a 35.9% share of the total industry, a decrease of 2.9 share
points from the comparable period of 2001.
Based on shipments, the premium segment accounted for approximately 72.0% of the
domestic cigarette industry volume in the second quarter of 2002, a decrease of
2.0 share points from the comparable period of 2001. In the premium segment, PM
Inc.'s volume decreased 13.6% during the second quarter of 2002, compared with a
9.5% decrease for the industry, resulting in a premium segment share of 58.5%, a
decrease of 2.8 share points from the second quarter of 2001. This volume and
share performance was due primarily to the timing of promotions, the depletion
of trade inventories and increased price competition.
-38-
In the discount segment, PM Inc.'s shipments decreased 15.3% to 4.9 billion
units in the second quarter of 2002, compared with an industry increase of 0.2%,
resulting in a discount segment share of 17.7%, a decrease of 3.2 share points
from the comparable period of 2001. Basic shipment volume for the second quarter
of 2002 was down 11.7% to 4.6 billion units, for a 16.8% share of the discount
segment, down 2.2 share points compared to the second quarter of 2001, due
primarily to a reduction in trade inventories versus the prior year and
increased price competition.
According to consumer purchase data from Information Resources Inc./Capstone, PM
Inc.'s share of cigarettes sold at retail decreased 0.7 share points to 50.2%
for the second quarter of 2002, due primarily to a 0.9 share point decline in
its brands, Merit, Benson & Hedges, and Cambridge, which were not supported by
promotional activity. However, the combined retail share for PM Inc.'s four
focus brands that received promotional support, Marlboro, Parliament, Virginia
Slims and Basic was up 0.2 share points to 47.3%, due to the growth of Marlboro
and Parliament, which increased their combined retail share by 0.4 share points.
The second quarter of 2002 retail share for Marlboro increased 0.1 share points
to 38.3% and PM Inc.'s retail share of the premium segment grew 0.6 share points
to 62.1%. Retail share for Basic, PM Inc.'s major discount brand, decreased 0.1
share points to 4.9%.
Information Resources Inc./Capstone is a proprietary retail tracking service
that uses a sample of stores to extrapolate market share performance in the
universe of stores PM Inc.'s sales representatives regularly visit. PM Inc.
currently estimates that this universe represents approximately 87% of estimated
industry volume.
PM Inc. cannot predict future changes or rates of change in domestic tobacco
industry volume, the relative sizes of the premium and discount segments or in
PM Inc.'s shipments, shipment market share or retail market share; however, it
believes that PM Inc.'s results may be materially adversely affected by price
increases related to increased excise taxes and tobacco litigation settlements,
as well as by the other items discussed under the caption "Tobacco--Business
Environment."
International tobacco. During the second quarter of 2002, international tobacco
net revenues, which include excise taxes billed to customers, increased $389
million (5.8%) over the second quarter of 2001. Excluding excise taxes, net
revenues increased $172 million (4.9%), due primarily to higher volume/mix ($122
million) and price increases ($90 million), partially offset by unfavorable
currency movements.
Operating companies income for the second quarter of 2002 increased $55 million
(4.1%) over the comparable 2001 period, due primarily to price increases ($90
million) and higher volume/mix ($47 million), partially offset by unfavorable
currency movements ($58 million) and a pre-tax charge for a voluntary retirement
program ($25 million) in 2002. Excluding the 2002 pre-tax charge for the
voluntary retirement program, operating companies income increased 5.9%.
PMI's volume for the second quarter of 2002 of 185.5 billion units increased 5.6
billion units (3.1%) over the second quarter of 2001, due primarily to volume
increases in Eastern Europe, Asia and Turkey. Volume advanced in a number of
important markets, including Belgium, Greece, Spain, the Czech Republic,
Romania, Turkey, Russia, Indonesia, Japan, Taiwan, Thailand, Brazil and Mexico.
In Germany, volume was flat while share was up 0.1 share points, reflecting
PMI's improving performance in that market. In France, Italy, Portugal, Saudi
Arabia and Lithuania, volume decreased due primarily to the timing of shipments;
and in Japan, volume increased due primarily to favorable timing of shipments.
Volume declined in Egypt, Poland and the Ukraine, due to intense price
competition. In Korea, volume declined due to heightened competition and trade
inventory reductions. Volume declined in the Philippines, due to a weak economy
and growth in the low-price segment. International volume for Marlboro decreased
1.8%, as lower volumes in Italy, France, the United Kingdom, Russia, Egypt,
Saudi Arabia, Korea, the Philippines and Argentina were partially offset by
higher volumes in Japan, Spain, Romania, Thailand, Indonesia and Mexico. In most
markets exhibiting downtrading from Marlboro, volume increased for other brands
in PMI's portfolio. PMI recorded market share gains in most of its major
markets.
-39-
Food
Business Environment
Kraft, the largest branded food and beverage company headquartered in the United
States, conducts its global business through two subsidiaries. KFNA manufactures
and markets a wide variety of snacks, beverages, cheese, grocery products and
convenient meals in the United States, Canada and Mexico. Subsidiaries and
affiliates of KFI manufacture and market a wide variety of snacks, beverages,
cheese, grocery products and convenient meals in Europe, the Middle East and
Africa, as well as the Latin America and Asia Pacific regions. KFNA and KFI are
subject to fluctuating commodity costs, currency movements and competitive
challenges in various product categories and markets, including a trend toward
increasing consolidation in the retail trade and consequent inventory
reductions, and changing consumer preferences. In addition, certain competitors
may have different profit objectives and some international competitors may be
more or less susceptible to currency exchange rates. To confront these
challenges, Kraft continues to take steps to build the value of its brands and
improve its food business portfolio with new product and marketing initiatives.
Fluctuations in commodity costs can cause retail price volatility, intensify
price competition and influence consumer and trade buying patterns. The North
American and international food businesses are subject to fluctuating commodity
costs, including dairy, coffee bean and cocoa costs. Dairy commodity costs on
average in the second quarter of 2002 have been lower than those incurred in the
second quarter of 2001. However, for the first six months of 2002, dairy
commodity costs have been higher than the first six months of 2001. Cocoa bean
prices have been higher than in 2001, while coffee bean prices have been lower
than in 2001.
On December 11, 2000, the Company, through Kraft, acquired all of the
outstanding shares of Nabisco. During 2001, certain Nabisco businesses were
reclassified as businesses held for sale, including their estimated results of
operations through anticipated sale dates. These businesses have subsequently
been sold with the exception of one business that had been held for sale since
the acquisition of Nabisco. This business has been included in the 2002 reported
operating results of KFNA. The closure of a number of Nabisco domestic and
international facilities resulted in severance and other exit costs of $379
million, which were included in the adjustments for the allocation of the
Nabisco purchase price. The closures will result in the termination of
approximately 7,500 employees and will require total cash payments of $373
million, of which approximately $170 million has been spent through June 30,
2002. Substantially all of the closures will be completed by the end of 2002.
The integration of Nabisco into the operations of Kraft also resulted in the
closure or reconfiguration of several existing Kraft facilities. The aggregate
charges to the consolidated statement of earnings to close or reconfigure
facilities and integrate Nabisco were originally estimated to be in the range of
$200 million to $300 million. As of June 30, 2002, the aggregate pre-tax charges
to the consolidated statement of earnings to close or reconfigure its facilities
and integrate Nabisco were $314 million, slightly above the original estimate.
KFNA incurred pre-tax integration costs of $75 million during the second quarter
of 2002, in addition to $27 million incurred during the first quarter of 2002
and $53 million incurred during the third and fourth quarters of 2001. KFI
incurred pre-tax integration costs of $17 million during the second quarter of
2002. During the first quarter of 2002, approximately 700 employees accepted the
benefits offered by a voluntary retirement program. As a result, Kraft recorded
a pre-tax charge of $142 million related to the voluntary retirement program, of
which $135 million related to KFNA.
During the first quarter of 2002, KFI acquired a biscuits company in Australia
for an aggregate cost of $62 million. During the first six months of 2001, KFI
purchased coffee businesses in Romania, Morocco and Bulgaria. The operating
results of the businesses acquired and divested were not material to the
consolidated operating results of KFI or the Company in any of the periods
presented.
During the first six months of 2002, KFNA sold several North American food
businesses, which were previously classified as businesses held for sale, for
$81 million. The operating results of the businesses divested were not material
to KFNA's or the Company's consolidated financial position or results of
operations in any of the periods presented.
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Operating Results
For the Six Months Ended June 30,
------------------------------------
Operating
Net Revenues Companies Income
----------------- ----------------
(in millions)
2002 2001 2002 2001
------- ------- ------ ------
North American food $10,862 $10,662 $2,467 $2,496
International food 3,798 4,008 551 537
------- ------- ------ ------
Total food $14,660 $14,670 $3,018 $3,033
======= ======= ====== ======
North American food. During the first six months of 2002, net revenues increased
$200 million (1.9%) over the first six months of 2001. Excluding businesses
divested since the beginning of 2001 and adjusting for businesses previously
held for sale, net revenues increased $98 million (0.9%), due primarily to
higher volume/mix ($107 million), partially offset by lower pricing
($12 million).
Operating companies income for the first six months of 2002 decreased $29
million (1.2%) from the comparable period of 2001. Excluding the 2002 pre-tax
charges for the voluntary retirement program ($135 million) and integration
costs ($102 million) and a 2001 loss on the sale of a food factory ($29
million), as well as the impact of businesses previously held for sale,
operating companies income increased $167 million (6.6%), due primarily to
lower marketing, administration and research costs ($128 million, including
synergy savings), productivity savings and higher volume/mix.
Volume for the first six months of 2002 increased 7.1% over the comparable
period for 2001. Excluding the impact of businesses divested and after adjusting
for businesses previously held for sale (the basis of presentation for all of
the following KFNA volume comparisons), volume increased 2.2%. In Cheese, Meals
and Enhancers, volume decreased due primarily to lower shipments in cheese and
food service. Cheese volume declined, due to aggressive competitive activity
and the challenges associated with translating lower commodity costs into
lower retail prices during the second quarter of 2002. Shipments to food
service customers were also lower, driven by the exit of non-branded
businesses and distributor consolidation in the food service industry. These
decreases were partially offset by higher shipments of macaroni & cheese
dinners, and the 2001 acquisition of It's Pasta Anytime. Volume increased in
Biscuits, Snacks and Confectionery, driven primarily by higher shipments of
biscuits, higher shipments of snacking nuts to non-grocery channels and the
introduction of new confectionery products. Volume gains were achieved in
Beverages, Desserts and Cereals, driven primarily by ready-to-drink beverages,
coffee and desserts, partially offset by trade inventory reductions in cereals.
In Oscar Mayer and Pizza, volume increased due primarily to increases in hot
dogs, bacon, lunch combinations, soy-based meat alternatives and frozen pizza.
International food. Net revenues for the first six months of 2002 decreased $210
million (5.2%) from the first six months of 2001. Excluding businesses divested
since the beginning of 2001, net revenues decreased $212 million (5.3%), due
primarily to unfavorable currency movements ($243 million) and unfavorable
volume/mix ($60 million), partially offset by the impact of acquisitions.
Operating companies income for the first six months of 2002 increased $14
million (2.6%) over the first six months of 2001. Excluding pre-tax charges for
the voluntary retirement program ($7 million) and integration costs ($17
million), as well as the impact of businesses divested since the beginning of
2001, operating companies income increased $38 million (7.1%), due primarily
to lower marketing, administration and research costs ($76 million), partially
offset by unfavorable volume/mix ($25 million) and unfavorable currency
movements ($14 million).
Volume for the first six months of 2002 increased 1.6% over the first six months
of 2001. Excluding the impact of divested businesses and after adjusting for the
impact of businesses previously held for sale (the basis of presentation for
-41-
all of the following KFI volume comparisons), volume increased 2.5%, benefiting
from acquisitions and the introduction of new products.
In Europe, Middle East and Africa, volume increased over the first six months of
2001, benefiting from acquisitions and from growth in most countries across the
region. In beverages, volume increased in both coffee and refreshment beverages.
Coffee volume grew in Sweden, the United Kingdom, Poland, Italy and the Ukraine,
and benefited from acquisitions in Romania, Morocco and Bulgaria. Refreshment
beverage volume increased, driven by higher sales to the Middle East, Turkey and
Morocco. Snacks volume increased, driven by higher confectionery and salty
snacks volume in several markets and an acquisition in Russia and Poland,
partially offset by lower volume in Germany. Cheese volume decreased, due
primarily to increased price competition in Europe, partially offset by gains in
the Middle East. In grocery, volume increased, due primarily to higher spoonable
dressings volume in Germany, and higher shipments of ready-to-serve desserts and
pourable dressings in the United Kingdom. Volume for convenient meals also
increased, due primarily to lunch combinations in the United Kingdom and higher
shipments of canned meats in Italy against a weak comparison in 2001.
Volume increased in the Latin America and Asia Pacific region driven by gains in
many markets and an acquisition in Australia, partially offset by declines in
certain countries due to the impact of weak economies and lower results in
China. Beverages volume increased, due primarily to growth in refreshment
beverages in Brazil, Argentina, the Philippines and Venezuela. Snacks volume
increased, driven primarily by biscuit growth in Brazil and Indonesia, and an
acquisition in Australia, partially offset by lower volume in Argentina and
China. Cheese volume decreased, due primarily to lower sales in Latin America
and Japan, partially offset by higher volume in the Philippines and Indonesia.
Grocery volume was lower, due primarily to lower sales in Latin America and
price competition in Australia.
For the Three Months Ended June 30,
------------------------------------
Operating
Net Revenues Companies Income
--------------- ----------------
(in millions)
2002 2001 2002 2001
------ ------ ------ ------
North American food $5,568 $5,428 $1,369 $1,353
International food 1,945 2,045 299 298
------ ------ ------ ------
Total food $7,513 $7,473 $1,668 $1,651
====== ====== ====== ======
North American food. During the second quarter of 2002, net revenues increased
$140 million (2.6%) over the second quarter of 2001, due primarily to businesses
previously held for sale ($122 million) and higher volume/mix ($76 million),
partially offset by lower pricing ($55 million). Excluding the businesses
divested since the beginning of 2001 and adjusting for businesses previously
held for sale, net revenues increased 0.4%.
Operating companies income for the second quarter of 2002 increased $16 million
(1.2%) over the comparable period of 2001, due primarily to higher margins,
higher volume/mix ($26 million) and lower marketing, administration and research
costs ($26 million, including synergy savings), partially offset by integration
costs ($75 million). Excluding the 2002 pre-tax charge for integration costs and
adjusting for businesses previously held for sale, operating companies income
increased 6.0%.
Volume for the second quarter of 2002 increased 8.7% over the comparable period
of 2001. Excluding the impact of businesses divested and after adjusting for
businesses previously held for sale (the basis of presentation for all of the
following KFNA volume comparisons), volume increased 2.0%. In Cheese, Meals
and Enhancers, volume decreased due primarily to lower cheese and food service
volume. Cheese volume declined due to aggressive competitive activity and the
challenges associated with translating lower commodity costs into lower retail
prices. Shipments to food service customers also declined, driven by the exit
of non-branded businesses and distributor consolidation in the food service
industry. These decreases were partially offset by higher shipments of macaroni
& cheese dinners, the 2001 acquisition of It's Pasta Anytime and higher volumes
in enhancers. Volume increased in Biscuits, Snacks and Confectionery, driven
primarily by new product introductions in
-42-
biscuits and confectionery, and higher shipments of snacking nuts. Volume gains
were achieved in Beverages, Desserts and Cereals, driven primarily by
ready-to-drink beverages, coffee and desserts, partially offset by trade
inventory reductions in cereals. In Oscar Mayer and Pizza, volume increased due
primarily to increases in hot dogs, lunch combinations, soy-based meat
alternatives and frozen pizza.
International food. Net revenues for the second quarter of 2002 decreased $100
million (4.9%) from the second quarter of 2001. After adjusting for businesses
held for sale, net revenues decreased $105 million (5.1%), due primarily to
unfavorable currency movements ($114 million) and lower volume/mix ($61
million), partially offset by higher pricing ($18 million) and the impact of
acquisitions.
Operating companies income for the second quarter of 2002 increased slightly
over the second quarter of 2001. Excluding the 2002 pre-tax charges for
integration costs, operating companies income increased $18 million (6.0%), due
primarily to lower marketing, administration and research costs ($33 million,
including synergy savings and other operating efficiencies), acquisitions and
productivity savings, partially offset by lower volume/mix ($22 million) and
unfavorable currency movements ($8 million).
Volume for the second quarter of 2002 increased 2.2% over the second quarter of
2001. Excluding the impact of divested businesses and after adjusting for the
impact of businesses held for sale (the basis of presentation for all of the
following KFI volume comparisons), volume increased 2.4%.
In Europe, Middle East and Africa, volume increased over the second quarter of
2001, driven by acquisitions and growth in most countries across the region,
partially offset by a decline in Germany. In beverages, volume decreased as
lower coffee shipments were partially offset by growth in refreshment beverages.
Snacks volume increased, driven by higher confectionery volume reflecting new
product introductions and an acquisition of businesses in Russia and Poland,
partially offset by price competition in Germany. Cheese volume increased,
driven by gains in the Middle East and Africa, Spain and the Nordic markets. In
grocery, volume increased due primarily to higher spoonable dressings volume in
Germany, benefiting from new product introductions. Volume for convenient meals
also increased, due primarily to lunch combinations in the United Kingdom and
higher shipments of canned meats in Italy against a weak comparison in 2001.
Volume increased in the Latin America and Asia Pacific region driven by gains in
many markets and the acquisition of a biscuits company in Australia, partially
offset by declines in certain countries due to the impact of weak economies and
lower results in China. Beverages volume increased, due primarily to growth in
powdered beverages in Brazil, Argentina, the Philippines and Venezuela. Cheese
volume decreased, due to lower sales in Latin America and Japan, partially
offset by higher volume in the Philippines and Indonesia. Grocery volume was
lower, due primarily to lower sales in Latin America and Australia. Snacks
volume increased, driven primarily by new product introductions and line
extensions in Brazil, biscuits growth in Indonesia, and an acquisition in
Australia, partially offset by lower volume in Argentina and China.
Beer
Business Environment
On May 30, 2002, the Company announced an agreement with South African Breweries
plc ("SAB") to merge Miller Brewing Company ("Miller") into SAB. The transaction
closed on July 9, 2002 and SAB changed its name to SABMiller plc ("SABMiller").
At closing, the Company received 430 million shares of SABMiller valued at
approximately $3.4 billion, based upon a share price of 5.12 British pounds per
share, in exchange for Miller, which had $2.0 billion of existing debt. The
shares in SABMiller owned by the Company resulted in an initial 36% economic
interest in SABMiller and a 24.9% voting interest. The transaction resulted in
a pre-tax gain of approximately $2.6 billion or approximately $1.7 billion
after-tax. The gain will be recorded in the third quarter of 2002. The Company's
ownership interest in SABMiller will be accounted for under the equity method,
according to which the Company will record its percentage of SABMiller's net
earnings going forward.
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Operating Results
2002 2001
------ ------
(in millions)
Net revenues:
Six months ended June 30, $2,641 $2,464
====== ======
Quarter ended June 30, $1,422 $1,350
====== ======
Operating companies income:
Six months ended June 30, $276 $292
==== ====
Quarter ended June 30, $169 $168
==== ====
Six Months Ended June 30
Net revenues for the first six months of 2002 increased $177 million (7.2%) over
the first six months of 2001, due primarily to higher pricing ($105 million) and
increased contract brewing revenues. Operating companies income for the first
six months of 2002 decreased $16 million (5.5%) from the first six months of
2001, due primarily to pre-tax charges for an asset impairment and a voluntary
retirement program. Excluding the pre-tax charges for an asset impairment and a
voluntary retirement program, operating companies income increased $7 million
(2.4%) to $299 million, due primarily to higher pricing ($58 million) and
increased contract brewing, partially offset by higher marketing, administration
and research costs ($55 million).
Domestic shipment volume of 20.4 million barrels for the first six months of
2002 decreased 0.6% from the first six months of 2001. The majority of Miller's
decrease in domestic shipments was due to lower shipments for both core brands
and lower-priced, non-core brands, partially offset by the 2002 introduction of
Skyy Blue'TM', Stolichnaya Citrona'TM' and Sauza Diablo'TM'.
Three Months Ended June 30
Net revenues for the second quarter of 2002 increased $72 million (5.3%) over
the second quarter of 2001, due primarily to higher pricing ($64 million) and
increased contract brewing revenues, partially offset by lower volume ($22
million). Operating companies income for the second quarter of 2002 increased
slightly over the second quarter of 2001, due primarily to higher pricing ($37
million) and increased contract brewing, partially offset by lower volume ($12
million) and higher marketing, administration and research costs ($25 million).
Domestic shipment volume of 10.9 million barrels for the second quarter of 2002
decreased 2.5% from the second quarter of 2001. The majority of Miller's
decrease in domestic shipments was due to lower shipments for both core brands
and lower-priced, non-core brands, partially offset by the 2002 introduction of
Skyy Blue'TM', Stolichnaya Citrona'TM' and Sauza Diablo'TM'.
Financial Services
Operating Results
2002 2001
------ ------
(in millions)
Net revenues:
Six months ended June 30, $265 $211
==== ====
Quarter ended June 30, $148 $111
==== ====
Operating companies income:
Six months ended June 30, $175 $140
==== ====
Quarter ended June 30, $104 $ 76
==== ====
Philip Morris Capital Corporation's ("PMCC") net revenues and operating
companies income for the first six months of 2002 increased $54 million (25.6%)
and $35 million (25.0%), respectively, over the first six months of 2001. During
the second quarter of 2002, net revenues and operating companies income
increased $37 million (33.3%) and $28 million (36.8%), respectively, over the
second quarter of 2001. These increases were due primarily to growth in leasing
activities and continued gains derived from PMCC's finance asset portfolio,
including a significant gain during the second quarter from the early
termination of a lease.
Financial Review
Net Cash Provided by Operating Activities
During the first six months of 2002, net cash provided by operating activities
was $5.7 billion compared with $4.6 billion during the comparable 2001 period.
The increase is due primarily to higher net earnings.
Net Cash Used in Investing Activities
One element of the growth strategy of the Company's operating subsidiaries
is to strengthen their brand portfolios through active programs of selective
acquisitions and divestitures. The Company's subsidiaries are constantly
investigating potential acquisition candidates and from time to time sell
businesses that are outside their core categories or that do not meet their
growth or profitability targets.
During the first six months of 2002, net cash used in investing activities was
$636 million, compared with $1.3 billion during the first six months of 2001.
The decrease reflects lower levels of cash used for acquisitions in
-44-
2002 and the cash provided by the 2002 divestiture of several North American
food businesses, as well as lower uses of cash by the Company's financial
services business.
Net Cash Used in Financing Activities
During the first six months of 2002, net cash used in financing activities was
$4.3 billion, compared with $3.9 billion during the first six months of 2001.
This difference was due primarily to an increase in cash used during 2002 to
repurchase Philip Morris common stock and to pay dividends on Philip Morris
common stock. During 2002, Miller borrowed $2.0 billion under a one-year bank
term loan agreement, and Kraft issued $2.5 billion of global bonds. These debt
issuances were mostly offset by debt repayments made during 2002. In 2001, the
proceeds from the Kraft IPO were used to repay debt and, as a result, had no net
impact on financing cash flows.
Debt and Liquidity
Debt - The Company's total debt (consumer products and financial services) was
$22.3 billion and $22.1 billion at June 30, 2002 and December 31, 2001,
respectively. Total consumer products debt was $20.3 billion and $20.1 billion
at June 30, 2002 and December 31, 2001, respectively. At June 30, 2002 and
December 31, 2001, the Company's ratio of consumer products debt to total equity
was 0.99 and 1.02, respectively. The ratio of total debt to total equity was
1.09 and 1.13 at June 30, 2002 and December 31, 2001, respectively. In April
2002, Kraft filed a Form S-3 shelf registration statement with the Securities
and Exchange Commission, under which Kraft may sell debt securities and/or
warrants to purchase debt securities in one or more offerings up to a total
amount of $5.0 billion. In May 2002, Kraft issued $2.5 billion of global bonds
under the shelf registration. The bond offering included $1.0 billion of 5-year
notes bearing interest at a rate of 5.25% and $1.5 billion of 10-year notes
bearing interest at a rate of 6.25%. At June 30, 2002, Kraft had $2.5 billion
of capacity remaining under its shelf registration statement. In May 2002,
Miller borrowed $2.0 billion under a one-year bank term loan agreement.
This Miller borrowing was outstanding as of July 9, 2002, the date of the merger
transaction with SAB.
Credit Lines - At June 30, 2002, the Company and its subsidiaries
maintained credit lines with a number of lending institutions amounting to
approximately $16.2 billion. Certain of these credit lines were used to
support $889 million of commercial paper borrowings at June 30, 2002, the
proceeds of which were used for general corporate purposes. A portion of these
lines is also used to meet the short-term working capital needs of the Company's
international businesses. At June 30, 2002, the Company's credit facilities
included $7.0 billion (of which $2.0 billion is for the sole use of Kraft) of
5-year revolving credit facilities expiring in July 2006, and $7.0 billion (of
which $4.0 billion is for the sole use of Kraft) of 364-day revolving credit
facilities expiring in July 2002. During July 2002, the expiring 364-day
revolving credit facilities were replaced by $6.0 billion (of which $3.0 billion
is for the sole use of Kraft) of new 364-day revolving credit facilities
expiring in July 2003. As a result, the amount of existing credit lines has
declined by $1.0 billion to approximately $15.2 billion. The Philip Morris
facilities require the maintenance of a fixed charges coverage ratio and the
Kraft facilities require the maintenance of a minimum net worth. Philip Morris
and Kraft exceeded these covenants at June 30, 2002 and do not currently
anticipate any difficulty in continuing to exceed these covenant requirements.
The foregoing revolving credit facilities do not include any other covenants
that could require an acceleration of maturity or the posting of collateral. The
majority of the Company's remaining lines expire within one year. The 5-year
revolving credit facilities enable the Company to reclassify short-term debt on
a long-term basis. At June 30, 2002, approximately $0.9 billion of short-term
borrowings that the Company intends to refinance were reclassified as long-term
debt, as compared with $3.5 billion at December 31, 2001. The Company expects to
continue to refinance long-term and short-term debt from time to time. The
nature and amount of the Company's long-term and short-term debt and the
proportionate amount of each can be expected to vary as a result of future
business requirements, market conditions and other factors.
-45-
Guarantees - At June 30, 2002, the Company was contingently liable for
guarantees and commitments of $1.1 billion, consisting of the following:
o $0.8 billion of guarantees of excise tax and import duties related to
international shipments of tobacco products. In these agreements, a
bank provides a guarantee of tax payments to respective governments.
PMI then issues a guarantee to the respective banks for the payment of
the taxes. These are revolving facilities that are integral to the
shipment of tobacco products in international markets, and the
underlying taxes payable are recorded on the Company's consolidated
balance sheet.
o $0.2 billion, primarily surety bonds to a non-U.S. governmental
entity, related to capacity expansion commitments at an international
tobacco facility. The surety bonds expire in 2002.
o $0.1 billion, including various guarantees relating to the tobacco and
food businesses.
Although these guarantees are typically short-term in nature, they are expected
to be replaced, upon expiration, with similar guarantees of similar amounts.
Guarantees do not have, and are not expected to have, a significant impact on
the Company's liquidity.
Litigation Escrow Deposits - As discussed in Note 8. Contingencies, on May 7,
2001, the trial court in the Engle class action approved a stipulation and
agreed order among PM Inc., certain other defendants and the plaintiffs
providing that the execution or enforcement of the punitive damages component of
the judgment in that case will remain stayed through the completion of all
judicial review. As a result of the stipulation, PM Inc. placed $500 million
into a separate interest-bearing escrow account that, regardless of the outcome
of the appeal, will be paid to the court and the court will determine how to
allocate or distribute it consistent with the Florida Rules of Civil Procedure.
As a result, a $500 million pre-tax charge was recorded by the domestic tobacco
business during the first quarter of 2001. In July 2001, PM Inc. also placed
$1.2 billion into an interest-bearing escrow account, which will be returned to
PM Inc. should it prevail in its appeal of the case. The $1.2 billion escrow
account is included in the June 30, 2002 and December 31, 2001 consolidated
balance sheets as other assets. Interest income on the $1.2 billion escrow
account is paid to PM Inc. quarterly and is being recorded as earned in interest
and other debt expense, net, in the consolidated statement of earnings.
Tobacco Litigation Settlement Payments - As discussed in Note 8. Contingencies,
PM Inc., along with other domestic tobacco companies, has entered into tobacco
litigation settlement agreements that require the domestic tobacco industry to
make substantial annual payments in the following amounts (excluding future
annual payments contemplated by the agreement with tobacco growers discussed
below), subject to adjustment for several factors, including inflation, market
share and industry volume: 2002, $11.3 billion; 2003, $10.9 billion; 2004
through 2007, $8.4 billion each year; and thereafter, $9.4 billion each year. In
addition, the domestic tobacco industry is required to pay settling plaintiffs'
attorneys' fees, subject to an annual cap of $500 million, as well as an
additional $250 million each year in 2002 and 2003. These payment obligations
are the several and not joint obligations of each settling defendant. PM Inc.'s
portion of ongoing adjusted payments and legal fees is based on its relative
share of the settling manufacturers' domestic cigarette shipments, including
roll-your-own cigarettes, in the year preceding that in which the payment is
due. Accordingly, PM Inc. records its portions of ongoing settlement payments as
part of cost of sales as product is shipped.
As part of the MSA, the settling defendants committed to work cooperatively with
the tobacco-growing states to address concerns about the potential adverse
economic impact of the MSA on tobacco growers and quota-holders. To that end,
four of the major domestic tobacco product manufacturers, including PM Inc., and
the grower states, have established a trust fund to provide aid to tobacco
growers and quota-holders. The trust will be funded by these four manufacturers
over 12 years with payments, prior to application of various adjustments,
scheduled to total $5.15 billion. Future industry payments (in 2002 through
2008, $500 million each year; and 2009 and 2010, $295 million each year) are
subject to adjustment for several factors, including inflation, United States
cigarette volume and certain other contingent events, and, in general, are to be
allocated based on each
-46-
manufacturer's relative market share. PM Inc. records its portion of these
payments as part of cost of sales as product is shipped.
During the six months ended June 30, 2002 and 2001, and the quarters ended June
30, 2002 and 2001, PM Inc. recognized $2.8 billion and $3.1 billion,
respectively, and $1.3 billion and $1.6 billion, respectively, as part of cost
of sales attributable to the foregoing settlement obligations.
As discussed above under "Tobacco--Business Environment," the present
legislative and litigation environment is substantially uncertain and could
result in material adverse consequences for the business, financial condition,
cash flows or results of operations of the Company, PM Inc. and PMI. Assuming
there are no material adverse developments in the legislative and litigation
environment, the Company expects its cash flow from operations and its access to
global capital markets to provide sufficient liquidity to meet the ongoing needs
of the business.
Leveraged Leases - As part of its lease portfolio, PMCC invests in leveraged
leases. At June 30, 2002, PMCC's net finance receivable of $7.1 billion in
leveraged leases, which is included in the Company's consolidated balance sheet
as finance assets, net, is comprised of total lease payments receivable ($26.4
billion) and the residual value of assets under lease ($2.7 billion), reduced by
non-recourse third-party debt ($18.2 billion) and unearned income ($3.8
billion). PMCC has no obligation for the payment of the non-recourse third-party
debt issued to purchase the assets under lease. The payment of the debt is
collateralized only by lease payments receivable and the leased property, and is
non-recourse to all other assets of PMCC or the Company. As required by
accounting principles generally accepted in the United States of America ("U.S.
GAAP"), the non-recourse debt has been offset against the related rentals
receivable and the residual value of the property, and has been presented on a
net basis within finance assets, net, in the Company's consolidated balance
sheet.
PMCC leases aircraft to a number of major U.S. and overseas airlines. On August
11, 2002, US Airways Group Inc. ("US Air") filed for Chapter 11 bankruptcy
protection. PMCC currently leases to US Air 16 Airbus A319 aircraft under long-
term leveraged leases, which expire in 2018 and 2019. The aircraft were leased
in 1998 and 1999 and represent a net finance receivable of $150 million, which
equals 1.8% of PMCC's portfolio of finance assets at June 30, 2002. PMCC is
currently evaluating the effect of the US Air bankruptcy filing and has placed
the leases on non-accrual status pending further developments in the bankruptcy
proceedings.
Equity and Dividends
The Company repurchased 45.0 million and 41.8 million shares of its common stock
during the first six months of 2002 and 2001, respectively, at a cost of $2.3
billion and $2.0 billion, respectively. At June 30, 2002, cumulative repurchases
under its previously announced $10 billion authority totaled 114.6 million
shares at an aggregate cost of $5.6 billion. The Company has announced its
intention to accelerate its rate of share repurchase during the second half of
2002 by utilizing approximately $1.7 billion of cash flow to the Company
resulting from the transfer of the Miller debt as a consequence of the merger of
Miller with SAB in July 2002. Total share repurchases in 2002 are expected to
exceed $6.0 billion.
On June 21, 2002, Kraft's board of directors approved the repurchase from time
to time of up to $500 million of Kraft's Class A common stock solely to satisfy
the obligations of Kraft to provide shares under its 2001 Performance Incentive
Plan, 2001 Compensation Plan for non-employee directors, and other plans where
options to purchase Kraft's Class A common stock are granted to employees of
Kraft. At July 31, 2002, no shares had been repurchased.
Dividends paid in the first six months of 2002 and 2001 were $2.49 billion and
$2.34 billion, respectively, an increase of 6.4%, reflecting a higher dividend
rate in 2002, partially offset by a lower number of shares outstanding as a
result of ongoing share repurchases. During the third quarter of 2001, the
Company's Board of Directors approved a 9.4% increase in the quarterly dividend
rate to $0.58 per share. As a result, the present annualized dividend rate is
$2.32 per share.
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Market Risk
The Company operates globally, with manufacturing and sales facilities in
various locations around the world, and utilizes certain financial instruments
to manage its foreign currency, interest rate and commodity exposures, which
primarily relate to forecasted transactions and debt. Derivative financial
instruments are used by the Company, principally to reduce exposures to market
risks resulting from fluctuations in foreign exchange rates, commodity prices
and interest rates, by creating offsetting exposures. The Company is not a party
to leveraged derivatives. For a derivative to qualify as a hedge at inception
and throughout the hedged period, the Company formally documents the nature and
relationships between the hedging instruments and hedged items, as well as its
risk-management objectives, strategies for undertaking the various hedge
transactions and method of assessing hedge effectiveness. Additionally, for
hedges of forecasted transactions, the significant characteristics and expected
terms of a forecasted transaction must be specifically identified, and it must
be probable that each forecasted transaction will occur. Financial instruments
qualifying for hedge accounting must maintain a specified level of effectiveness
between the hedging instrument and the item being hedged, both at inception and
throughout the hedged period. The Company does not use derivative financial
instruments for speculative purposes.
Substantially all of the Company's derivative financial instruments are
effective as hedges under U.S. GAAP. Accordingly, the Company increased
accumulated other comprehensive losses by $127 million during the first six
months of 2002. This reflects a decrease in the fair value of derivatives of
$206 million, partially offset by deferred losses transferred to earnings of $79
million. For the three months ended June 30, 2002, the Company increased
accumulated other comprehensive losses by $169 million. This reflects deferred
gains transferred to earnings of $13 million and a decrease in the fair value of
derivatives of $156 million. The fair value of all derivative financial
instruments has been calculated based on active market quotes.
Foreign exchange rates. The Company uses forward foreign exchange contracts and
foreign currency options to mitigate its exposure to changes in exchange rates
from third-party and intercompany forecasted transactions. The primary
currencies to which the Company is exposed include the Japanese yen, Swiss franc
and the euro. At June 30, 2002 and December 31, 2001, the Company had option and
forward foreign exchange contracts with aggregate notional amounts of $8.9
billion and $3.7 billion, respectively, for the purchase or sale of foreign
currencies. The Company uses foreign currency swaps to mitigate its exposure to
changes in exchange rates related to foreign currency denominated debt. These
swaps typically convert fixed-rate foreign currency denominated debt to
fixed-rate debt denominated in the functional currency of the borrowing entity.
Foreign currency swap agreements are accounted for as cash flow hedges. At June
30, 2002 and December 31, 2001, the notional amounts of foreign currency swap
agreements aggregated $2.5 billion and $2.3 billion, respectively.
The Company also uses certain foreign currency denominated debt as net
investment hedges of foreign operations. At June 30, 2002, a loss of $113
million, net of income taxes of $60 million, which represented effective hedges
of net investments, was reported as a component of accumulated other
comprehensive earnings (losses) within currency translation adjustments.
Commodities. The Company is exposed to price risk related to forecasted
purchases of certain commodities used as raw materials by the Company's
businesses. Accordingly, the Company uses commodity forward contracts, as cash
flow hedges, primarily for coffee, cocoa, milk, cheese and wheat. Commodity
futures and options are also used to hedge the price of certain commodities,
including milk, coffee, cocoa, wheat, corn, sugar and soybean oil. At June 30,
2002 and December 31, 2001, the Company had net long commodity positions of $527
million and $589 million, respectively.
Interest rates. The Company uses interest rate swaps to hedge the fair value of
an insignificant portion of its long-term debt. The differential to be paid or
received is accrued and recognized as interest expense. If an interest rate swap
agreement is terminated prior to maturity, the realized gain or loss is
recognized over the remaining life of the agreement if the hedged amount remains
outstanding, or immediately if the underlying hedged exposure does not remain
outstanding. If the underlying exposure is terminated prior to the maturity of
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the interest rate swap, the unrealized gain or loss on the related interest rate
swap is recognized in earnings currently. During the six months ended June 30,
2002, there was no ineffectiveness relating to these fair value hedges. At June
30, 2002, the Company had interest rate swap agreements that converted $102
million of fixed-rate debt to variable-rate debt, of which $29 million will
mature in 2003 and $73 million will mature in 2004.
----------
Use of the above-mentioned financial instruments has not had a material impact
on the Company's financial position at June 30, 2002 and December 31, 2001, or
the Company's results of operations for the three months ended June 30, 2002 or
the year ended December 31, 2001.
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Contingencies
See Note 8 to the Condensed Consolidated Financial Statements for a discussion
of contingencies.
New Accounting Standards
On July 30, 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Costs covered by SFAS No. 146 include lease termination
costs and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing or other exit or disposal
activity. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. Accordingly, the Company will apply the
provisions of SFAS No. 146 prospectively to exit or disposal activities
initiated after December 31, 2002.
On January 1, 2002, the Company adopted SFAS No. 141, "Business Combinations"
and SFAS No. 142, "Goodwill and Other Intangible Assets." As a result, the
Company stopped recording the amortization of goodwill and indefinite life
intangible assets as a charge to earnings as of January 1, 2002. The Company
estimates that net earnings and diluted EPS would have been approximately $4.6
billion and $2.05, respectively, for the six months ended June 30, 2001, and
approximately $2.5 billion and $1.14, respectively, for the three months ended
June 30, 2001, had the provisions of the new standards been applied as of
January 1, 2001. In addition, the Company is required to conduct an annual
review of goodwill and intangible assets for potential impairment. The Company
completed its review and did not have to record a charge to earnings for an
impairment of goodwill or other intangible assets as a result of these new
standards.
Effective January 1, 2002, the Company also adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed Of." SFAS No. 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets, expands the scope of a discontinued operation to include a
component of an entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. The adoption of this new
standard did not have a material impact on the Company's financial position,
results of operations or cash flows.
Effective January 1, 2002, the Company adopted Emerging Issues Task Force
("EITF") Issue No. 00-14, "Accounting for Certain Sales Incentives" and EITF
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendor's Products." The adoption of EITF Issues No. 00-14
and No. 00-25 resulted in a reduction of revenues of approximately $4.8 billion
and $2.4 billion in the first six months and the second quarter of 2001,
respectively. In addition, the adoption reduced marketing, administration and
research costs in the first six months and the second quarter of 2001 by
approximately $5.2 billion and $2.6 billion, respectively. Cost of sales
increased in the first six months and the second quarter of 2001 by
approximately $307 million and $162 million, respectively, and excise taxes on
products increased by
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approximately $114 million and $58 million, respectively. The adoption of these
EITF Issues had no impact on net earnings or basic and diluted EPS.
Forward-Looking and Cautionary Statements
The Company and its representatives may from time to time make written or oral
forward-looking statements, including statements contained in the Company's
filings with the Securities and Exchange Commission and in its reports to
stockholders, including this Quarterly Report on Form 10-Q. One can identify
these forward-looking statements by use of words such as "strategy," "expects,"
"continues," "plans," "anticipates," "believes," "will," "estimates," "intends,"
"projects," "goals," "targets" and other words of similar meaning. One can also
identify them by the fact that they do not relate strictly to historical or
current facts. In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company is hereby identifying
important factors that could cause actual results and outcomes to differ
materially from those contained in any forward-looking statement made by or on
behalf of the Company; any such statement is qualified by reference to the
following cautionary statements.
The tobacco industry continues to be subject to health concerns relating to the
use of tobacco products and exposure to ETS; legislation, including actual and
potential excise tax increases; increasing marketing and regulatory
restrictions; governmental regulation; privately imposed smoking restrictions;
governmental and grand jury investigations; litigation, including risks
associated with adverse jury and judicial determinations, courts reaching
conclusions at variance with the Company's understanding of applicable law,
bonding requirements and the absence of adequate appellate remedies to get
timely relief from any of the foregoing; and the effects of price increases
related to excise tax increases and concluded tobacco litigation settlements
on consumption rates and consumer preferences within price segments. The food
industry continues to be subject to recalls if products become adulterated or
misbranded; liability if product consumption causes injury; ingredient
disclosure and labeling laws and regulations; and the possibility that consumers
could lose confidence in the safety and quality of certain food products. Each
of the Company's consumer products subsidiaries is subject to intense
competition, changes in consumer preferences and local economic conditions.
Their results are dependent upon their continued ability to promote brand equity
successfully; to anticipate and respond to new consumer trends; to develop new
products and markets and to broaden brand portfolios in order to compete
effectively with lower priced products in a consolidating environment at the
retail and manufacturing levels; to improve productivity; and to respond to
changing prices for their raw materials. In addition, PMI, KFI and KFNA are
subject to the effects of foreign economies and the related shifts in consumer
preferences, currency movements and fluctuations in levels of customer
inventories. Developments in any of these areas, which are more fully described
above and which descriptions are incorporated into this section by reference,
could cause the Company's results to differ materially from results that have
been or may be projected by or on behalf of the Company. The Company cautions
that the foregoing list of important factors is not exclusive. The Company does
not undertake to update any forward-looking statement that may be made from time
to time by or on behalf of the Company.
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Part II - OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 8. Contingencies, of the Notes to the Condensed Consolidated
Financial Statements included in Part I, Item 1 of this report for a discussion
of legal proceedings pending against the Company and its subsidiaries. See also
Exhibits 99.1 and 99.2 to this report.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Agreement between the Company and William H. Webb.
10.2 Agreement among the Company, PM Inc. and Michael E. Szymanczyk.
12 Statement regarding computation of ratios of earnings to fixed
charges.
99.1 Certain Pending Litigation Matters and Recent Developments.
99.2 Trial Schedule for Certain Cases.
(b) Reports on Form 8-K. The Registrant filed Current Reports on Form 8-K
on May 30, 2002 and June 11, 2002, each of which covered Item 5 (Other
Events), and related to an agreement with South African Breweries plc
("SAB") to merge Miller Brewing Company with a wholly-owned subsidiary
of SAB.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHILIP MORRIS COMPANIES INC.
/s/ DINYAR S. DEVITRE
Dinyar S. Devitre, Senior Vice President and
Chief Financial Officer
August 13, 2002
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