May 15, 2003UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,Washington, D.C. 20549
FORM 10-Q
(Mark(Mark One)
(X)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended
September 30, 2002March 31, 2003OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto Commission file number 1-8940
Philip Morris CompaniesAltria Group, Inc.
- -------------------------------------------------------------------------------- (Exact(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
Virginia
13-3260245
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
120 Park Avenue, New York, New York
10017
(Address of principal executive offices)
(Zip Code)
(917) 663-4000
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
Xx No------ ------¨Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No ¨
At
October 31, 2002,April 30, 2003, there were2,068,629,2702,024,843,316 shares outstanding of theregistrant'sregistrant’s common stock, par value $0.331/1/3 per share.PHILIP MORRIS COMPANIESALTRIA GROUP, INC.
TABLE OF CONTENTS
Page No.
PART
I -I—FINANCIAL INFORMATIONItem 1.
Financial Statements (Unaudited)
3-4
5
6
7-8
Notes to Condensed Consolidated Financial Statements
10 - 289-29
Item 2.
Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations
29 - 5530-53
Item 4.
54
PART
II -II—OTHER INFORMATIONItem 1.
55
Item
5. Other Information 574.55-56
Item 6.
56
57
Signature 5858-59
-2-
PART
I -I—FINANCIAL INFORMATIONItem 1. Financial Statements.
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in(in millions of dollars)
(Unaudited)
September 30, December 31, 2002 2001 ------------ -----------ASSETS Consumer products Cash and cash equivalents $ 455 $ 453 Receivables (less allowances of $135 and $193) 5,030 5,148 Inventories: Leaf tobacco 3,624 3,827 Other raw materials 2,077 1,909 Finished product 3,630 3,187 ------- ------- 9,331 8,923 Other current assets 2,295 2,751 ------- ------- Total current assets 17,111 17,275 Property, plant and equipment, at cost 24,050 25,625 Less accumulated depreciation 9,487 10,488 ------- ------- 14,563 15,137 Goodwill and other intangible assets, net 37,568 37,548 Other assets 7,992 6,144 ------- ------- Total consumer products assets 77,234 76,104 Financial services Finance assets, net 8,590 8,691 Other assets 161 173 ------- ------- Total financial services assets 8,751 8,864 ------- ------- TOTAL ASSETS $85,985 $84,968 ======= =======
March 31,
2003
December 31,
2002
ASSETS
Consumer products
Cash and cash equivalents
$
1,391
$
565
Receivables (less allowances of $140 and $142)
5,465
5,139
Inventories:
Leaf tobacco
3,421
3,605
Other raw materials
2,109
1,935
Finished product
3,917
3,587
9,447
9,127
Other current assets
2,888
2,610
Total current assets
19,191
17,441
Property, plant and equipment, at cost
25,338
24,553
Less accumulated depreciation
10,237
9,707
15,101
14,846
Goodwill and other intangible assets, net
38,109
37,871
Other assets
8,606
8,151
Total consumer products assets
81,007
78,309
Financial services
Finance assets, net
8,751
9,075
Other assets
142
156
Total financial services assets
8,893
9,231
TOTAL ASSETS
$
89,900
$
87,540
See notes to condensed consolidated financial statements.
Continued
-3-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in(in millions of dollars, except per share data)
(Unaudited)
September 30, December 31, 2002 2001 ------------ -----------LIABILITIES Consumer products Short-term borrowings $ 434 $ 997 Current portion of long-term debt 870 1,942 Accounts payable 2,739 3,600 Accrued liabilities: Marketing 2,894 2,794 Taxes, except income taxes 1,748 1,654 Employment costs 980 1,192 Settlement charges 4,020 3,210 Other 2,684 2,480 Income taxes 1,936 1,021 Dividends payable 1,340 1,251 ------- ------- Total current liabilities 19,645 20,141 Long-term debt 16,274 17,159 Deferred income taxes 5,735 5,238 Accrued postretirement health care costs 3,100 3,315 Minority interest 4,235 4,013 Other liabilities 7,767 7,796 ------- ------- Total consumer products liabilities 56,756 57,662 Financial services Short-term borrowings 512 Long-term debt 2,112 1,492 Deferred income taxes 5,417 5,246 Other liabilities 355 436 ------- ------- Total financial services liabilities 7,884 7,686 ------- ------- Total liabilities 64,640 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 4,658 4,503 Earnings reinvested in the business 42,796 37,269 Accumulated other comprehensive losses (including currency translation of $3,087 and $3,238) (3,276) (3,373) ------- ------- 45,113 39,334 Less cost of repurchased stock (726,258,871 and 653,458,100 shares) (23,768) (19,714) ------- ------- Total stockholders' equity 21,345 19,620 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $85,985 $84,968 ======= =======
March 31,
2003
December 31, 2002
LIABILITIES
Consumer products
Short-term borrowings
$
1,026
$
407
Current portion of long-term debt
905
1,558
Accounts payable
2,726
3,088
Accrued liabilities:
Marketing
2,622
3,192
Taxes, except income taxes
2,075
1,735
Employment costs
779
1,099
Settlement charges
3,883
3,027
Other
2,462
2,563
Income taxes
2,075
1,103
Dividends payable
1,300
1,310
Total current liabilities
19,853
19,082
Long-term debt
20,782
19,189
Deferred income taxes
6,092
6,112
Accrued postretirement health care costs
3,136
3,128
Minority interest
4,445
4,366
Other liabilities
7,574
8,004
Total consumer products liabilities
61,882
59,881
Financial services
Long-term debt
2,126
2,166
Deferred income taxes
5,516
5,521
Other liabilities
227
494
Total financial services liabilities
7,869
8,181
Total liabilities
69,751
68,062
Contingencies (Note 10)
STOCKHOLDERS’ EQUITY
Common stock, par value $0.33 1/3 per share (2,805,961,317 shares issued)
935
935
Additional paid-in capital
4,776
4,642
Earnings reinvested in the business
44,016
43,259
Accumulated other comprehensive losses (including currency translation of $2,636 and $2,951)
(3,614
)
(3,956
)
46,113
44,880
Less cost of repurchased stock (781,410,558 and 766,701,765 shares)
(25,964
)
(25,402
)
Total stockholders’ equity
20,149
19,478
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
89,900
$
87,540
See notes to condensed consolidated financial statements.
-4-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in(in millions of dollars, except per share data)
(Unaudited)
For the Nine Months Ended September 30, ------------------------- 2002 2001 -------- --------Net revenues $61,634 $60,997 Cost of sales 24,707 25,430 Excise taxes on products 13,916 13,160 ------- ------- Gross profit 23,011 22,407 Marketing, administration and research costs 9,650 9,371 Litigation related expense 500 Amortization of intangibles 5 758 ------- ------- Operating income 13,356 11,778 Gain on Miller Brewing Company transaction (2,653) Interest and other debt expense, net 881 1,165 ------- ------- Earnings before income taxes, minority interest and cumulative effect of accounting change 15,128 10,613 Provision for income taxes 5,370 4,018 ------- ------- Earnings before minority interest and cumulative effect of accounting change 9,758 6,595 Minority interest in earnings and other, net 424 193 ------- ------- Earnings before cumulative effect of accounting change 9,334 6,402 Cumulative effect of accounting change (6) ------- ------- Net earnings $ 9,334 $ 6,396 ======= ======= Per share data: Basic earnings per share before cumulative effect of accounting change $ 4.39 $ 2.92 Cumulative effect of accounting change ------- ------- Basic earnings per share $ 4.39 $ 2.92 ======= ======= Diluted earnings per share before cumulative effect of accounting change $ 4.34 $ 2.89 Cumulative effect of accounting change (0.01) ------- ------- Diluted earnings per share $ 4.34 $ 2.88 ======= ======= Dividends declared $ 1.80 $ 1.64 ======= =======
For the Three Months Ended
March 31,
2003
2002
Net revenues
$
19,371
$
20,535
Cost of sales
7,565
8,532
Excise taxes on products
4,887
4,575
Gross profit
6,919
7,428
Marketing, administration and research costs
3,053
3,063
Integration costs
27
Separation programs and asset impairment
165
Amortization of intangibles
2
2
Operating income
3,864
4,171
Interest and other debt expense, net
283
293
Earnings before income taxes and minority interest
3,581
3,878
Provision for income taxes
1,261
1,376
Earnings before minority interest
2,320
2,502
Minority interest in earnings and other, net
134
137
Net earnings
$
2,186
$
2,365
Per share data:
Basic earnings per share
$
1.08
$
1.10
Diluted earnings per share
$
1.07
$
1.09
Dividends declared
$
0.64
$
0.58
See notes to condensed consolidated financial statements.
-5-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of
Earnings (inStockholders’ Equityfor the Year Ended December 31, 2002 and
the Three Months Ended March 31, 2003
(in millions of dollars, except per share data)
(Unaudited)
For the Three Months Ended September 30, -------------------------- 2002 2001 -------- --------Net revenues $19,996 $20,249 Cost of sales 7,674 8,299 Excise taxes on products 4,758 4,350 ------- ------- Gross profit 7,564 7,600 Marketing, administration and research costs 3,005 3,141 Amortization of intangibles 1 252 ------- ------- Operating income 4,558 4,207 Gain on Miller Brewing Company transaction (2,653) Interest and other debt expense, net 279 276 ------- ------- Earnings before income taxes and minority interest 6,932 3,931 Provision for income taxes 2,461 1,492 ------- ------- Earnings before minority interest 4,471 2,439 Minority interest in earnings and other, net 112 111 ------- ------- Net earnings $ 4,359 $ 2,328 ======= ======= Per share data: Basic earnings per share $ 2.07 $ 1.07 ======= ======= Diluted earnings per share $ 2.06 $ 1.06 ======= ======= Dividends declared $ 0.64 $ 0.58 ======= =======
Accumulated Other
Comprehensive Earnings (Losses)
Common Stock
Addi-
tional
Paid-in Capital
Earnings Reinvested in the Business
Currency Translation Adjustments
Other
Total
Cost of Repurchased Stock
Total Stock-
holders’ Equity
Balances, January 1, 2002
$
935
$
4,503
$
37,269
$
(3,238
)
$
(135
)
$
(3,373
)
$
(19,714
)
$
19,620
Comprehensive earnings:
Net earnings
11,102
11,102
Other comprehensive earnings (losses), net of income taxes:
Currency translation adjustments
287
287
287
Additional minimum pension liability
(760
)
(760
)
(760
)
Change in fair value of derivatives accounted for as hedges
(110
)
(110
)
(110
)
Total other comprehensive losses
(583
)
Total comprehensive earnings
10,519
Exercise of stock options and issuance of other stock awards
139
15
563
717
Cash dividends declared ($2.44 per share)
(5,127
)
(5,127
)
Stock repurchased
(6,251
)
(6,251
)
Balances, December 31, 2002
935
4,642
43,259
(2,951
)
(1,005
)
(3,956
)
(25,402
)
19,478
Comprehensive earnings:
Net earnings
2,186
2,186
Other comprehensive earnings (losses), net of income taxes:
Currency translation adjustments
315
315
315
Additional minimum pension liability
(3
)
(3
)
(3
)
Change in fair value of derivatives accounted for as hedges
30
30
30
Total other comprehensive earnings
342
Total comprehensive earnings
2,528
Exercise of stock options and
issuance of other stock awards
134
(130
)
127
131
Cash dividends declared ($0.64 per share)
(1,299
)
(1,299
)
Stock repurchased
(689
)
(689
)
Balances, March 31, 2003
$
935
$
4,776
$
44,016
$
(2,636
)
$
(978
)
$
(3,614
)
$
(25,964
)
$
20,149
Total comprehensive earnings were $2,153 million for the quarter ended March 31, 2002.
See notes to condensed consolidated financial statements.
-6-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of
Stockholders' Equity for the Year Ended December 31, 2001 and the Nine Months Ended September 30, 2002 (inCash Flows(in millions of
dollars, except per share data)dollars)(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 9,334 9,334 Other comprehensive earnings, net of income taxes: Currency translation adjustments 151 151 151 Additional minimum pension liability 18 18 18 Change in fair value of derivatives accounted for as hedges (72) (72) (72) ------- Total other comprehensive earnings 97 ------- Total comprehensive earnings 9,431 Exercise of stock options and ------- issuance of other stock awards 155 11 549 715 Cash dividends declared ($1.80 per share) (3,818) (3,818) Stock repurchased (4,603) (4,603) ---- ------ ------- ------- ----- ------- -------- ------- Balances, September 30, 2002 $935 $4,658 $42,796 $(3,087) $(189) $(3,276) $(23,768) $21,345 ==== ====== ======= ======= ===== ======= ======== =======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 $4,348 million and $2,368 million, respectively, for the quarters ended September 30, 2002 and 2001, and $5,899 million for the first nine months of 2001.
For the Three Months
Ended
March 31,
2003
2002
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net earnings —Consumer products
$
2,130
$
2,322
—Financial services
56
43
Net earnings
2,186
2,365
Adjustments to reconcile net earnings to operating cash flows:
Consumer products
Depreciation and amortization
341
334
Deferred income tax (benefit) provision
(162
)
736
Minority interest in earnings and other, net
134
137
Integration costs
27
Separation programs and asset impairments
165
Cash effects of changes, net of the effects from acquired and divested companies:
Receivables, net
(271
)
(192
)
Inventories
(187
)
66
Accounts payable
(420
)
(887
)
Income taxes
970
22
Accrued liabilities and other current assets
(797
)
(321
)
Settlement charges
856
(1,477
)
Pension plan contributions
(678
)
(36
)
Other
87
56
Financial services
Deferred income tax benefit
(5
)
(15
)
Other
119
120
Net cash provided by operating activities
2,173
1,100
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Consumer products
Capital expenditures
(423
)
(364
)
Purchases of businesses, net of acquired cash
(5
)
(62
)
Proceeds from sales of businesses
81
Other
13
11
Financial services
Investments in finance assets
(109
)
(61
)
Proceeds from finance assets
80
105
Net cash used in investing activities
(444
)
(290
)
See notes to condensed consolidated financial statements.
Continued
-7-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in(Continued)(in millions of dollars)
(Unaudited)
For the Nine Months Ended September 30, ------------------------------- 2002 2001 --------- ---------CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net earnings - Consumer products $ 9,180 $ 6,267 - Financial services 154 129 ------- ------- Net earnings 9,334 6,396 Adjustments to reconcile net earnings to operating cash flows: Consumer products Cumulative effect of accounting change 6 Depreciation and amortization 976 1,724 Deferred income tax provision 1,024 229 Minority interest in Kraft Foods Inc. 396 110 Loss on sale of a North American food factory and integration costs 119 66 Escrow bond for domestic tobacco litigation (1,200) Separation programs and asset impairments 223 Gain on Miller Brewing Company transaction (2,653) Gains on sales of businesses (3) (8) Cash effects of changes, net of the effects from acquired and divested companies: Receivables, net (371) (441) Inventories (262) (346) Accounts payable (725) (1,068) Income taxes 1,091 1,932 Accrued liabilities and other current assets 821 744 Other (357) (456) Financial services Deferred income tax provision 171 198 Other 148 (4) ------- ------- Net cash provided by operating activities 9,932 7,882 ------- ------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES Consumer products Capital expenditures (1,349) (1,219) Purchases of businesses, net of acquired cash (132) (364) Proceeds from sales of businesses 86 9 Other 87 145 Financial services Investments in finance assets (443) (511) Proceeds from finance assets 314 216 ------- ------- Net cash used in investing activities (1,437) (1,724) ------- -------
For the Three Months Ended
March 31,
2003
2002
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
Consumer products
Net issuance of short-term borrowings
$
2,085
$
2,043
Long-term debt proceeds
18
13
Long-term debt repaid
(675
)
(738
)
Financial services
Net repayment of short-term borrowings
(512
)
Long-term debt proceeds
440
Long-term debt repaid
(144
)
Repurchase of Altria Group, Inc. common stock
(777
)
(1,087
)
Repurchase of Kraft Foods Inc. common stock
(79
)
Dividends paid on Altria Group, Inc. common stock
(1,309
)
(1,248
)
Issuance of Altria Group, Inc. common stock
52
306
Other
(104
)
(74
)
Net cash used in financing activities
(933
)
(857
)
Effect of exchange rate changes on cash and cash equivalents
30
(23
)
Cash and cash equivalents:
Increase (decrease)
826
(70
)
Balance at beginning of period
565
453
Balance at end of period
$
1,391
$
383
See notes to condensed consolidated financial statements.
Continued-8-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued) (in millions of dollars) (Unaudited)
For the Nine Months Ended September 30, ---------------------------- 2002 2001 -------- --------CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES Consumer products Net repayment of short-term borrowings $(3,442) $(6,991) Long-term debt proceeds 4,555 68 Long-term debt repaid (1,841) (2,186) Financial services Net repayment of short-term borrowings (512) (624) Long-term debt proceeds 440 557 Repurchase of Philip Morris common stock (4,545) (2,952) Repurchase of Kraft Foods Inc. common stock (77) Dividends paid on Philip Morris common stock (3,729) (3,504) Issuance of Philip Morris common stock 715 662 Issuance of Kraft Foods Inc. common stock 8,435 Other (161) (131) ------- ------- Net cash used in financing activities (8,597) (6,666) ------- ------- Effect of exchange rate changes on cash and cash equivalents 104 30 ------- ------- Cash and cash equivalents: Increase (decrease) 2 (478) Balance at beginning of period 453 937 ------- ------- Balance at end of period $ 455 $ 459 ======= =======See notes to condensed consolidated financial statements. -9-Philip Morris Companies Inc. and SubsidiariesNotes 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 theCompany'sname of the parent company from Philip Morris Companies Inc. to Altria Group, Inc. (“ALG”). TheCompany's Board of Directors retains the discretion to effect thename changeand the Company currently anticipates doing so in the first quarter ofbecame effective on January 27, 2003.Note 2. Accounting Policies:
- -----------------------------Basis of Presentation
The interim condensed consolidated financial statements of
the CompanyAltria Group, Inc. and subsidiaries (“Altria Group, Inc.”) are unaudited. It is the opinion ofthe Company'sAltria Group, Inc.’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'smanagement’s discussion and analysis of financial condition and results of operations, which appear inthe Company'sAltria Group, Inc.’s Annual Report to Stockholders and which are incorporated by reference intothe Company'sAltria Group, Inc.’s Annual Report on Form 10-K for the year ended December 31,20012002 (the"2001“2002 Form10-K"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.year’s presentation, due primarily to the disclosure of more detailed information on the condensed consolidated statements of earnings and the condensed consolidated statements of cash flows.Stock-Based Compensation Expense
Altria Group, Inc. accounts for employee stock compensation plans in accordance with the intrinsic value-based method permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” which does not result in compensation cost for stock options. The market value of restricted stock at date of grant is recorded as compensation expense over the period of restriction.
In January 2003, Altria Group, Inc. granted approximately 2.3 million shares of restricted stock to eligible U.S.-based employees of Altria Group, Inc. and also issued to eligible non-U.S. employees rights to receive approximately 1.5 million equivalent shares. In addition, Kraft Foods Inc. (“Kraft”) granted approximately 3.7 million Class A shares to eligible U.S.-based employees and issued rights to receive approximately 1.6 million Class A equivalent shares to eligible non-U.S. employees. Restrictions on the shares lapse in the first quarter of 2006. During the quarters ended March 31, 2003 and March 31, 2002, Altria Group, Inc.’s consolidated financial statements reflect compensation expense related to restricted stock awards of $17 million (including $9 million related to Kraft awards) and $5 million, respectively.
-9-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
At March 31, 2003, Altria Group, Inc. had stock-based employee compensation plans. Altria Group, Inc. applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for those plans. No compensation expense for employee stock options is reflected in net earnings, as all options granted under those plans had an exercise price not less than the market value of the common stock on the date of the grant. Net earnings, as reported, includes the after-tax impact of compensation expense related to restricted stock. The following table illustrates the effect on net earnings and earnings per share (“EPS”) if Altria Group, Inc. had applied the fair value recognition provisions of SFAS No. 123 to measure stock-based compensation expense for the quarters ended March 31, 2003 and March 31, 2002 (in millions, except per share data):
2003
2002
Net earnings, as reported
$
2,186
$
2,365
Deduct:
Total stock-based employee compensation expense determined under fair value method for all stock option awards, net of related tax effects
13
42
Pro forma net earnings
$
2,173
$
2,323
Earnings per share:
Basic—as reported
$
1.08
$
1.10
Basic—pro forma
$
1.07
$
1.08
Diluted—as reported
$
1.07
$
1.09
Diluted—pro forma
$
1.07
$
1.07
Note 3. Recently Adopted Accounting Standards:
- ----------------------------------------------- OnEffective January 1,
2002,2003, Altria Group, Inc. adopted SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at theCompanydate 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. The adoption of SFAS No. 146 did not have a material impact on Altria Group, Inc.’s consolidated financial position, results of operations or cash flows for the period ended March 31, 2003.Effective January 1, 2003, Altria Group, Inc. adopted
Statement ofFinancial Accounting Standards("SFAS"Board (“FASB”) Interpretation No.141, "Business Combinations"45, “Guarantor’s Accounting andSFASDisclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Interpretation No.142, "Goodwill and Other Intangible Assets." As45 required the disclosure of certain guarantees existing at December 31, 2002. In addition, Interpretation No. 45 required the recognition of aresult,liability for theCompany stopped recordingfair value of theamortizationobligation ofgoodwill and indefinite life intangible assets as a chargequalifying guarantee activities that are initiated or modified after December 31, 2002. Accordingly, Altria Group, Inc. has applied the recognition provisions of Interpretation No. 45 toearningsguarantee activities initiated after December 31, 2002. Adoption of Interpretation No. 45 as of January 1,2002. The Company estimates that net earnings and diluted earnings per share ("EPS") would have been as follows for 2001 had the provisions of the new standards been applied as of January 1, 2001:
Nine Months Ended Three Months Ended September 30, 2001 September 30, 2001 ------------------ ------------------ (in millions, except per share data)Net earnings, as previously reported $6,396 $2,328 Adjustment for amortization of goodwill 752 250 ------ ------ Net earnings, as adjusted $7,148 $2,578 ====== ====== Diluted EPS, as previously reported $2.88 $1.06 Adjustment for amortization of goodwill 0.34 0.11 ----- ----- Diluted EPS, as adjusted $3.22 $1.17 ===== =====In addition, the Company is required to conduct an annual review of goodwill and intangible assets for potential impairment. The Company completed its review and2003 did not have a material impact on Altria Group, Inc.’s consolidated financial statements. See Note 10.Contingencies for a further discussion of guarantees.In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” Interpretation No. 46 requires a variable interest entity to
recordbe consolidated by achargecompany if that company is subject toearningsa majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual return or both. Interpretation No. 46 also provides criteria for determining whether animpairment of goodwill or other intangible assets asentity is aresult of these new standards.variable interest entity subject to consolidation. Interpretation No. 46 requires immediate-10-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
At September 30, 2002, goodwillconsolidation of variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, consolidation is required on July 1, 2003. ALG’s financial services subsidiary, Philip Morris Capital Corporation (“PMCC”), uses various legal entity formations, such as owner trusts, grantor trusts, limited liability companies and partnerships to purchase and hold assets, which are leased to third parties. Most of these entities have historically been and are currently consolidated entities of PMCC. Altria Group, Inc. is currently evaluating the impact, if any, of adoption of the provisions of Interpretation No. 46 on July 1, 2003. However, Altria Group, Inc. does not currently expect the adoption of Interpretation No. 46 to have a material impact on its consolidated financial statements.
Note 4. Goodwill and Other Intangible Assets, net:
Goodwill by segment was as follows (in millions):
International tobacco $ 899 North American food 20,655 International food 4,193 ------- Total goodwill $25,747 =======
March 31,
2003
December 31, 2002
International tobacco
$
1,000
$
981
North American food
20,768
20,722
International food
4,512
4,334
Total goodwill
$
26,280
$
26,037
Intangible assets
as of September 30, 2002were as follows:
Gross Carrying Accumulated Amount Amortization ------ ------------ (in millions)Non-amortizable intangible assets $11,793 Amortizable intangible assets 55 $27 ------- --- Total intangible assets $11,848 $27 ======= ===
March 31, 2003
December 31, 2002
Gross
Carrying Amount
Accumulated Amortization
Gross Carrying Amount
Accumulated Amortization
(in millions)
(in millions)
Non-amortizable intangible assets
$
11,794
$
11,810
Amortizable intangible assets
67
$
32
54
$
30
Total intangible assets
$
11,861
$
32
$
11,864
$
30
Non-amortizable intangible assets are substantially
comprisecomprised of brand names purchased through the Nabisco acquisition. Amortizable intangible assets consist primarily of certain trademark licenses and non-compete agreements.The pre-taxPre-tax amortization expense for intangible assets during thenine months andquarter endedSeptember 30, 2002March 31, 2003 was$5 million and $1 million, respectively.$2 million. Based upon the amortizable intangible assets recorded on the balance sheet as ofSeptember 30, 2002,March 31, 2003, 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
September 30, 2002March 31, 2003 from December 31,20012002 of$20$238 million is due primarily to currencytranslation, partially offset by the impact of the Miller Brewing Company ("Miller") transaction discussed more fully intranslation.Note 5.
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 $7.0 billion and $2.2 billion in the first nine months and the third quarter of 2001, respectively. In addition, the adoption reduced marketing, administration and research costs in the first nine months and the third quarter of 2001 by approximately $7.6 billion and $2.4 billion, respectively. Cost of sales increased in the first nine months and the third quarter of 2001 by approximately $467 million and $160 million, respectively, and excise taxes on products increased by approximately $171 million and $57 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 -11-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) 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
nine months andthree months endedSeptember 30,March 31, 2003 and 2002,and 2001,ineffectiveness related to fair value hedges and cash flow hedges was not material.The CompanyAltria Group, Inc. is hedging forecasted transactions for periods not exceeding the nextsixteentwenty-two months. AtSeptember 30, 2002, the CompanyMarch 31, 2003, Altria Group, Inc. estimates derivativegainslosses of$3$51 million, net of income taxes, reported in accumulated other comprehensivelossesearnings (losses) will be reclassified to the consolidated statement of earnings within the next twelve months.Within currency translation adjustments at
September 30,March 31, 2003 and 2002,and 2001, the CompanyAltria Group, Inc. recorded a loss of$127$65 million, net of income taxes,of $68 million,and alossgain of$26$1 million, net of income taxes,of $14 million,respectively, which represented effective hedges of net investments.-11-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Hedging activity affected accumulated other comprehensive
losses,earnings (losses), net of income taxes, as follows:
For the Nine Months Ended For the Three Months Ended September 30, September 30, ------------------------- -------------------------- 2002 2001 2002 2001 ------ ------ ------ ------ (in millions) (in millions)Gain (loss) at beginning of period $ 33 $ - $(94) $ (4) Impact of SFAS No. 133 adoption 15 Derivative losses (gains) transferred to earnings 71 (69) (8) (17) Change in fair value (143) (4) 63 (37) ----- ---- ---- ---- Loss as of September 30 $ (39) $(58) $(39) $(58) ===== ==== ==== ====
For the Three Months Ended
March 31,
2003
2002
(in millions)
(Loss) gain at beginning of period
$
(77
)
$
33
Derivative losses transferred to earnings
2
92
Change in fair value
28
(50
)
(Loss) gain as of March 31
$
(47
)
$
75
Note
5. Acquisitions and Divestitures: - ---------------------------------------6. Miller Brewing Company Transaction:On May 30, 2002,
the CompanyALG announced an agreement with South African Breweries plc("SAB"(“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"(“SABMiller”). At closing,the CompanyALG 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 bythe CompanyALG resulted inan initiala 36% economic interest in SABMiller and a 24.9% voting interest. The transaction resulted in a pre-tax gain of$2.7$2.6 billion, or $1.7 billion after-tax. The gain was recorded in the third quarter of 2002. Beginning with the third quarter of 2002,the Company'sALG’s ownership interest in SABMiller is being accounted for under the equity method. Accordingly,the Company'sALG’s investment in SABMiller of approximately $2.0 billion and $1.9 billion is included in other assets on theSeptember 30, 2002condensed consolidated balancesheet as other assets.sheets at March 31, 2003 and December 31, 2002, respectively. In addition,the Company is recordingALG records its share ofSABMiller'sSABMiller’s net earnings, based on its economic ownership percentage, in minority interest in earnings and other,net. On October 31, 2002,net, on the condensed consolidated statement of earnings.Note 7. Acquisitions and Divestitures:
In April 2003, Kraft Foods International, Inc.
("KFI"(“KFI”)soldcompleted the acquisition of a biscuits business in Egypt and announced an agreement to sell itsLatin American yeastretail rice business in Germany, Austria andindustrial bakery ingredientsDenmark, subject to approval by the German competition authorities. In May 2003, Philip Morris International Inc. (“PMI”) announced an agreement to purchase 76% of a tobacco business in Greece for approximately$110 million.$420 million with the intention to bid for the remaining 24%. Theresulting gain will be recordedtransaction, which is expected to close in thefourth quartersecond half of2002.2003, is subject to the completion of due diligence and regulatory approval.During the
thirdfirst quarter of 2002, KFI acquired asnacks company in Turkey and, during the first quarter of 2002, acquired abiscuits business inAustralia. In addition, during the first half of 2002,Australia for $62 million and Kraft Foods North-12-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)America, Inc.("KFNA"(“KFNA”) sold several small North American food businesses, which were previously classified as businesses held forsale.sale, for $81 million. The net revenues and operating results of the businesses held for sale, which were not significant, were excluded fromthe Company'sAltria Group, Inc.’s condensed consolidated statements of earnings and no gain or loss was recognized on these sales.The aggregate pre-tax proceeds received from the sales of these businesses during the first nine 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, and also acquired confectionery businesses in Russia and Poland.The operating results of
the tobacco and foodbusinesses acquired and sold were not material totheAltria Group, Inc.’s consolidated financial position or operating resultsof the Companyin any of the periods presented.-12-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note
6.8. Earnings Per Share:- ----------------------------Basic and diluted EPS were calculated using the following:
For
For the Three Months Ended
March 31,
2003
2002
(in millions)
Net earnings
$
2,186
$
2,365
Weighted average shares for basic EPS
2,032
2,145
Plus incremental shares from assumed conversions:
Restricted stock and stock rights
1
3
Stock options
7
23
Weighted average shares for diluted EPS
2,040
2,171
Incremental shares from assumed conversions are calculated as the
Nine Months Ended September 30, ------------------------- 2002 2001 ------ ------ (in millions)Earnings before cumulative effect of accounting change $9,334 $6,402 Cumulative effect of accounting change (6) ------ ------ Net earnings $9,334 $6,396 ====== ====== Weighted average shares for basic EPS 2,128 2,189 Plus incremental shares from assumed conversions: Restricted stock and stock rights 2 7 Stock options 20 22 ------ ------ Weighted average shares for diluted EPS 2,150 2,218 ====== ======
For the Three Months Ended September 30, -------------------------- 2002 2001 ------ ------ (in millions)Net earnings $4,359 $2,328 ====== ====== Weighted average shares for basic EPS 2,104 2,175 Plus incremental shares from assumed conversions: Restricted stock and stock rights 1 7 Stock options 14 20 ------ ------ Weighted average shares for diluted EPS 2,119 2,202 ====== ======Thenumber of shares that would be issued, net of the number of shares that could be purchased in the marketplace with the cash received upon stock option exercise or, in the case of restricted stock, the amount of the related unamortized compensation expense. For the first quarter of 2003, 76 million shares of common stock were excluded from the calculation of weighted average shares for diluted EPS because their effects were antidilutive (i.e., the cash that would be received upon exercise is greater than the average market price of the stock during the period). The number of shares excluded for the first quarter of 2002 wasimmaterial for all periods presented. -13-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)immaterial.Note
7.9. Segment Reporting:- ---------------------------The products of
the Company'sALG’s subsidiaries include cigarettes, food (consisting principally of a wide variety of snacks, beverages, cheese, grocery products and convenient meals) and beer,(priorprior to the merger of Miller intoSAB).SAB on July 9, 2002. Another subsidiary ofthe Company, Philip Morris Capital Corporation,ALG, PMCC, is primarily engaged in leasing activities. The products and services of these subsidiaries constitutethe Company'sAltria Group, Inc.’s reportable segments of domestic tobacco, international tobacco, North American food, international food, beer (prior to July 9, 2002) and financial services.The Company'sAltria Group, Inc.’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 (consumer products), and provision for income taxes are centrally managed at the
corporateALG level and, accordingly, such items are not presented by segment since they are excluded from the measure of segment profitability reviewed bythe Company'sAltria Group, Inc.’s management.Segment data were as follows:
For the Nine Months Ended September 30, ----------------------------- 2002 2001 ------- ------- (in millions)Net revenues: Domestic tobacco $14,921 $14,826 International tobacco 21,817 20,463 North American food 16,087 15,813 International food 5,789 5,875 Beer 2,641 3,699 Financial services 379 321 ------- ------- Total net revenues $61,634 $60,997 ======= ======= Operating companies income: Domestic tobacco $ 4,222 $ 3,662 International tobacco 4,489 4,346 North American food 3,770 3,679 International food 851 814 Beer 276 404 Financial services 257 215 ------- ------- Total operating companies income 13,865 13,120 Amortization of intangibles (5) (758) General corporate expenses (504) (584) ------- ------- Total operating income 13,356 11,778 Gain on Miller transaction 2,653 Interest and other debt expense, net (881) (1,165) ------- ------- Total earnings before income taxes, minority interest and cumulative effect of accounting change $15,128 $10,613 ======= =======-14-Philip Morris Companies-13-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
For the Threee Months Ended September 30, ----------------------------- 2002 2001 ------- ------- (in millions)Net revenues: Domestic tobacco $ 5,022 $ 5,144 International tobacco 7,644 6,742 North American food 5,225 5,151 International food 1,991 1,867 Beer 1,235 Financial services 114 110 ------- ------- Total net revenues $19,996 $20,249 ======= ======= Operating companies income: Domestic tobacco $ 1,518 $ 1,577 International tobacco 1,522 1,440 North American food 1,303 1,183 International food 300 277 Beer 112 Financial services 82 75 ------- ------- Total operating companies income 4,725 4,664 Amortization of intangibles (1) (252) General corporate expenses (166) (205) ------- ------- Total operating income 4,558 4,207 Gain on Miller transaction 2,653 Interest and other debt expense, net (279) (276) ------- ------- Total earnings before income taxes and minority interest $ 6,932 $ 3,931 ======= =======On May 30, 2002, theSegment data were as follows:
For the Three Months Ended
March 31,
2003
2002
(in millions)
Net revenues:
Domestic tobacco
$
3,817
$
5,018
International tobacco
8,079
7,034
North American food
5,380
5,294
International food
1,979
1,853
Beer
1,219
Financial services
116
117
Net revenues
$
19,371
$
20,535
Operating companies income:
Domestic tobacco
$
742
$
1,250
International tobacco
1,690
1,564
North American food
1,297
1,098
International food
237
252
Beer
107
Financial services
83
71
Total operating companies income
4,049
4,342
Amortization of intangibles
(2
)
(2
)
General corporate expenses
(183
)
(169
)
Operating income
3,864
4,171
Interest and other debt expense, net
(283
)
(293
)
Earnings before income taxes and minority interest
$
3,581
$
3,878
As more fully discussed in Note 6.Miller Brewing Company
announced an agreement with SAB to merge Miller into SAB. The transaction closedTransaction, on July 9, 2002,andMiller was merged into SABchanged its nameto form SABMiller.At closing,During 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 $2.7 billion or $1.7 billion after-tax. The gain was recorded in the thirdfirst quarter of2002. Beginning with the third quarter of 2002, the Company's ownership interest in SABMiller is being accounted for under the equity method. Accordingly, the Company's investment in SABMiller is included in the September 30, 2002 condensed consolidated balance sheet as other assets. In addition, the Company is recording its share of SABMiller's net earnings based on its economic ownership percentage in minority interest in earnings and other, net. During2002, operating companies income for the North American foodand international food segmentssegment included a pre-taxchargescharge of $27 million related to the consolidation of productionlines, the closing of a facility and other consolidation programs. Pre-tax charges of $102 million and $17 million were recorded in marketing, administration and research costs of the North American food and international food segment, respectively, for the nine months ended September 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 these charges will approximate $37 million, of which $4 million has been paid through September 30, 2002. The majority of the remaining payments are expected to be made throughout the remainder of 2002 and 2003. During the third quarter of 2002, PMI announced a separation program in the United Kingdom and approximately 90 employees were terminated. As a result, pre-tax charges of $27 million, including an asset impairment charge of $8 million and severance of $11 million, were recorded in the third quarter of 2002 in marketing, administration and research costs of the international tobacco segment. -15-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) During the second quarter of 2002, PMI announced a separation program in Germany and approximately 160 employees accepted the benefits offered by this program. As a result, pre-tax charges of $6 million and $25 million, which include enhanced severance, pension and postretirement benefits, were recorded in the third quarter of 2002 and the second quarter of 2002, respectively, 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.lines.During the first quarter of 2002, approximately 800 food and beer employees accepted the benefits offered by
theseseparation programs and elected to retire or terminate employment. Pre-tax charges of $135 million, $7 million and $23 million were recorded inmarketing, administration and research coststhe operating companies income of the North American food, international food and beer segments, respectively,induring the first quarter of 2002 for thesevoluntary retirementseparation programs,andas well as a beer asset impairment.As discussed inNote
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 September 30, 2002 and December 31, 2001 condensed 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 condensed consolidated statements of earnings. During the third quarter of 2001, KFNA incurred pre-tax integration costs of $37 million related to consolidation programs. In addition, during the first quarter of 2001, KFNA sold a North American food factory, which resulted in a pre-tax loss of $29 million. During the third quarter of 2001, Miller entered into an agreement with Pabst Brewing Co. modifying the terms of an existing contract brewing agreement. This modification resulted in a pre-tax charge of $19 million in the Company's beer segment. Note 8.10. Contingencies:- -----------------------Legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against
the Company,ALG, its subsidiaries and affiliates, includingPM Inc. and the Company's international tobacco subsidiary,Philip MorrisInternationalUSA Inc.("PMI"(“PM USA”),and PMI, 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.-14-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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
-16-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)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"“Lights” and"Ultra Lights"“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.Plaintiffs'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 ofNovemberMay 1,2002,2003, and discusses certain developments in such cases sinceAugust 12, 2002.March 27, 2003.As of
NovemberMay 1,20022003, there were approximately1,5001,375 smoking and health cases filed and served on behalf of individual plaintiffs in the United States against PMInc.USA and, in some instances,the Company,ALG, compared with approximately 1,500 such cases onNovemberMay 1,2001,2002 and onNovemberMay 1,2000.2001. In certain jurisdictions, individual smoking and health cases have been aggregated for trial in a single proceeding; the largest such proceeding aggregates1,2501,100 cases in WestVirginia and is currently scheduled for trial in June 2003.Virginia. An estimated1415 of the individual cases involve allegations of various personal injuries allegedly related to exposure to environmental tobacco smoke("ETS"(“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 individual lawsuits seeking compensatory damages, but prohibit them from seeking punitive damages.As of
NovemberMay 1,2002,2003, there were an estimated2541 smoking and health putative class actions pending in the United States against PMInc.USA and, in some cases,the CompanyALG (includingtwothree that involve allegations of various personal injuries related to exposure to ETS), compared with approximately2825 such cases onNovemberMay 1,2001,2002, and approximately3731 such cases onNovemberMay 1,2000.2001.As of
NovemberMay 1,2002,2003, there were an estimated4341 health care cost recovery actions, including the suit discussed below under"Federal Government's“Federal Government’s Lawsuit"” filed by the United States government, pending in the United States against PMInc.USA and, in some instances,the Company,ALG, compared with approximately4844 such cases pending onNovemberMay 1,2001,2002, and5550 such cases onNovemberMay 1,2000.2001. In addition, health care cost recovery actions are pending in Israel, the Province of British Columbia, Canada, France 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
8389 smoking and health cases brought on behalf of individuals (Argentina(43)(45), Australia,(1),Brazil(26)(27), Czech Republic,(1),Germany, Ireland,(1),Israel (2), Italy(4), Japan (1)(5), the Philippines,(1),Poland, Scotland,(1),Spain (2) andSpain (2))Venezuela), compared with approximately7170 such cases onNovemberMay 1,2001,2002, and6860 such cases onNovemberMay 1,2000.2001. In addition, as ofNovemberMay 1,2002,2003, there werenineeight smoking and health putative class actions pending outside the United States (Brazil,(1),Canada (4), and Spain(4)(3)), compared with12 such cases on November 1, 2001 andeight such cases onNovemberMay 1,2000.2002, and 11 such cases on May 1, 2001.-15-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Pending and Upcoming Trials
Jury selection has been completed and opening arguments have been stayed pending the resolution of certain appealsTrial is currently underway in a smoking and health class action in Louisiana in which PM
Inc.USA is a defendant and in which plaintiffs seek the creation of funds to pay for medical monitoring and smoking cessationprograms. Trial isprograms (Scott, et al. v. The American Tobacco Company, Inc. et al.). Trials are also underway inantwo individual smoking and healthcasecases in Missouri (Welch v. Brown & Williamson, et al.) and Californiain which PM Inc. is a defendant. In addition, -17-(Reller v. Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) trial is scheduled to begin in December in an individual smoking and health case in California in which PM Inc. is a defendant.Incorporated, et al.).As set forth in Exhibit 99.2 hereto, additional cases against PM
Inc.USA and, in some instances,the Company,ALG, are scheduled for trial through the end of 2003. They includea class action in New York in which plaintiffs seek punitive damages for a class of persons residing in the United States who smoke or smoked cigarettes and have been diagnosed with an enumerated disease during the class period,a class action in California in which plaintiffs seek restitution under the California Business and Professions Code for the costs of cigarettes purchased by class members during the class period, acase in West Virginia that aggregates 1,250 individual smoking and health cases, twoputative Lights/Ultra Lights classactionsaction inIllinois andOhio and a class action in Kansas in which plaintiffs allege that defendants, including PMInc.,USA, conspired to fix cigarette prices in violation of antitrust laws.In addition, anAn estimated22nine individual smoking and health cases are scheduled for trial through the end of 2003, including one trial scheduled to begin in June in California and8 additionaltwo trials scheduled to begin in August in Missouri and Puerto Rico. In addition, 12 cases brought by flight attendants seeking compensatory damages for personal injuries allegedly caused by ETS are scheduled for trial through the end of2003. Four of the trials in the individual smoking and health cases are scheduled to begin in January 2003. Trial is scheduled to begin in one2003; seven of the cases brought by flight attendantsin January 2003.are scheduled to begin trial during 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,
juryverdicts have been returned in2431 smoking and health, Lights/Ultra Lights and health care cost recovery cases in which PMInc.USA was a defendant. Verdicts in favor of PMInc.USA and other defendants were returned in1419 of the2431 cases. These1419 cases were tried inRhode Island, West Virginia,California, Florida (6), Mississippi, New Jersey, New York (3), Ohio (2),New Jersey, Florida (4), New York (2), Mississippi andPennsylvania, Rhode Island, Tennessee (2). Plaintiffs'and West Virginia. Plaintiffs’ appeals or post-trial motions challenging the verdicts are pending in West Virginia, Ohio and Florida; a motion for a new trial has been granted in one of the cases in Florida. In December 2002, the court in an individual smoking and health case in California dismissed the case at the end of trial after ruling that plaintiffs had not introduced sufficient evidence to support their claims, and plaintiffs have appealed. In addition, 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. Inaddition, in2001, 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 theten12 cases that have gone to trial since January 1999 in which verdicts were returned in favor of plaintiffs.
Date
Location of
Court/Name of
Plaintiff
Type of Case
Verdict
Post-Trial
Date of Court Case VerdictDevelopments- ---- -------- ---- ------- ------------October CaliforniaApril 2003
Florida/Eastman
Individual
$850,000Smoking and
Health
$6.54 million in compensatory damages, including $2.62 million against PM
Inc. has filedUSA.PM USA intends to file post-trial motions challenging the verdict.
-16-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Date
Location of
Court/Name of
Plaintiff
Type of Case
Verdict
Post-Trial Developments
March 2003
Illinois/Price
Lights/Ultra
Lights Class
Action
$7.1005 billion in compensatory damages and $3 billion in punitive damages against PM USA.
See the discussion of the Price case under the heading Certain Other Tobacco-Related Litigation—Lights/Ultra Lights Cases.
October 2002
California/Bullock
Individual Smoking
&and Health$850,000 in compensatory damages and $28 billion in punitive damages
motions challenging the Healthagainst PMInc. verdict.USA.In December 2002, the trial court reduced the punitive damages award to
$28 million; PM USA and plaintiff have appealed.
June
Florida2002Florida/French
Flight
$5.5Attendant ETS Litigation$5.5 million in compensatory damages against all defendants, including PM USA.
In September 2002, the court
2002 Attendant damages against all defendants,reduced the damages award toETS including PM Inc.$500,000; plaintiff andLitigationdefendants have appealed.June
Florida2002Florida/Lukacs
Individual
$37.5Smoking and Health$37.5 million in compensatory
Defendants have filed 2002 Smoking anddamages against all defendants,post-trial motions Healthincluding PMInc. challengingUSA.In March 2003, the
verdict.-18-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)
Location Type of Post-Trial Date of Court Case Verdict Developments - ---- -------- ---- ------- ------------court reduced the damages award to $24.86 million; PM USA intends to appeal. March
Oregon2002Oregon/Schwarz
Individual
$168,500Smoking and Health$168,500 in compensatory damages and $150 million in punitive damages against PM USA.
In May 2002, the trial court
2002 Smoking and and $150 million in punitivereduced the punitive damagesHealth damages against PM Inc.award to $100 million, and in July 2002, the trial court denied PMInc.'sUSA’s post-trial motions challenging the verdict. PMInc. hasUSA and plaintiff have appealed.June
California2001California/Boeken
Individual
$5.5Smoking and Health$5.5 million in compensatory
In August 2001, the trial 2001 Smoking anddamages, and $3 billion in punitive damages against PM USA.In August 2001, the trial court reduced the punitive
Health damages against PM Inc.damages award to $100 million; PMInc. hasUSA and plaintiff have appealed.June 2001
New York/Empire Blue Cross and Blue Shield
Health Care
$17.8Cost Recovery$17.8 million in compensatory damages against all defendants, including $6.8 million against PM USA.
In February 2002, the trial
2001 Cost Recoverycourt awarded plaintiffs $38 million in attorneys’ fees. Defendants have appealed.-17-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Date
Location of
Court/Name of
Plaintiff
Type of Case
Verdict
Post-Trial Developments
July 2000
Florida/Engle
Smoking and Health Class Action
$145 billion in punitive damages against all defendants,
court awarded plaintiffs $38including$6.8 million against PM million in attorneys' fees. Inc. Defendants have appealed. July Florida Smoking and $145 billion in punitive damages See "Engle Class Action," 2000 Health Class against all defendants, including below. Action$74 billion against PMInc.USA.See “Engle Class Action,” below.
March
California2000California/Whitely
Individual
$1.72Smoking and Health$1.72 million in compensatory
Defendants have appealed. 2000 Smoking anddamages against PMInc.USA and anotherHealthdefendant, and $10 million in punitive damages against PMInc.USA and $10 million in punitive damages against the other defendant.Defendants have appealed.
March
Oregon1999Oregon/Williams
Individual
$800,000Smoking and Health$800,000 in compensatory damages, $21,500 in medical expenses and $79.5 million in punitive damages against PM USA.
The trial court reduced the
1999 Smoking and $21,500 in medical expenses andpunitive damages award toHealth $79.5 million in punitive damages$32 million, and PMInc. against PM Inc.USA appealed. In June 2002, the Oregon Court of Appeals reinstated the $79.5 million punitive damagesaward; PM Inc. has appealed to theaward. The Oregon SupremeCourt.Court refused to hear PM USA’s appeal in December 2002. PM USA has petitioned the United States Supreme Court for further review. In view of these developments, although PM USA intends to continue to defend this case vigorously, it recorded a provision of $32 million in the 2002 consolidated financial statements as its best estimate of the probable loss in this case.-19-Philip Morris Companies-18-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Date
Location of
Court/Name of
Plaintiff
Type of Case
Verdict
Post-Trial
Date of Court Case VerdictDevelopments- ---- -------- ---- ------- ------------February 1999
California/Henley
Individual
$1.5Smoking and Health$1.5 million in compensatory damages and $50 million in punitive damages against
PM USA.
The trial court reduced the
punitive 1999 Smoking and damages and $50 million inpunitive damages award to $25 million and PMHealth damages against PM Inc. Inc.USA appealed.In November 2001, aA California District Court of Appeals affirmed the trialcourt'scourt’s ruling, and PMInc.USA appealed to the California Supreme Court. In October 2002, the California Supreme Court vacated the decision of the District Court of Appeals and remanded the case back to the District Court of Appeals for further consideration. In March 2003, the District Court of Appeals again affirmed the trial court’s ruling. PM USA has appealed to the California Supreme Court.In October 2002, the California Supreme Court vacated the decision of the District Court of Appeals and remanded the case back to the District Court of Appeals for further consideration.With respect to certain adverse verdicts currently on appeal, excluding amounts relating to theEngle andPrice cases, PM USA has posted various forms of security totaling $364 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. These cash deposits are included in other assets on the condensed consolidated balance sheets.
In addition, since January 1999, jury verdicts have been returned in 13 tobacco-related cases in which neither
the CompanyALG nor any of its subsidiaries were defendants. Verdicts in favor of defendants were returned in eight of the 13 cases in cases tried in Connecticut, Texas, South Carolina, Mississippi, Louisiana, Missouri and Tennessee (2).Plaintiffs'Plaintiffs’ appeal is pending in Mississippi. Verdicts in favor of plaintiffs were returned in5five of the 13 cases in cases tried in Australia, Kansas, Florida (2) and Puerto Rico.Defendants'Defendants’ appeals or post-trial motions are pending. In December 2002, the appellate court reversed the ruling in favor of plaintiff in the case in Australia. In October 2002, the court granteddefendants'defendants’ motion for judgment as anew trialmatter of law in the case in PuertoRico.Rico, and entered judgment in favor of defendant. In addition, in a case in France the trial court found in favor of plaintiff; however, the appellate court reversed the trialcourt'scourt’s ruling and dismissedplaintiff'splaintiff’s claim.Engle Class Action
Verdicts have been returned and judgment has been entered against PM
Inc.USA 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“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"“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-19-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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.USA. PMInc.USA 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 thejury'sjury’s dismissal; (ii) punitive damages cannot 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"“punish” but cannot"destroy"“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“Florida law is clear that compensatory damages must be determined prior to an award of punitivedamages"damages” in cases such asEngle.Engle. As noted above, compensatory damages for all but three members of the class have not been determined.-20-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)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'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'smember’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'sjury’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'defendants’ post-trial motions and entered judgment on the compensatory and punitive damages awarded by the jury. PMInc.USA andthe CompanyALG believe that the entry of judgment by the trial court is unconstitutional and violates Florida law. PMInc.USA has filed an appeal with respect to the entry of judgment, class certification and numerous other reversible errors that have occurred during the trial. PMInc.USA 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 caplegislation"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.USA to post a bond in the full amount of the judgment and, absent appellate relief, PMInc.USA would not-20-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
be able to stay any attempted execution of the judgment in Florida. PM
Inc.USA andthe CompanyALG 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"“Stipulation”) among PMInc.,USA, certain other defendants, plaintiffs and the plaintiff class that provides that execution or enforcement of the punitive damages component of theEngle judgment will remain stayed against PMInc.USA 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, PMInc.USA placed $1.2 billion into an interest-bearing escrow account for the benefit of theEngle class. Should PMInc.USA prevail in its appeal of the case, both amounts are to be returned to PMInc.USA. PMInc.USA also placed an additional $500 million into a separate interest-bearing escrow account for the benefit of theEngle class. If PMInc.USA 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 CompanyALG recorded a $500 million pre-tax charge in its consolidated statement of earnings for the quarter ended March 31, 2001.PM
Inc.USA andthe CompanyALG remain of the view that theEngle 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. PMInc.USA 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. The appellate court heard oral argument ondefendants'defendants’ appealsonin November6,2002.-21-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)Smoking and Health Litigation
Plaintiffs'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 casethat a class consisting of all"addicted"“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"“addiction” claims and, in many cases, claims of physical injury as well. As ofNovemberMay 1,2002,2003, smoking and health putative class actions were pending in Alabama, Florida, Illinois, Kentucky, Louisiana, Massachusetts, Missouri, Nevada, New Jersey, Oregon, Utah and 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 in2930 smoking and health class actions involving PMInc.USA in Arkansas, the District of Columbia (2), 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 theEnglecase 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 lowercourt'scourt’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 PMInc.,USA, and plaintiffs have appealed. In February 2003, the West Virginia Supreme Court agreed to hear plaintiffs’ appeal.-21-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Exhibit 99.1 hereto lists the smoking and health class actions pending as of
NovemberMay 1,2002,2003, and discusses certain developments in such cases sinceAugust 12, 2002.March 27, 2003.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"(“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 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"“unjustly enriched” byplaintiffs'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.-22-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)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"“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"“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“standing in theshoes"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.Exhibit 99.1 hereto lists the health care cost recovery cases pending as of May 1, 2003, and discusses certain developments in such cases since March 27, 2003.
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,
eightnine federal circuit courts of appeals, the Second, Third, Fifth, Sixth, Seventh, Eighth, Ninth, Eleventh and District of Columbia circuits, as well as California, Florida, New York and Tennessee intermediate appellate courts, relying primarily on grounds thatplaintiffs'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 considerplaintiffs'plaintiffs’ appeals from the cases decided by the courts of appeals for the Second, Third, Fifth, Ninth and District of Columbia circuits. As ofNovemberMay 1,2002,2003, there were an estimated4341 health care cost recovery cases pending in the United States against PMInc.,USA, and in some instances,the Company,ALG, including the case filed by the United States government, which is discussed below under"Federal Government's“Federal Government’s Lawsuit." Exhibit 99.1 hereto lists the health care cost recovery cases pending as of November 1, 2002, and discusses certain developments in such cases since August 12, 2002.” The cases brought in the United States include actions brought by Belize, Bolivia, Ecuador, Guatemala, Honduras, Nicaragua, the Province of-22-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Ontario, Canada, Panama, the Russian Federation, Tajikistan, Ukraine, Venezuela, 11 Brazilian states and 11 Brazilian cities. 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 appealed. In September 2002, the appellate court affirmed the dismissal of the case brought by Venezuela, and Venezuela has petitioned the state supreme court for further review. 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 compensatory damages against PM
Inc.USA 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 forattorneys'attorneys’ fees. Defendants, including PMInc.,USA, have appealed.Settlements of Health Care Cost Recovery Litigation
In November 1998, PM
Inc.USA and certain other United States tobacco product manufacturers entered into the Master Settlement Agreement (the"MSA"“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. PMInc.USA and certain other United States tobacco product-23-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the"State“State SettlementAgreements"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 settlingplaintiffs' attorneys'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. PMInc.'sUSA’s portion of ongoing adjusted payments and legal fees is based on its relative share of the settlingmanufacturers'manufacturers’ domestic cigarette shipments, including roll-your-own cigarettes, in the year preceding that in which the payment is due. PMInc.USA records its portions of ongoing settlement payments as part of cost of sales as product is shipped.The State Settlement Agreements also include provisions 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.,USA, 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(2003 through 2008, $500 million each year; 2009-23-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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'smanufacturer’s relative market share. PMInc.USA 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.USA andthe Company; the Companymay adversely affect future volumes. ALG believes that they may also materially adversely affect thebusiness, volumes,results of operations, cash flows or financial position of PMInc.USA andthe CompanyAltria Group, Inc. 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, PMInc.'sUSA’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.
Federal
Government'sGovernment’s LawsuitIn 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.USA andthe Company,ALG, asserting claims under three federal statutes, the Medical Care Recovery Act("MCRA"(“MCRA”), the Medicare Secondary Payer("MSP"(“MSP”) provisions of the Social Security Act and the Racketeer Influenced and Corrupt Organizations Act("RICO"(“RICO”). The lawsuit seeks to recover an unspecified amount of health care costs for tobacco-related illnesses allegedly caused bydefendants'defendants’ fraudulent and tortious conduct and paid for by the government under various federal health care programs, including Medicare, military andveterans'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-24-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)disgorgement, an injunction prohibiting certain actions by the defendants, and a declaration that the defendants are liable for the federalgovernment'sgovernment’s future costs of providing health care resulting fromdefendants'defendants’ alleged past tortious and wrongful conduct. PMInc.USA andthe CompanyALG 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 thegovernment'sgovernment’s MCRA and MSP claims, but permitted discovery to proceed on thegovernment'sgovernment’s claims for relief under RICO. In October 2000, the government moved for reconsideration of the trialcourt'scourt’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 thegovernment'sgovernment’s motion for reconsideration of the dismissal of the MCRA claims and dismissed thegovernment'sgovernment’s amended MSP claims. In January 2003, the government and defendants submitted preliminary proposed findings of fact and conclusions of law; rebuttals were filed in April. The government’s January filing included the government’s allegation that disgorgement by defendants of approximately $289 billion is an appropriate remedy in the case. Trial of the case is currently scheduled for September 2004.Certain Other Tobacco-Related Litigation
Lights/Ultra Lights
Cases:Cases: As ofNovemberMay 1,2002,2003, there were1118 putative or certified class actions pending against PMInc.USA and, in some instances,the CompanyALG in California, Florida, Georgia, Illinois (2), Louisiana, Massachusetts, Minnesota, Missouri, New Hampshire (2), New Jersey, Ohio (2), Oregon, Tennessee and West Virginia (2) on behalf of individuals who purchased and consumed various brands of cigarettes, includingMarlboro Lights,Marlboro Ultra Lights,Virginia Slims Lights andSuperslims,Merit Lights andCambridge Lights.Plaintiffs in these cases allege, among other things, that the use of the terms"Lights"“Lights” and/or"Ultra Lights"“Ultra Lights” constitutes deceptive and-24-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
unfair trade practices, and seek injunctive and equitable relief, including
restitution.restitution and, in certain cases, punitive damages. Classes have been certified in one of the cases in Illinois and in Massachusetts and Florida, and defendants have appealed the certification orders in the cases pending in Massachusetts and Florida.Trial in one of the Illinois class actions (thePrice case) in which PM USA was the defendant, commenced in January 2003 and was tried before a judge rather than a jury. In March 2003, the judge found in favor of the plaintiff class and awarded approximately $7.1 billion in compensatory damages and $3 billion in punitive damages. At the request of PM USA, the judge stayed enforcement of the judgment for 30 days. Thereafter, under the judgment, enforcement would have been stayed only if an appeal bond in the amount of $12 billion had been presented and approved. On April 14, 2003, the judge reduced the bond that PM USA must provide and stayed enforcement of the judgment pending the completion of appellate review. Under the judge’s order, PM USA will transfer possession of a pre-existing 7.0%, $6 billion long-term note from ALG to PM USA to an escrow account with an Illinois financial institution. (Since this note is the result of an intercompany financing arrangement, it does not appear on the consolidated balance sheet of Altria Group, Inc.) In addition, PM USA will make cash deposits with the clerk of the Madison County Circuit Court in the following amounts: beginning October 1, 2003, an amount equal to the interest earned by PM USA on the ALG note (presently, $210 million every six months), an additional $800 million in four equal quarterly installments between September 2003 and June 2004 and the payments of principal of the note, which are due in April 2008, 2009 and 2010. (Cash payments into the account will be presented as other assets on the consolidated balance sheet.) If PM USA prevails on appeal, the escrowed note and all cash deposited with the court will be returned to PM USA, with accrued interest less administrative fees payable to the court. Plaintiffs have indicated their intent to appeal the judge’s order reducing the bond. PM USA believes that thePricecase
is scheduled for January 2003. Trialshould not have been certified as a class action and that the judgment should ultimately be set aside on any one of a number of legal and factual grounds that it intends to pursue on appeal.While class certification has not yet been granted, trial in one of the Ohio cases is scheduled for August 2003.
Cigarette Contraband
Cases:Cases: As ofNovemberMay 1,2002,2003, the European Community and ten member states, various Departments of Colombia, Ecuador, Belize and Honduras had filed suits in the United States againstthe CompanyALG and certain of its subsidiaries, including PMInc.USA 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 granteddefendants'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. Plaintiff in that case petitioned the United States Supreme Court for further review, and in October 2002, the Supreme Court deniedplaintiff'splaintiff’s petition.Asbestos Contribution
Cases:Cases: As ofNovemberMay 1,2002,2003, an estimatedeightseven suits were pending on behalf of former asbestos manufacturers and affiliated entities against domestic tobacco manufacturers, including PMInc.USA. 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:Case: Three domestic tobacco manufacturers filed suit against PMInc.USA seeking to enjoin the PMInc. "Retail Leaders"USA “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'attorneys’ fees, costs and interest. In May 2002, the court granted PMInc.'sUSA’s motion for summary judgment and dismissed all ofplaintiffs'plaintiffs’ claims with prejudice. Plaintiffs have appealed.-25-
Philip Morris CompaniesAltria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Vending Machine
Case:Case: Plaintiffs, who began their case as a purported nationwide class of cigarette vending machine operators, allege that PMInc.USA 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'attorneys’ fees and costs, and other unspecified relief. In June 1999, the court deniedplaintiffs'plaintiffs’ motion for a preliminary injunction. Plaintiffs have withdrawn their request for class action status. In August 2001, the court granted PMInc.'sUSA’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 districtcourt'scourt’s dismissal would, if affirmed, be binding on all plaintiffs.Tobacco Price
Cases:Cases: As ofNovemberMay 1,2002,2003, there were3936 putative class actions and one additional case pending against PMInc.USA and other domestic tobacco manufacturers, as well as, in certain instances,the CompanyALG and PMI, alleging that defendants conspired to fix cigarette prices in violation of antitrust laws. The cases are listed in Exhibit 99.1. Seven of the putative class actions were filed in various federal district courts by direct purchasers of tobacco products, and the remaining3233 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 was denied. 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 actionshave beenwere consolidated in the United States District Court for the Northern District ofGeorgia. In July 2002, the court granted defendants'Georgia, and subsequently dismissed on defendants’ motion for summaryjudgment dismissingjudgment. Plaintiffs have appealed. Plaintiffs’ motions for class certification have been granted in two cases pending in state court in Kansas and New Mexico, and trial in the case inits entirety,Kansas is scheduled for September 2003. Plaintiffs’ motions for class certification have been denied in two cases pending in state courts in Michigan and Minnesota. Defendants’ motion to dismiss was granted in a case pending in state court in Florida, and plaintiffs’ appeal is pending. Defendants’ motions to dismiss were granted in three cases pending in state court in New York, and plaintiffshaveappealed.The cases are listedIn March 2003, plaintiffs withdrew their appeals. In addition, defendants’ motion to dismiss was granted inExhibit 99.1.a case pending in state court in Arizona and the Arizona Court of Appeals reversed the trial court’s decision. Defendants appealed to the Arizona Supreme Court, which has accepted defendants’ appeal.Cases Under the California Business and Professions
Code:Code: In June 1997 and July 1998, two suits were filed in California courts alleging that domestic cigarette manufacturers, including PMInc.USA 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 toplaintiffs'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. In September 2002, the court granteddefendants'defendants’ motions for summary judgment as to all claims in one of thecases; in November 2002, the court confirmed its earlier rulings granting defendants' motions for summary judgment.cases. Plaintiffs have appealed. Trial in the other case is scheduled forAprilSeptember 2003.Tobacco
Growers' Case: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 PMInc.,USA, 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 complaint and to transfer the case, and plaintiffs filed a motion for class certification. In November 2000, the court granteddefendants'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 buyerdefendants'defendants’ motions to dismiss the case, and in April 2002 grantedplaintiffs'-26-
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
plaintiffs’ motion for class certification.
Defendants'Defendants’ petition for interlocutory review of the class certification order was denied in June 2002.TrialPM USA and certain other defendants are currently involved in the final stages of concluding an agreement with plaintiffs to resolve the lawsuit. The agreement would include a commitment by each settling manufacturer defendant to purchase a certain percentage of its leaf requirements from U.S. tobacco growers over a period of at least ten years. In addition, PM USA’s share of the settlement payments could range up to approximately $145 million, which would be recorded as a charge to earnings when the agreement isscheduled for April 2004. -26-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)approved by the court. PM USA would also pay a substantial portion of any attorneys’ fees that the court may award.Consolidated Putative Punitive Damages
Cases:Cases: In September 2000, a putative class action was filed in the federal district court in the Eastern District of New York that purported to consolidate punitive damages claims in ten tobacco-related actions then pending in federal district courts in New York and Pennsylvania. In July 2002, plaintiffs filed an amendedconsolidated class actioncomplaint and a motionfor class certification. The complaint soughtseeking certification of a punitive damages class of persons residing in the United States who smoke or smokeddefendants'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. The following persons are excluded from the class: (1) those who have obtained judgments or settlements against any defendants; (2) those against whom any defendant has obtained judgment; (3) persons who are part of the certifiedEngle class; (4) persons who should have reasonably realized that they had an enumerated disease prior to April 9, 1993; and (5) those whose diagnosis or reasonable basis for knowledge predates their use of tobacco. In September 2002, the court grantedplaintiffs'plaintiffs’ motion for classcertification, and defendants havecertification. Defendants petitioned the United States Court of Appeals for the Second Circuit for review of the trialcourt's ruling.court’s ruling, and the Second Circuit has agreed to hear defendant’s petition. Trialis scheduled for January 2003.of the case has been stayed pending resolution of defendants’ petition.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, and plaintiffs have petitioned the United States Supreme Court for further review. 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: OneMatters: Two hundredninety-fourtax assessments,alleging thethat allege 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 ofthe Company.ALG. The aggregate amount of alleged unpaid taxes assessed to date is the euro equivalent of$2.3$2.8 billion. In addition, the euro equivalent of$3.5$4.5 billion in interest and penalties has been assessed.The Company anticipates that value-addedValue-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 rejected8184 of the appeals filed by the taxauthorities.authorities and confirmed 19 of the appeals. The tax authorities have appealed4548 of the8184 decisions of the regional appellate court to the Italian Supreme Court, and a hearing onthese45 of the 48 cases was held in December 2001. Six of the8184 decisions were not appealed and are now final. In March, May, July andJulyDecember 2002, the Italian Supreme Court issued its decisions in43 ofthe 45appeals.appeals that were heard in December 2001. 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 in3133 of the cases and remanded these cases back to the regional appellate court for further hearings on the merits.Two 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 ofthe Company,ALG, 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 Milanprosecutor'sprosecutor’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"“preliminary judge” hearing the case would evaluate whether the Milanprosecutor'sprosecutor’s charges should be sent to a criminal judge for a-27-Philip Morris Companies Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)full trial. At the June 2002 hearing, the"preliminary judge"“preliminary judge” ruled that there was no legal basis for theprosecutor'sprosecutor’s charges and acquitted all of the defendants; the prosecutor has appealed.The Company,ALG, its affiliates and the officers and directors who are subject to the proceedings believe they have complied with applicable Italian taxlawslaws.-27-
Altria Group, Inc. and
are vigorously contesting the pending assessments and proceedings. --------------SubsidiariesNotes to Condensed Consolidated Financial Statements
(Unaudited)
It is not possible to predict the outcome of the litigation pending against
the CompanyALG and its subsidiaries. Litigation is subject to many uncertainties.UnfavorableAs discussed above under “Recent Trial Results,” unfavorable verdicts awardingcompensatory and/or punitivesubstantial damages against PMInc.USA have been returned inthe Engle smoking12 cases in recent years andhealth class action, several individual smoking and healththese casesa flight attendant ETS lawsuit, and a health care cost recovery case andarebeing appealed.in various post-trial stages. It is possible that there could be further adverse developments in these cases and that additional cases could be decided unfavorably. In the event of an adverse trial result in certain pending litigation, the defendant may not be able to obtain a required bond or obtain relief from bonding requirements in order to prevent a plaintiff from seeking to collect a judgment while an adverse verdict is being appealed. An unfavorable outcome or settlement ofapending 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 ofpotential triers of factjudges and jurors with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional similar litigation.ManagementALG and its subsidiaries record provisions in the consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Except as discussed elsewhere in this Note 10.Contingencies: (i) management has not concluded that it is probable that a loss has been incurred in any of the pending tobacco-related litigation; (ii) 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,litigation; andthe Company(iii) accordingly, management 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'sbusiness and volume of ALG’s subsidiaries, as well as Altria Group, Inc.’s consolidated 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 CompanyALG 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 CompanyALG and its subsidiaries may enter into settlement discussions inan attempt to settleparticular cases if they believe it is in the best interests ofthe Company'sALG’s stockholders to do so.Guarantees
At March 31, 2003, Altria Group, Inc.’s third-party guarantees, which are primarily derived from acquisition and divestiture activities, approximated $253 million, of which $209 million have no expiration dates. The remainder expire through 2012, with $26 million expiring through March 31, 2004. Altria Group, Inc. is required to perform under these guarantees in the event that a third-party fails to make contractual payments or achieve performance measures. Altria Group, Inc. has recorded a liability of $88 million at March 31, 2003 relating to these guarantees.
Note
9.11. Recently Issued Accounting Pronouncements:- --------------------------------------------------- On July 30, 2002,In April 2003, the
Financial Accounting Standards BoardFASB issued SFAS No.146, "Accounting for Costs Associated with Exit or Disposal149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities."” SFAS No.146 requires companies to recognize costs associated with exit or disposal149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activitieswhen they are incurred rather than at the date of a commitment to an exit or disposal plan. Costs covered byunder SFAS No.146 include lease termination costs133, “Accounting for Derivative Instruments andcertain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity. This statementHedging Activities.” In general, SFAS No. 149 is effective forexitcontracts entered into ordisposal activities that are initiatedmodified afterDecember 31, 2002. Accordingly,June 30, 2003 and for hedging relationships designated after June 30, 2003. Altria Group, Inc. does not currently expect theCompany will apply the provisionsadoption of SFAS No.146 prospectively149 toexit or disposal activities initiated after December 31, 2002.have a material impact on its 2003 consolidated financial statements.-28-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSAltria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
In November 2002, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” which addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF Issue No. 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. EITF Issue No. 00-21 is effective for Altria Group, Inc. for revenue arrangements entered into beginning July 1, 2003. Altria Group, Inc. does not expect the adoption of EITF Issue No. 00-21 to have a material impact on its 2003 consolidated financial statements.
-29-
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Operating Results
- ------------------------------
For the Nine Months Ended September 30, Net Revenues ----------------------------- (in millions) 2002 2001 ------- -------Domestic tobacco $14,921 $14,826 International tobacco 21,817 20,463 North American food 16,087 15,813 International food 5,789 5,875 Beer 2,641 3,699 Financial services 379 321 ------- ------- Net revenues $61,634 $60,997 ======= =======Operating Income ----------------------------- (in millions) 2002 2001 ------- -------Domestic tobacco $ 4,222 $ 3,662 International tobacco 4,489 4,346 North American food 3,770 3,679 International food 851 814 Beer 276 404 Financial services 257 215 ------- ------- Operating companies income 13,865 13,120 Amortization of intangibles (5) (758) General corporate expenses (504) (584) ------- ------- Operating income $13,356 $11,778 ======= =======
For the Three Months Ended September 30, Net Revenues ----------------------------- (in millions) 2002 2001 ------- -------Domestic tobacco $ 5,022 $ 5,144 International tobacco 7,644 6,742 North American food 5,225 5,151 International food 1,991 1,867 Beer 1,235 Financial services 114 110 ------- ------- Net revenues $19,996 $20,249 ======= =======-29-
For the Three Months Ended September 30, Operating Income ---------------------------- (in millions) 2002 2001 ------ ------Domestic tobacco $1,518 $1,577 International tobacco 1,522 1,440 North American food 1,303 1,183 International food 300 277 Beer 112 Financial services 82 75 ------ ------ Operating companies income 4,725 4,664 Amortization of intangibles (1) (252) General corporate expenses (166) (205) ------ ------ Operating income $4,558 $4,207 ====== ======SeveralFor the Three Months Ended March 31,
Net Revenues
(in millions)
2003
2002
Domestic tobacco
$
3,817
$
5,018
International tobacco
8,079
7,034
North American food
5,380
5,294
International food
1,979
1,853
Beer
1,219
Financial services
116
117
Net revenues
$
19,371
$
20,535
Operating Income
(in millions)
2003
2002
Domestic tobacco
$
742
$
1,250
International tobacco
1,690
1,564
North American food
1,297
1,098
International food
237
252
Beer
107
Financial services
83
71
Operating companies income
4,049
4,342
Amortization of intangibles
(2
)
(2
)
General corporate expenses
(183
)
(169
)
Operating income
$
3,864
$
4,171
The following events occurred during the first
ninethree months of20022003 and20012002 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 Miller Transaction -
• Miller Transaction—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 $2.7 billion or $1.7 billion after-tax. The gain was recorded in the third quarter of 2002. Beginning with the third quarter of 2002, the Company's ownership interest in SABMiller is being accounted for under the equity method. Accordingly, the Company's investment in SABMiller is included in the September 30, 2002 condensed consolidated balance sheet as other assets. In addition, the Company is recording its share of SABMiller's net earnings based on its economic ownership percentage in minority interest in earnings and other, net. o Sale of Food Factory and Integration Costs - The integration of Nabisco into the operations of Kraft Foods Inc. ("Kraft") 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. Kraft Foods North America, Inc. ("KFNA") incurred pre-tax integration costs of $75 million during the second quarter of 2002, $27 million during the first quarter of 2002, $37 million during the third quarter of 2001 and $16 million during the fourth quarter of 2001. Kraft Foods International, Inc. ("KFI") incurred pre-tax integration costs of $17 million during the second quarter of 2002. As of September 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 ($142 million), 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 these charges will approximate $37 million of which $4 million has been paid through September 30, 2002. The majority of the remaining payments are expected to be made throughout the remainder of 2002 and 2003. In addition, during the first quarter of 2001 KFNA recorded a pre-tax loss 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 Separation Programs and Asset Impairments - During the third quarter of 2002, a separation program in the international tobacco business in the United Kingdom was announced and approximately 90 employees were terminated. As a result, in the third quarter of 2002, pre-tax charges of $27 million, including an asset -30-impairment charge of $8 million and severance of $11 million, were recorded in marketing, administration and research costs of the international tobacco segment. In the second quarter of 2002, the international tobacco business in Germany announced a separation program and approximately 160 employees accepted the benefits offered by this program. As a result, pre-tax charges of $6 million and $25 million, which include enhanced severance, pension and post-retirement benefits, were recorded in marketing, administration and research costs of the international tobacco segment in the third and second quarters of 2002, respectively. In the fourth quarter of 2001, voluntary early retirement programs were offered to 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 $23 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 and a beer asset impairment. o Contract Brewing Charge - During the third quarter of 2001, Miller entered into an agreement with Pabst Brewing Co. modifying the terms of an existing contract brewing arrangement. This modification resulted in a pre-tax charge of $19 million in the Company's beer segment. 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 $7.1 billion and $2.6 billion in the first nine months and third quarter of 2001, respectively, and diluted earnings per share ("EPS") would have been $3.22 and $1.17, respectively, had the provisions of the new standards been applied as of January 1, 2001. 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 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 September 30, 2002 and December 31, 2001 condensed 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 condensed consolidated statements of earnings. o 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 owned 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. As of September 30, 2002, the Company owns approximately 84.0% of the outstanding shares of Kraft's capital stock and holds approximately 98% of the combined voting power of Kraft's outstanding common stock. Following the IPO, the Company's sources of funds from Kraft are from the repayment of debt and payment of dividends. The Company received dividends of $567 million from Kraft during the first nine months of 2002. -31-Results of Operations for the Nine Months Ended September30, 2002, ALG 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”). The transaction, which is discussed more fully in Note 6.Miller Brewing Company Transaction, resulted in a pre-tax gain of $2.6 billion, or $1.7 billion after-tax, in the third quarter of 2002. ALG records its share of SABMiller’s net earnings, based on its economic ownership percentage, in minority interest in earnings and other, net, on the condensed consolidated statement of earnings.
• Separation Programs and Asset Impairment—During the first quarter of 2002, approximately 800 employees elected to retire or terminate employment under separation programs. Pre-tax charges of $135 million, $7 million and $23 million were recorded in operating companies income of the North American food, international food and beer segments, respectively, for these separation programs and a beer asset impairment.
• Integration Costs—During the first quarter of 2002, Kraft Foods North America, Inc. (“KFNA”) recorded a pre-tax charge of $27 million to consolidate production lines in North America. Net revenues for the first
nine monthsquarter of2002 increased $637 million (1.0%2003 decreased $1.2 billion (5.7%)over 2001,from 2002, due primarily tohigher tobacco net revenues, partially offset bythe impact of the Miller transactionwhereby beerand a decrease in net revenueswere no longer recorded beginning infrom thethird quarter of 2002. Excluding the unusual items from each period and the results of operations divested since the beginning of 2001,domestic tobacco business, partially offset by higher net revenuesforfrom thefirst nine months of 2002 increased $1.5 billion (2.7%) over 2001.food and international tobacco businesses, and favorable currency.-30-
Operating income for the first
nine monthsquarter of2002 increased $1.6 billion (13.4%2003 decreased $307 million (7.4%)overfrom the comparable2001 period. Excluding2002 period, due primarily to lower operating results from theunusual items from each perioddomestic tobacco business and the impact of the Miller transaction, partially offset by pre-tax charges for integration costs and separation programs in 2002, higher operating results from the food and international tobacco businesses, and the favorable impact ofoperations divested since the beginning of 2001,currency.As discussed in Note 9.Segment Reporting, management reviews operating
income for the first nine months of 2002 increased $686 million (5.4%) over the first nine months of 2001, due to increases from all business segments. Operatingcompanies income, which is defined as operating income beforegeneralcorporate expenses and amortization of intangibles,increased $745to evaluate segment performance and allocate resources. Management believes it is appropriate to disclose this measure to help investors analyze business performances and trends. Operating companies income decreased $293 million(5.7%(6.7%)overfrom the firstnine months of 2001, due primarily to higher operating companies income from the Company's tobacco and food operations, and the 2001 litigation related expense, partially offset by the impact of the Miller transaction whereby beer operating companies income was no longer recorded beginning in the thirdquarter of2002. Excluding the unusual items from each period and the results of operations divested since the beginning of 2001, operating companies income increased $605 million (4.5%),2002, due tohigher operating income from all business segments.the same factors discussed above.Currency movements
have decreasedincreased net revenues by$843$619 million ($507307 million, after excluding the impact of currency movements on excise taxes) and operating companies income by$236$91 millionfromcompared with the firstnine months of 2001. Declines in net revenues and operating companies income are due primarily to the strength versus prior year of the U.S. dollar against the Japanese yen, the Russian ruble 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 last three months 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 $881 million for the first nine months of 2002 decreased $284 million from the first nine months of 2001. This decrease was due primarily to higher average debt outstanding in 2001 as a result of the Nabisco acquisition. The net proceeds of the Kraft IPO of $8.4 billion were used to retire a portion of the Nabisco acquisition debt during June 2001. During the first nine months of 2002, the Company's effective tax rate decreased by 2.4 percentage points to 35.5%. This decrease is due primarily to the adoption on January 1, 2002 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 $4.34 and $4.39, respectively, for the first nine months of 2002, increased by 50.7% and 50.3%, respectively, over the first nine months of 2001. Net earnings of $9.3 billion for the first nine months of 2002 increased $2.9 billion (45.9%) over the comparable period of 2001. These results include the gain from the Miller transaction, as well as the other unusual items previously discussed. Excluding the after-tax impact of the gain from the Miller transaction, as well as the other unusual items, net earnings increased 6.0% to $7.8 billion, diluted EPS increased 9.3% to $3.64 and basic EPS increased 8.9% to $3.67. On September 26, 2002, plans were announced to expand PM Inc.'s sales force and to increase promotional spending for core U.S. cigarette brands which have experienced market share decreases due to weak economic conditions, increases in state cigarette excise taxes and the growth of deep-discount cigarette brands. As a result of these plans, the Company anticipates that full-year 2002 diluted EPS, excluding the impact of the unusual items, will increase 3% to 5% over full-year 2001. -32-Results of Operations for the Three Months Ended September 30, 2002 Net revenues for the thirdquarter of2002 decreased $253 million (1.2%) from 2001, due primarily to the impact of the Miller transaction whereby beer net revenues were no longer recorded beginning in the third quarter of 2002, and lower domestic tobacco net revenues, partially offset by higher international tobacco and 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 third quarter of 2002 increased $930 million (4.9%) over 2001. Operating income for the third quarter of 2002 increased $351 million (8.3%) 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 third quarter of 2002 increased $200 million (4.6%) over the third quarter of 2001, due to increases from all business segments except domestic tobacco. Operating companies income increased $61 million (1.3%) over the third quarter of 2001, due primarily to higher operating companies income from the Company's international tobacco and North American and international food segments, partially offset by the impact of the Miller transaction whereby beer operating companies income was no longer recorded beginning in the third quarter of 2002, and lower operating income from the domestic tobacco segment. Excluding the unusual items from each period and the results of operations divested since the beginning of 2001, operating companies income increased $160 million (3.5%), due to increases from all business segments except domestic tobacco. Currency movements have increased net revenues by $173 million ($76 million, after excluding the impact of currency movements on excise taxes) and operating companies income by $14 million over the third quarter of 2001.2002. Increases in net revenues and operating companies income are due primarily to the weakness versus prior year of the U.S. dollar against the euro and other currencies, partially offset by thestrength versus prior yearimpact ofthe U.S. dollar against the Russian ruble, the Japanese yen andcertain Latin American currencies. Althoughthe CompanyAltria Group, Inc. cannot predict future movements in currency rates, therecentweakening of the U.S. dollar against the euro and other currencies, if sustained during the remainder of2002,2003, could continue to have a favorable impact on net revenues and operating companies income comparisonsin the last three months of the year. Diluted and basic EPS of $2.06 and $2.07, respectively, for the third quarter of 2002, increased by 94.3% and 93.5%, respectively, over the third quarter of 2001.with 2002.Net earnings of
$4.4$2.2 billion for thethirdfirst quarter of2002 increased $2.0 billion (87.2%2003 decreased $179 million (7.6%)overfrom the comparable period of2001. These2002, due primarily to lower operating resultsinclude the gainfrom theMiller transaction, as welldomestic tobacco business. Diluted and basic earnings per share of $1.07 and $1.08, respectively, for the first quarter of 2003, decreased by 1.8% from the first quarter of 2002, as theother unusual items previously discussed. Excluding the after-taxadverse impact of lower operating results was partially offset by thegain from the Miller transaction, as well as the other unusual items, net earnings increased 4.1% to $2.7 billion, diluted EPS increased 8.6% to $1.26 and basic EPS increased 7.6% to $1.27.favorable impact of share repurchases.Operating Results by Business Segment
- -------------------------------------Tobacco
Business Environment
Taxes, Legislation, Regulation and Other Matters Regarding Tobacco
- ------- Business Environmentand SmokingThe tobacco industry, both in the United States and
abroad,foreign jurisdictions, has faced, and continues to face, a number of issuesthat maywhich are expected to continue to adversely affect the business, volume, results of operations, cash flows and financial position of Philip Morris USA Inc. (“PMInc.USA”), Philip Morris International Inc.("PMI"(“PMI”)and/or the Company.and Altria Group, Inc.These issues, some of which are more fully discussed below, include:
o a $74.0 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, including six punitive damages verdicts in California and Oregon in the aggregate amount of $31.3 billion; o
• a $74.0 billion punitive damages verdict against PM USA in theEngle smoking and health class action case, a compensatory and punitive damages judgment totaling approximately $10.1 billion against PM USA in thePrice Lights/Ultra Lights class action and punitive damages verdicts against PM USA in individual smoking and health cases discussed in Note 10.Contingencies (“Note 10”); the civil lawsuit filed by the United States federal governmentagainstseeking disgorgement of approximately $289 billion from various cigarette manufacturers, including PMInc.,USA, and others discussed in Note8; -33-o10;pending and threatened litigation and bonding requirements as discussed in Note 10 and in “Cautionary Factors that May Affect Future Results”;legislation or other governmental action seeking to ascribe to the industry responsibility and liability for the adverse health effects caused by both smoking and exposure to environmental tobacco smoke("ETS"(“ETS”);o-31-
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;oactual and proposed excise tax increases in the United States and foreign markets;odiversion into the United States market of products intended for sale outside the United States;othe sale of counterfeit cigarettes by third parties;opricedisparitiesgaps and changes in pricedisparitiesgaps between premium and lowest price brands;othe outcome of proceedings and investigations involving contraband shipments of cigarettes;ogovernmental investigations;oactual and proposed requirements regarding the use and disclosure of cigarette ingredients and other proprietary information;ogovernmental and private bans and restrictions on smoking;oactual and proposed price controls and restrictions on imports in certain jurisdictions outside the United States;oactual and proposed restrictions affecting tobacco manufacturing, marketing, advertising and sales inside and outside the United States;othe diminishing prevalence of smoking and increased efforts by tobacco control advocates to further restrict smoking; andoactual and proposed tobacco legislationin Congress and other jurisdictionsboth inside and outside the UnitedStates, including legislation to require the establishment of fire-safety standards for cigarettes.States.Excise
Taxes:Taxes: Cigarettes are subject to substantialfederal,local, state andlocalfederal excise taxes in the United States and to similar taxes inmostforeign 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 $4.10 per pack of 20 cigarettes. Further tax increases in various jurisdictions are currently under consideration or pending. Thus far in 2002, 21 states and the Commonwealth of Puerto Rico have implemented excise tax increases, ranging from $0.07 per pack in Tennessee to as much as $1.81 per pack in New York. Congress has considered significant increases in the federal excise tax or other payments from tobacco manufacturers, and significantSignificant increases in excise and other cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted at the local, state andlocalfederal levels within the United States andin many jurisdictions outside the United States. Inalso within the European Union (the"EU"“EU”), taxes on cigarettes vary considerablyandcurrently may be as high as the equivalent of $5.50 per pack of 20 cigarettes on the most popular brands (using the exchange rate at October 18, 2002). In Germany, where total tax on cigarettes is currently equivalent to $2.23 per pack of 19 cigarettes on the most popular brands, the excise tax is scheduled to increase by approximately the equivalent of $0.19 (using the exchange rate on Oct. 18, 2002) per pack of 19 cigarettes January 2003. In the opinion of PM Inc. and PMI, increasesin other foreign jurisdictions.Increases in excise and
similarother cigarette-related taxes have had and are expected to continue to have an adverse impact on sales of cigarettesparticularly the legitimate sales of cigarettes, and create an incentive for smokers to turn to untaxed or lower-taxed products. Any future increases, the extent of which cannot be predicted, may result in volume declines for the cigarette industry, includingby PMInc.USA and PMI due to lower consumption levels andmight also causeto a shift of salesto shiftfrom the premiumsegmentto the non-premiumincluding theor discountsegment. -34-Eachsegments or to sales outside ofthe countries currently anticipated to join the EU by 2004 will be required to increase excise levels to EU standards by a date negotiated with the EU, but in all cases to levels that may produce the results described above.legitimate channels.-32-
Tar and Nicotine Test Methods and Brand
Descriptors: SeveralDescriptors: Authorities in several jurisdictions have questioned the utility of standardized test methods to measure average tar and nicotine yields of cigarettes. InSeptember1997, the United States Federal Trade Commission("FTC"(“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. InFebruary 1998, PM Inc. and three other domestic cigarette manufacturers filed comments on the proposed revisions. In November1998, the FTCwrote torequested assistance from the Department of Health and Human Services("HHS"(“HHS”)requesting its assistancein developingspecific recommendations on the future of the FTC'sa testing program fortestingthe tar, nicotine, and carbon monoxide content of cigarettes. InNovember2001, the National Cancer Institute issueda report as a part of HHS' response to the FTC's request. The report stated, among other things,its Monograph 13 stating that there was no meaningful evidence of a difference in smoke exposure or risk to smokers between cigarettes with different machine-measured tar and nicotine yields. In September 2002, PMInc. filed a petition withUSA petitioned the FTCasking itto promulgate new rules governing the disclosure of average tar and nicotine yields of cigarette brands. PMInc. is askingUSA asked the FTC to take action in response to evolving scientific evidence about machine-measured low-yield cigarettes, including the National CancerInstitute'sInstitute’s Monograph 13, which represents a fundamental departure from the scientific and public healthcommunity'scommunity’s prior thinking about the health effects of low-yield cigarettes. Public health officials in other countries and the EU have stated that the use of terms such as"lights"“lights” to describelow yieldlow-yield cigarettes is misleading. Some jurisdictions have questioned the relevance of the method for measuring tar, nicotine, and carbon monoxide yields established by the InternationalStandards Organization.Organization for Standardization. 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 theUnited States, theEU and Braziland other countrieshavecalled for the prohibition of or passed legislation prohibitingprohibited the use of brand descriptors such as"Lights"“Lights” and"Ultra Lights." Brazil banned the use of descriptors“Ultra Lights,” and public health authorities inJanuary 2002. In the EU, Member States are required to pass legislation prohibiting by October 2003 the use of texts, names, trademarks and figurative orothersigns suggesting that a particular tobacco product is less harmful than others, which the EU and Member Statesjurisdictions havesuggested include the term "Lights" and other similar descriptors.called for such prohibitions. See Note8,10, which describes pending litigation concerning the use of brand descriptors.Food and Drug Administration
("FDA"(“FDA”)Regulations:Regulations: InAugust1996, the FDA promulgated regulations asserting jurisdiction over cigarettes as"drugs"“drugs” or"medical devices"“medical devices” under the provisions of the Food, Drug and Cosmetic Act("FDCA"(“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 inMarch2000.The CompanyPM USA has stated that while it continues to oppose FDA regulation over cigarettes as"drugs"“drugs” or"medical devices"“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,therebills areseveral billspending in Congress that, if enacted, would give the FDA authority to regulate tobacco products; PMInc.USA has expressed support foronecertain of the bills. The bills take a variety of approaches to the issue,of the FDA's proposed regulation of tobacco productsranging from codification of the original FDA regulations under the"drug"“drug” and"medical device"“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. In addition, some of the proposed legislation would impose fees to pay for the cost of regulation and other matters. The ultimate outcome of any Congressional action regarding the pending bills cannot be predicted.Ingredient Disclosure
Laws: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 toxicologicalinformation regarding the ingredients. In the United States, theinformation. The Commonwealth of Massachusettshasenacted 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-35-could result in the publicdisclosure of valuable proprietary information.In September 2000, the districtThe trial court granted theplaintiffs'manufacturers’ 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,which decision was affirmed by the United States Court of Appeals for the First Circuit,reversedsittingen banc and thedistrict court's decision, holding thatdeadline for an appeal to theMassachusettsUnited States Supreme Court has passed.-33-
Ingredient 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 arguments in January 2002. The ultimate outcome of this lawsuit cannot be predicted. Similarlegislation has been enacted or proposed in other states and in jurisdictions outside the United States, including the EU. In some jurisdictions, proposals have also been discussed that would permit governments to prohibit the use of certain ingredients. Under an EU tobacco product directive, tobacco companies are now required to disclose ingredients and toxicological information to each MemberState the use of, and provide toxicologicalState. In December 2002, PMI submitted this informationabout, ingredients in tobacco products by the end of 2002 and annually thereafter. PMI has already voluntarily disclosed the ingredients in its brandsto all EU Member States in anumber ofform it believes complies with this directive. In implementing the EUmember states and in other countries. Other jurisdictions have also enacted or proposed legislationtobacco product directive, the Netherlands has issued a decree that would require tobacco companies to disclose thesubmissioningredients used in each brand ofinformation about ingredients and would permit governmentscigarettes, including quantities used. PMI is considering a legal challenge toprohibit their use.this decree.Health Effects of Smoking and Exposure to
ETS:ETS: Reports with respect to the health risks of cigarette smoking have been publicized for many years, and 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 ofHealth and Human ServicesHHS 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 focused 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--includingdiseases—including lung cancer and heartdisease--indisease—in nonsmokers. In 2002, the International Agency for Research on Cancer concluded that ETS is carcinogenic and that exposure to ETS causes diseases in non-smokers.It is the policy of each of PM
Inc.USA 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 content of warnings in advertisements and on product packaging regarding the health effects of smoking, addiction and exposure to ETS.In 1999, PM
Inc.USA and PMI each established web sites that include, among other things, the views of public health authorities on smoking, disease causation in smokers, addiction and ETS. In October 2000, the sites were updated to reflect PMInc.'sUSA’s andPMI'sPMI’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
disease--includingdisease—including lung cancer and heartdisease--indisease—in non-smoking adults,as well asand causes 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 thatsecondhandsecond-hand smoke can exacerbate adult asthma and cause eye, throat and nasal irritation. Thesitesites alsostatesstate that the public should be guided by the conclusions of public health officials regarding the health effects of ETS in deciding whether to be in places where ETS is present or, if they are smokers, when and where to smoke around others. In addition,PM Inc. and PMI alsothe sites stateon their web sites that they believethat particular care should be exercised where children are concerned, and adults should avoid smoking around children. PMInc.USA and PMI also state on their sites that the-36-conclusions of the public health officials concerning ETS are sufficient to warrant measures that regulate smoking in public places, and that where smoking is permitted, the government should require the posting of warning notices that communicate public health officials'officials’ conclusions that second-hand smoke causes diseases in non-smokers.-34-
The World Health
Organization'sOrganization’s Framework Convention for TobaccoControl:Control: The World Health Organization("WHO"(“WHO”) 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 otherthings,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;adopt measures that would 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;phase out duty-free tobacco sales; andencourage litigation against tobacco product manufacturers.PM
Inc.USA and PMI have stated that they would support a 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
fifthsixth round of treaty negotiations was recently concluded and the WHOexpectshas indicated that the draft treaty will be presented for ratification torelease a revised draft ofthetreaty by mid-January,World Health Assembly in May 2003. The outcome of the treaty negotiations cannot be predicted.Other Legislative
Initiatives: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, thatwouldwould:subject cigarettes to various regulations under the HHS or regulation under the Consumer Products SafetyAct,Act;establish educational campaigns relating to tobacco consumption or tobacco control programs, or provide additional funding for governmental tobacco controlactivities,activities;further restrict the advertising ofcigarettes,cigarettes;-35-
require additional warnings, including graphic warnings, on packages and inadvertising,advertising;eliminate or reduce the tax deductibility of tobaccoadvertising,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 commonlaw,law; andallow 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
and/or adopted in a number of jurisdictions outside the United States. In 2001, the EU adopted a directive on tobacco product regulation requiring EU Member States to implement regulationsthat, among other things,that:reduce maximum permitted levels of tar, nicotine and carbon monoxide yields to 10, 1 and 10 milligrams,respectively,respectively;require manufacturers to disclose ingredients and toxicological data oningredients,ingredients;require rotational health warnings that coverat leastno less than 30% of the front panel of each pack of cigarettes and14 rotationalwarnings that cover no less than 40% of the backpanel,panel;require the health warnings to be surrounded by a blackborder,border;require the printing of tar, nicotine and carbon monoxide numbers on the side panel of the pack at a minimum size of 10% of the sidepanel,panel; andas described above,prohibitas of October 2003the use of texts, names, trademarks and figurative or other signs suggesting that a particular tobacco product is less harmful than others.EU Member States are in the process of implementing these regulations over the course of 2003 and 2004. The European Commission is currently working on guidelines for graphic warnings on cigarette packaging which are expected to be issued
byin 2003. In March 2003, theend of 2002.EUMember states are to wait for the guidelines before implementing any regulations on graphic warnings. The EU is also consideringadopted a new directivethat would restrictrestricting radio, press and Internet tobacco marketing and advertising thatcrossescross Member State borders. EU Member States are to implement this directive by July 31, 2005. 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'sState’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. On December 31, 2002, the State Office of Fire Prevention and Control published a proposed regulation to implement this legislation. On April 15, 2003, PM USA submitted comments concerning the proposed regulation, and will continue to participate in the public rule-making process. It is, however, not possible to predict the impact ofthisthe New York State lawon PM Inc.until thestandards are published.regulation is promulgated. Similar legislation is being considered in other states and localities,andat the federal level,as well asand 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
tothe tobacco industry generally.However, ifIf, however, any or all of the foregoing were to be implemented, the business, volume, results of-37-operations, cash flows and financial position of PM Inc.,USA, PMI andthe Company couldAltria Group, Inc. will be materially adversely affected.-36-
Governmental
Investigations: The CompanyInvestigations: ALG and its subsidiaries are subject to governmental investigations on a range of matters, includingthe following: As previously disclosed, the Companythose discussed below. ALG believes that Canadian authorities are contemplating a legal proceeding based on an investigation of PMI and its subsidiary, Philip Morris Duty Free Inc., relating to allegations of contraband shipments of cigarettes into Canada in the early tomid 1990s.mid-1990s. During 2001, the competitionauthoritiesauthority in Italyand Turkeyinitiatedseparate investigationsan investigation into the pricing activitiesamongby participants in that cigarette market. In March 2003, thecigarette marketsauthority issued its findings, and imposed fines totaling €50 million on certain affiliates ofthose countries.PMI. Theorder initiatingparties will have theItalian investigation namedright to appeal theCompanyauthority’s findings andcertain of itsany fines before the administrative court and thereafter before the supreme administrative court, and PMI’s affiliatesas well as all other parties purportedly engaged in the sale of cigarettes in Italy, including the Italian state tobacco monopoly. The Turkish investigation was directed at one of the Company's Turkish affiliates and another cigarette manufacturer.intend to appeal. In 2002, the Italian authorities, at the request of a consumer group, initiated an investigation into the use of descriptors forMarlboroLights.Lights. The investigation is directed atthe Company'sPMI’s German and Dutch affiliates, which manufacture product for sale in Italy. The competition authority issued its decision in September 2002, finding that the use of the term"lights"“lights” on the packaging of theMarlboro Lights brand is misleading advertising under Italian law, but that it was not necessary to take any actionat this timebecause the use of the term"lights"“lights” will be prohibited as of October 2003 under the EU directive on tobacco product regulation. The consumer group that requested the investigationhasindicated that itwillwould appeal the decision,seeking an order to remove Marlboro Lights frombut did not do so within themarket.permitted time period. The group has also requested that the public prosecutor in Naples, Italy investigate whether a crime has been committed under Italian law with regard to the use of the term"lights."“lights.” In October 2002, the consumer group filed new requests with the competition authority asking for investigation of the use of descriptors for additionallow yieldlow-yield brands, includingMerit Ultra Lights and certain brands manufactured by other companies. In 2001, authorities in Australia initiated an investigation into the use of descriptors, alleging that their use was false and misleading. The investigation is directed at one ofthe Company'sPMI’s Australian affiliates and other cigarette manufacturers.The CompanyPMI cannot predict the outcome of these investigations or whether additional investigations may be commenced.Tobacco-Related
Litigation:Litigation: There is substantial litigation pending related to tobacco products in the United States and certain foreign jurisdictions. See Note810 for a discussion of such litigation.State Settlement
Agreements:Agreements: As discussed in Note8,10, during 1997 and 1998, PMInc.USA 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 tobaccoindustry'sindustry’s 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; andfree sampling.In addition, the settlement agreements require companies to affirm corporate principles
to reducedirected at:reducing underage use of cigarettes;imposeimposing requirements regarding lobbying activities;mandatemandating public disclosure of certain industry documents;limit-37-
limiting theindustry'sindustry’s ability to challenge certain tobacco control and underage use laws; andprovideproviding for the dissolution of certain tobacco-related organizations andplaceplacing restrictions on the establishment of any replacement organizations.-38-Operating Results
For the Nine Months Ended September 30, --------------------------------------------------------------- Operating Net Revenues Companies Income -------------------------- ------------------------- (in millions) 2002 2001 2002 2001 --------- --------- -------- -------Domestic tobacco $14,921 $14,826 $4,222 $3,662 International tobacco 21,817 20,463 4,489 4,346 -------- -------- ------- ------- Total tobacco $36,738 $35,289 $8,711 $8,008 ======= ======= ====== ======
For the Three Months Ended March 31,
Net Revenues
Operating
Companies Income
(in millions)
2003
2002
2003
2002
Domestic tobacco
$
3,817
$
5,018
$
742
$
1,250
International tobacco
8,079
7,034
1,690
1,564
Total tobacco
$
11,896
$
12,052
$
2,432
$
2,814
Domestic tobacco.During the first
nine monthsquarter of2002,2003, PMInc.'sUSA’s net revenues, which include excise taxes billed to customers,increased $95 million (0.6%decreased $1.2 billion (23.9%)overfrom the comparable20012002 period. Excluding excise taxes, net revenues decreased$109 million (0.9%$1.0 billion (26.0%), due primarily to lower volume ($958818 million), partially offset byand higher promotional spending, net of higher pricingnet of promotional spending($832225 million).Operating companies income for the first
nine monthsquarter of2002 increased $5602003 decreased $508 million(15.3%(40.6%)overfrom the comparable20012002 period, due primarily tothe 2001 litigation related expenselower volume ($500514 million) and higher promotional spending, net of price increasesnet of promotional spendingand lower ongoing resolution costs(aggregating $897($27 million), partially offset by lowervolume ($630 million) and highermarketing, administration and researchcosts ($217 million, primarily marketing expenses). Excludingcosts. As discussed more fully in Note 10, and in theimpact“Debt and Liquidity” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, PM USA executed an appeal bond to stay execution of the2001 litigation related expense, operating companies income increased 1.4%. As reportedjudgment in thePrice case while that case is under appeal.PM USA uses information gathered by Management Science Associates to monitor shipment
volume forand the related share trends within the domestictobacco industry during the first nine months of 2002 decreased to 301.0 billion units, a 2.5% decrease from the first nine months of 2001. PM Inc.'s shipment volume for the first nine months of 2002 was 147.9 billion units, a decrease of 6.3% from the comparable 2001 period, due primarily to weak economic conditions, increases in state excise taxes, the growth of deep-discount cigarettes, competitive promotional activity and the increased incidence of counterfeit product. During the third quarter of 2002, plans were announced to invest approximately $350 million to promote the premium brands and retail presence of PM Inc. and PMI to enhance future volumes and market shares. On September 26, 2002, the Company announced plans for PM Inc. to increase its promotional programs and retail presence during the remainder of 2002. These plans will reduce fourth quarter operating companies income by $600 million to $650 million.cigarette industry. It should be noted that Management ScienceAssociates'Associates’ current measurements of the domestic cigaretteindustry'sindustry’s total shipments and related share data do not include all shipments of some manufacturers that Management Science Associates is presently unable to monitor effectively. Accordingly, it should also be noted that the discussion herein of PMInc.'sUSA’s performance within the industry is based upon Management ScienceAssociates'Associates’ estimates of total industry volume.As reported by Management Science Associates, shipment volume for the domestic tobacco industry during the first quarter of 2003 decreased 12.9% from the first quarter of 2002 to 88.2 billion units. PM USA’s shipment volume for the first quarter of 2003 was 43.8 billion units, a decrease of 16.1% from the comparable 2002 period. Comparisons to the first quarter of 2002 for PM USA were adversely affected by the timing and nature of promotional shipments and wholesalers’ decisions to rebuild inventory levels in the first quarter of 2002 after the January 1, 2002 increase in the federal excise tax rate. PM USA’s shipment volume comparisons also continued to be affected by a weak economic environment and resulting consumer frugality, sharp increases in state excise taxes and heightened competition, and continued to be disproportionately affected by price competition because of PM USA’s large share of the premium segment.
For the first
nine monthsquarter of2002,2003, PMInc.'sUSA’s shipment market share was49.1%49.7%, a decrease of2.01.9 share points from the comparable period of2001.2002.Marlboro shipment volume decreased5.46.5 billion units(4.5%(15.9%) from the firstnine monthsquarter of20012002 to114.834.2 billion units for a38.1%38.8% share of the total domestic tobacco industry, a decrease of0.81.4 share points from the comparable period of2001.2002. This volume and share performance wasdue primarily toalso adversely affected by the factors mentioned above. However, on a sequential basis, PM USA’s shipment market share increased by 1.4 share points from 48.3% in the fourth quarter of 2002, whileMarlboro’s shipment market share increased 1.4 share points from 37.4% in the fourth quarter.-38-
Based on shipments, the premium segment accounted for approximately
73.0%72.9% of the domestic tobacco industry volume in the firstnine monthsquarter of2002,2003, a decrease of1.11.6 share points from the comparable period of2001.2002. In the premium segment, PMInc.'sUSA’s volume decreased5.4%15.4% during the firstnine monthsquarter of2002,2003, compared with a4.0%14.7% decrease for thetotal domestic tobaccoindustry, resulting in a premium segment share of60.7%62.1%, a decrease of0.90.6 share points from the firstnine monthsquarter of2001,2002, due primarily tocompetitive promotional activitya weak economic environment and resulting consumer frugality, and heightened competition. However, on a sequential basis, premium share of the total domestic tobacco industry in the first quarter of 2003 increasedincidence0.9 share points from 72.0% in the fourth quarter ofcounterfeit product. -39-2002, while PM USA’s premium segment share increased 1.6 share points. In the discount segment, PM
Inc.'sUSA’s shipments decreased13.7%22.8% to14.53.9 billion units in the firstnine monthsquarter of2002,2003, compared with a total domestic tobacco industryincreasedecrease of1.8%7.7%, resulting in a discount segment share of17.9%16.3%, a decrease of 3.2 share points from the comparable period of2001.2002.Basic shipment volume for the firstnine monthsquarter of20022003 was down10.3%21.4% to13.83.7 billion units, for a16.9%15.6% share of the discount segment, down2.32.7 share points compared to the firstnine monthsquarter of2001,2002, due primarily to the growth of deep-discount cigarettes and increased competitive promotional activity.AccordingEffective with the first quarter of 2003, PM USA is reporting retail market share results based on an enhanced retail tracking service, the IRI/Capstone Total Retail Panel. This new service was developed to provide a more comprehensive measure of market share in all retail outlets selling cigarettes, versus approximately 87% coverage in the previous service. Retail market share data for the fourth quarter of 2002 has been restated to reflect this new retail service. PM USA’s retail market share is lower using data from
Information Resources Inc./the IRI/Capstone Total Retail Panel compared to its previous service, because the new service expands coverage into stores where PMInc.'sUSA historically had a lower retail presence. The new service’s audit sample was not complete until the fourth quarter of 2002. Consequently, PM USA is not reporting retail market share comparisons versus the year-ago period. However, sequential retail market share comparisons to the fourth quarter of 2002 are provided. The new service cannot be meaningfully compared to previously reported retail market shares, which reflected data projected to a smaller universe of stores.Based on data from the new IRI/Capstone Total Retail Panel, PM USA’s retail market share increased from the fourth quarter of 2002 to the first quarter of 2003, aided by PM USA’s new off-invoice promotional allowance program that is paid at the wholesale level on its four focus brands. The promotional program broadens the reach of these brands’ price promotions to a greater number of retail stores and has been extended through June 2003.
PM USA essentially held its share of
cigarettes sold at retail decreased 0.8 share points to 50.0% forboth thefirst nine months of 2002. Marlboro's retail share for the first nine months of 2002 was flat at 38.2%premium andPM Inc.'s retaildiscount segments, as its share of the premium segmentgrewdeclined 0.1 share point to 61.0% versus the fourth quarter of 2002 and its share of the discount segment increased 0.1 share point to 15.7%. Total industry retail market share for the discount segment decreased from the fourth quarter of 2002 to the first quarter of 2003 by 0.4 share points to62.0%. Retail share for Basic,28.1%, while growth of the deep-discount segment moderated.During the first quarter of 2003, PM
Inc.'s major discount brand, decreased 0.1 share points to 4.9%. Information Resources Inc./Capstone isUSA launched aproprietary retail tracking servicenew line extension,MarlboroBlend No. 27, which began shipping nationwide during the last week of March. PM USA also announced thatuses a sample of stores to project market share performanceit will launch another new line extension,Parliament Ultra Lights in theuniversesecond quarter ofstores2003.During the first quarter of 2003, PM
Inc.'s sales representatives regularly visit.USA announced that it is moving its corporate headquarters from New York City to Richmond, Virginia, with the move to be completed by June 2004. PMInc.USA estimates thatthis universe (which doesthe total cost of the relocation will be approximately $120 million, including compensation to those employees who do notinclude stores added during a recent retail coverage expansion) represents approximately 87%relocate, and is expected to result in annual cost savings ofindustry volume.$60 million for PMInc. believes thatUSA beginning in 2005. The announced move had no impact on operating results for thesharefirst quarter ofdeep-discount cigarettes sold at retail2003, inthose stores not regularly visited by its sales representatives may be higher than in those stores whose sales are reflected inaccordance with recently adopted Statement of Financial Accounting Standards (“SFAS”) No. 146 “Accounting for Costs Associated with Exit or Disposal Activities,” which requires theInformation Resources Inc./ Capstone data. PM Inc. is working to develop a new approach to more comprehensively track retail performance.recognition of exit or disposal costs when incurred.-39-
In March 2002, PM
Inc.USA 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 PMInc.USA equates to a $0.02 increase in the price to wholesalers of each pack of twenty cigarettes.PM
Inc.USA cannot predict future changes or rates of change in domestic tobacco industry volume, the relative sizes of the premium and discount segments or in PMInc.'sUSA’s shipments, shipment market share or retail market share; however, it believes that PMInc.'sUSA’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“Tobacco—Business Environment."”International tobacco.During the first
nine monthsquarter of2002,2003, international tobacco net revenues, which include excise taxes billed to customers, increased$1.4$1.0 billion(6.6%(14.9%) over the firstnine monthsquarter of2001.2002. Excluding excise taxes, net revenues increased$592$358 million(5.5%(9.7%), due primarily to favorable currency movements ($226 million), higher volume/mix ($350129 million) and price increases ($32734 million), partially offset by unfavorable currency movements..Operating companies income for the first
nine monthsquarter of20022003 increased$143$126 million(3.3%(8.1%) over the comparable20012002 period, due primarily toprice increasesfavorable currency movements ($32785 million)and, higher volume/mix ($9576 million) and price increases ($34 million), partially offset byunfavorable currency movements ($225 million) and pre-tax charges for separation programs and asset impairment ($58 million) in 2002. Excluding 2002 pre-tax charges for the separation programs and asset impairment, operating companies income increased 4.6%. PMI'shigher investment spending.PMI’s volume for the first
nine monthsquarter of20022003 of557.3190.7 billion units increased14.26.7 billion units(2.6%(3.6%) over the firstnine monthsquarter of2001,2002, due primarily to volume increases in Central & Eastern Europe,Japan,AsiaTurkeyandworldwide duty-free,Latin America, partially offset by lower volumefrom lower overall marketsinFranceWestern Europe andSpain, economic weakness in Egypt and continued price competition in Poland.the Middle East. Volume advanced in a number of important markets, includingGermany,Spain, Austria, Greece, theBenelux countries, Austria,Czech Republic, Poland, Romania, Turkey, Russia,Japan (partially offset bythenegative impact of the temporary shut down of U.S. West Coast shipping ports during the third quarter of 2002),Ukraine, Japan, Taiwan, Thailand,Indonesia,Argentina, Brazil andBrazil.Mexico. International volume forMarlboro decreased1.6%1.5%, due primarily tothe timing of shipmentstax-driven price increases in France andSpain, consumer downtrading to lower-priced brands in the Czech Republic, Turkey, Saudi Arabia, Egypt, Lebanon, Russia and Argentina, and intense priceGermany, low-price competition inPoland,Italy and anti-American sentiment in certain markets, partially offset by higher volumes inGermany, Italy, Austria, Romania, the Ukraine,Russia, JapanIndonesiaandworldwide duty-free. In many markets exhibiting downtrading from Marlboro, volume increased for other brands in PMI's portfolio.Argentina. PMI recorded market share gains in many of its majormarkets. -40-
For the Three Months Ended September 30, -------------------------------------------------------------- Operating Net Revenues Companies Income --------------------------- ------------------------ (in millions) 2002 2001 2002 2001 --------- --------- -------- -------Domestic tobacco $ 5,022 $ 5,144 $1,518 $1,577 International tobacco 7,644 6,742 1,522 1,440 ------- ------- ------ ------ Total tobacco $12,666 $11,886 $3,040 $3,017 ======= ======= ====== ======Domestic tobacco. During the third quarter of 2002, PM Inc.'s net revenues, which include excise taxes billed to customers,markets including Germany, Japan, Russia, Spain and Turkey. Market share decreased$122 million (2.4%) from the comparable 2001 period. Excluding excise taxes, net revenues decreased $195 million (4.6%),in Western Europe, due primarily tolower volume ($309 million), partially offsetItaly, where share loss was also aggravated byhigher pricing, net of promotional spending ($103 million). Operating companies income for the third quarter of 2002 decreased $59 million (3.7%) from the comparable 2001 period, due primarily to lower volume ($201 million) and higher promotional spending, partially offset by higher pricing. As reported by Management Science Associates,distortions in competitor shipmentvolume for the domestic tobacco industry during the third quarter of 2002 decreased to 101.5 billion units, a 3.1% decrease from the third quarter of 2001, despite one extra shipping day in the third quarter of 2002. PM Inc.'s shipment volume for the third quarter of 2002 was 49.4 billion units, a decrease of 6.0% from the comparable 2001 period, due primarily to weak economic conditions, increases in state excise taxes, the growth of deep-discount cigarettes, competitive promotional activity and the increased incidence of counterfeit product. As previously noted, on September 26, 2002, the Company announced plans to increase retail promotional programs during the remainder of 2002 and indicated that the reach of such programs will be broadened due to expanded retail coverage. 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 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 third quarter of 2002, PM Inc.'s shipment share was 48.7%, a decrease of 1.5 share points from the comparable period of 2001. Marlboro shipment volume decreased 1.1 billion units (2.7%) from the third quarter of 2001 to 38.8 billion units for a 38.2% share of the total domestic tobacco industry, an increase of 0.1 share points over the comparable period of 2001. Based on shipments, the premium segment accounted for approximately 72.4% of the domestic tobacco industry volume in the third quarter of 2002, a decrease of 1.3 share points from the comparable period of 2001. In the premium segment, PM Inc.'s volume decreased 4.3% during the third quarter of 2002, compared with a 4.9% decrease for the total domestic tobacco industry, resulting in a premium segment share of 60.9%, an increase of 0.3 share points over the third quarter of 2001. This volume decline was due primarily to competitive promotional activity and the increased incidence of counterfeit product. In the discount segment, PM Inc.'s shipments decreased 19.4% to 4.6 billion units in the third quarter of 2002, compared with a total domestic tobacco industry increase of 1.8%, resulting in a discount segment share of 16.6%, a decrease of 4.3 share points from the comparable period of 2001. Basic shipment volume for the third quarter of 2002 was down 17.2% to 4.4 billion units, for a 15.8% share of the discount segment, down 3.6 share points compared to the third quarter of 2001, due primarily to the growth of deep-discount cigarettes and competitive promotional activity. -41-According to retail data from Information Resources Inc./Capstone, PM Inc.'s share of cigarettes sold at retail decreased 1.5 share points to 49.2% for the third quarter of 2002. The combined retail share for PM Inc.'s four focus brands, Marlboro, Parliament, Virginia Slims and Basic, was down 0.7 share points to 46.5%, due primarily to Marlboro's decline of 0.7 share points to 37.7%. PM Inc.'s retail share of the premium segment declined 0.1 share points to 61.7%. Retail share for Basic, PM Inc.'s major discount brand, decreased 0.2 share points to 4.8%. Information Resources Inc./Capstone is a proprietary retail tracking service that uses a sample of stores to project market share performance in the universe of stores PM Inc.'s sales representatives regularly visit. PM Inc. estimates that this universe (which does not include stores added during a recent retail coverage expansion) represents approximately 87% of industry volume. PM Inc. believes that the share of deep-discount cigarettes sold at retail in those stores not regularly visited by its sales representatives may be higher than in those stores whose sales are reflected in the Information Resources Inc./ Capstone data. PM Inc. is working to develop a new approach to more comprehensively track retail performance. 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 third quarter of 2002, international tobacco net revenues, which include excise taxes billed to customers, increased $902 million (13.4%) over the third quarter of 2001. Excluding excise taxes, net revenues increased $346 million (9.8%), due primarily to price increases ($147 million), higher volume/mix ($38 million) and favorable currency movements. Operating companies income for the third quarter of 2002 increased $82 million (5.7%) over the comparable 2001 period, due primarily to price increases ($147 million) and favorable currency movements, partially offset by lower volume/mix ($31 million, due primarily to unfavorable mix resulting from downtrading in weak economies and delay of shipments to Japan discussed below) and pre-tax charges for separation programs and asset impairment ($33 million) in 2002. Excluding 2002 pre-tax charges for separation programs and asset impairment, operating companies income increased 8.0%. PMI's volume for the third quarter of 2002 of 187.8 billion units increased 4.3 billion units (2.3%) over the third quarter of 2001, due primarily to volume increases in Western, Central and Eastern Europe, partially offset by lower shipments to Japan as a result of the temporary shutdown of U.S. West Coast shipping ports. Volume advanced in a number of important markets, including Greece, Germany, Italy, Spain, the Czech Republic, Romania, Turkey, Russia, the Philippines, Taiwan, Malaysia, Thailand, Australia, Argentina and Brazil. In Germany, volume increased 5.4% and share was up 0.4 share points, reflecting PMI's continued recovery in that market. In France, volume decreased due primarily to the timing of shipments. In Japan, volume decreased due primarily to the shipment delays caused by the temporary shutdown of U.S. West Coast shipping ports during the third quarter of 2002. Volume declined in Egypt and Poland, reflecting economic recession and continued price competition, and Saudi Arabia due to price competition. In Korea, volume declined due to heightened competition and lower industry sales. Volume declined in Mexico, reflecting the effect of differing trade purchasing patterns as a result of the different year- over-year timing of price increases. International volume for Marlboro decreased 1.7%, as lower volumes in France, the United Kingdom, Egypt, Saudi Arabia, Korea, Argentina and Mexico were partially offset by higher volumes in Japan, Spain, Romania, the Philippines and world-wide duty-free. In many markets exhibiting downtrading from Marlboro, volume increased for other brands in PMI's portfolio.patterns.Food
- ----Business Environment
Kraft Foods Inc. (“Kraft”) is the largest branded food and beverage company headquartered in the United States and 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.
KFIKraft Foods International, Inc. (“KFI”) manufactures-42-and markets 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 internationalcompetitors 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
costsprices 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. Dairyand coffeecommoditycostsprices on average have been lower than those incurred in2001,the first quarter of 2002, while cocoa bean priceshave beenincreased significantly and coffee bean prices were also higher than in2001. Recently, coffee commodity prices have been increasing due to drought concerns intheBrazilian coffee belt and cocoa commodity prices have increased further due to political and military unrest in the Ivory Coast.first quarter of 2002.On December 11, 2000,
the Company,Altria Group, Inc., through Kraft, acquired all of the outstanding shares ofNabisco. During 2001, certainNabiscobusinesses 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, which is no longer held for sale, has been included in the 2002 consolidated operating results of KFNA.Holdings Corp. (“Nabisco”). The closure of a number of Nabisco domestic and international facilities resulted-40-
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
$190$200 million has been spent throughSeptember 30, 2002.March 31, 2003. Substantially all of the closureswill bewere completedbyas of December 31, 2002, and theend of 2002.remaining payments relate to salary continuation for severed employees and lease payments.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.KFNA incurred pre-tax integration costs of$75 million during the second quarter of 2002,$27 million during the first quarter of2002, $37 million2002. In addition, duringthe third quarter of 2001 and $16 million during the fourth quarter of 2001. KFI incurred pre-tax integration costs of $17 million during the second quarter of 2002. Duringthe first quarter of 2002, approximately 700 employees accepted the benefits offered by avoluntary retirement program. As a result, Kraft recorded a pre-tax chargeseparation program for certain salaried employees. Pre-tax charges of$142 million related to the voluntary retirement program, of which$135 millionrelated to KFNA. These charges aggregated to $314and $7 millionslightly above Kraft's original estimate. On October 31, 2002, KFI sold its Latin American yeast and industrial bakery ingredients business for approximately $110 million. The resulting gain will bewere recorded in thefourth quarteroperating results of2002.the North American and international food segments, respectively, for these separation programs.In April 2003, KFI completed the acquisition of a biscuits business in Egypt and announced an agreement to sell its retail rice business in Germany, Austria and Denmark, subject to approval by the German competition authorities.
During the
thirdfirst quarter of 2002, KFI acquired asnacks company in Turkey and during the first quarter of 2002, acquired abiscuits business inAustralia. The total cost of these and other smaller businesses purchased during the first nine months of 2002 and 2001 was $119Australia for $62 million and$107 million, respectively. During 2001, KFI purchased coffee businesses in Romania, Morocco and Bulgaria, and also acquired confectionery businesses in Russia and Poland. 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 half of 2002,KFNA sold several small North American food businesses, which were previously classified as businesses held for sale, for $81 million. The net revenues and operating results of the businessesdivestedheld for sale, which were not significant, were excluded from Altria Group, Inc.’s condensed consolidated statements of earnings and no gain or loss was recognized on these sales.The operating results of businesses acquired and sold were not material to
KFNA's or the Company'sAltria Group, Inc.’s consolidated financial position or operating resultsof operationsin any of the periods presented.-43-Operating Results
For the Nine Months Ended September 30, -------------------------------------------------------------- Operating Net Revenues Companies Income ------------------------- ------------------------ (in millions) 2002 2001 2002 2001 ------- ------- ------ ------North American food $16,087 $15,813 $3,770 $3,679 International food 5,789 5,875 851 814 ------- ------- ------ ------ Total food $21,876 $21,688 $4,621 $4,493 ======= ======= ====== ======
For the Three Months Ended March 31,
Net Revenues
Operating
Companies Income
(in millions)
2003
2002
2003
2002
North American food
$
5,380
$
5,294
$
1,297
$
1,098
International food
1,979
1,853
237
252
Total food
$
7,359
$
7,147
$
1,534
$
1,350
North American food.During the first
nine monthsquarter of2002,2003, net revenues increased$274$86 million(1.7%(1.6%) over the firstnine monthsquarter of2001. Excluding businesses divested since the beginning of 2001 and adjusting for businesses previously held for sale, net revenues increased $122 million (0.8%),2002, due primarily to higher volume/mix ($26253 million) and higher pricing ($43 million), partially offset bylower pricing ($137 million).unfavorable currency movements and the divestiture of a small confectionery business in the fourth quarter of 2002.Operating companies income for the first
nine monthsquarter of20022003 increased$91$199 million(2.5%(18.1%) over the comparable period of2001. Excluding the2002,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) and 2001 integration costs ($37 million), as well as the impact of businesses divested since the beginning of 2001 and the impact of businesses previously held for sale, operating companies income increased $241 million (6.4%),due primarily to the absence of separation and integration charges recorded in 2002 ($162 million) and highervolume/mixpricing, net of cost increases on certain businesses, lower cheese commodity costs and productivity and synergy savings ($11787 million),favorable margins ($95 million, including productivity savings) and lowerpartially offset by higher marketing, administration and research costs ($8327 million, includingsynergy savings).higher benefit costs) and unfavorable volume/mix.Volume for the first
nine monthsquarter of20022003 increased7.4%1.3% over the comparable period for2001. 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 2.5%. In Cheese, Meals and Enhancers, volume decreased due primarily to lower shipments in cheese and food service. Cheese volume declined, as lower dairy costs in the second and third quarters of 2002 resulted in aggressive competitive activity by private label manufacturers as they reduced prices and increased merchandising levels. Shipments to food service customers were also lower, driven by the exit of low-margin businesses and distributor consolidation in the food service industry during the first and second quarters of2002.These decreases were partially offset by higher shipments of pourable dressings, barbecue sauce and steak sauce, and the 2001 acquisition of It's Pasta Anytime. Volume increased in Biscuits, Snacks and Confectionery, driven primarily by higher shipments of biscuits, which benefited from new product introductions, and higher shipments of snacking nuts to non-grocery channels, partially offset by lower confectionery shipments due to competitive activity in the breath freshening category.Volume gains were achieved in Beverages, Desserts and Cereals, driven primarily by ready-to-drink beveragescoffee, dessertsandcereals.cereals, which were aided by new product introductions, partially offset by the shift in Easter shipments. In Oscar Mayer and Pizza, volume increased, due primarily toincreaseshigher volume in frozen pizza, bacon, hot dogs,bacon,lunch combinations and soy-based meatalternativesalternatives. In Cheese, Meals andfrozen pizza, benefiting fromEnhancers, volume decreased slightly, due primarily to the shift in Easter shipments and lower trade inventories, partially offset by increased shipments in Canada and Mexico. Volume in KFNA’s food service business in the United States increased due to higher shipments to-41-
national accounts. Volume decreased in Biscuits, Snacks and Confectionery due to the divestiture of a confectionery business in 2002, trade inventory reductions and a planned shift to lower-weight, higher-revenue-per-pound new products.
International food. Net revenues for the first
nine monthsquarter of2002 decreased $862003 increased $126 million(1.5%(6.8%)fromover the firstnine monthsquarter of2001. Excluding businesses divested since the beginning of 2001 and adjusting for businesses previously held for sale, net revenues decreased $90 million (1.5%),2002, due primarily tounfavorablefavorable currency movements ($24587 million) and higher pricing ($73 million), partially offset by lower volume/mix ($25 million) and the impact ofacquisitions ($113 million) and higher pricing ($54 million).a divestiture in the fourth quarter of 2002.Operating companies income for the first
nine monthsquarter of2002 increased $372003 decreased $15 million(4.5%(6.0%)overfrom the firstnine monthsquarter of2001. Excluding pre-tax charges for the voluntary retirement program ($7 million) and integration costs ($17 million), the impact of businesses divested since the beginning of 2001, as well as the impact of businesses previously held for sale, operating companies income increased $61 million (7.5%),2002, due primarily tolowerhigher marketing, administration and research costs ($54 million, including synergy savings), favorable margins ($2325 million) andthe impact of acquisitionslower volume/mix ($1321 million), partially offset byunfavorable volume/mixhigher pricing, net of cost increases ($2317 million), the 2002 charge for separation programs ($7 million) andunfavorablefavorable currency movements ($87 million).-44-Volume for the first
nine monthsquarter of 2003 decreased 3.2% from the first quarter of 2002,increased 2.3% overdue primarily to thefirst nine monthsdivestiture of2001. Excludinga Latin American bakery ingredients business in 2002, theimpact of divested businessesnational strike in Venezuela andafter adjusting fortheimpact of businesses previously held for sale (the basis of presentation for all of the following KFI volume comparisons), volume increased 3.1%, benefiting from growthshift indeveloping markets, acquisitions andEaster shipments, partially offset by new productintroductions.launches, marketing programs and the 2002 acquisition of a snacks business in Turkey.In Europe, Middle East and Africa, volume increased over the first
nine monthsquarter of2001,2002, benefitingfrom acquisitions andfrom growth inmostmany countries across theregion.region, an acquisition in Turkey and new product introductions, partially offset by a shift in Easter shipments and price competition in select markets impacting the European Union. In beverages, volume increased, driven primarily by coffee inboth coffee and refreshment beverages. Coffee volume grew in many countries,most markets, including France, Germany,Austria, Sweden andItaly, Poland andbenefited from acquisitions in Romania, Morocco and Bulgaria. Refreshment beverages volume increased, driven by powdered beverages in the Middle East, the Slovak and Czech Republics and Morocco.Russia. Snacks volume increased,driven bybenefiting from an acquisition in Turkey and continued growthin several markets including France, Hungary and the Ukraine and fromof confectioneryacquisitionsbusinesses in Russia and Poland, partially offset by the shift in Easter shipments. Cheese volume was comparable with prior year, as gains in cream cheese and cheese slices in Italy were offset by lower volume in Germany andRomania.Iberia due to increased price competition. In grocery, volumeincreased,declined, due primarily to lower sales inSouth Africa and higher spoonable dressings volume in Germany. Volume forthe European Union. In convenient meals,also increased, due primarilyvolume was comparable tolunch combinations in the United Kingdom andprior year as higher shipments of canned meats in Italyagainst a weak comparisonwere offset primarily by declines in2001. Cheese volume was flat in comparison with prior year.Germany.Volume
increaseddecreased in the Latin America and Asia Pacific region,drivenimpacted bygains acrossthe divestiture of anumber of marketsLatin American bakery ingredients business in 2002, the national strike in Venezuela and theacquisition of a biscuits companyshift inAustralia,Easter shipments, partially offset bydeclinesgrowth incertain countries due to the impact of weak economies and lower results in China.most Asia Pacific markets. Beverages volume increased,due primarily to growthwith gains inrefreshment beverages in Brazil, Argentina, the Philippines and Venezuela. Snacks volume increased, driven primarily by higher biscuits and confectionery volume in Brazil, and by the 2002 acquisition in Australia, partially offset by the negative impact of the continued economic weakness in Argentina and distributor inventory reductions in China. Cheese and grocery volume decreased, due to lower sales in Latin America and Asia Pacific.
For the Three Months Ended September 30, -------------------------------------------------------------- Operating Net Revenues Companies Income ------------------------ ------------------------- (in millions) 2002 2001 2002 2001 ------ ------ ------ -----North American food $5,225 $5,151 $1,303 $1,183 International food 1,991 1,867 300 277 ------ ------ ------ ------ Total food $7,216 $7,018 $1,603 $1,460 ====== ====== ====== ======North American food. During the third quarter of 2002, net revenues increased $74 million (1.4%) over the third quarter of 2001, due primarily to higher volume/mix ($155 million) and businesses previously held for sale ($54 million), partially offset by lower pricing ($125 million). Excluding the businesses divested since the beginning of 2001 and adjusting for businesses previously held for sale, net revenues increased 0.5%. Operating companies income for the third quarter of 2002 increased $120 million (10.1%) over the comparable period of 2001, due primarily to higher volume/mix ($87 million), favorable margins ($64 million, including productivity savings), synergy savings and 2001 integration costs ($37 million), partially offset by higher marketing, administration and research costs ($45 million). Excluding the businesses divested since the beginning of 2001, the 2001 pre-tax charge for integration costs and adjusting for businesses previously held for sale, operating companies income increased 6.0%. Volume for the third quarter of 2002 increased 8.1% 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 3.0%. In Cheese, Meals and Enhancers, volume increased due primarily to higher food services volume and higher shipments of pourable and spoonable dressings and barbecue sauce. These increases were partially offset by a decline in cheese volume as lower dairy costs in the third quarter of 2002 resulted in aggressive competitive activity by private label manufacturers -45-as they reduced prices and increased merchandising levels. Volume decreased slightly in Biscuits, Snacks and Confectionery, driven primarily by a decline in confectionery shipments, due to trade inventory reductions and increased competitive activity in the breath freshening category, partially offset by volume gains resulting from the introduction of new biscuit and confectionery products. Volume gains were achieved in Beverages, Desserts and Cereals, driven primarily by ready-to-drink beverages, coffee and cereals. In Oscar Mayer and Pizza, volume increased due primarily to increases in hot dogs, bacon, soy-based meat alternatives and frozen pizza, partially offset by consumption declines in luncheon meats. International food. Net revenues for the third quarter of 2002 increased $124 million (6.6%) over the third quarter of 2001. After adjusting for businesses held for sale, net revenues increased $122 million (6.5%), due primarily to higher pricing ($62 million), higher volume/mix ($31 million) and the impact of acquisitions. Operating companies income for the third quarter of 2002 increased $23 million (8.3%) over the third quarter of 2001, due primarily to favorable margins ($30 million, including productivity and synergy savings), favorable currency movements ($6 million) and the impact of acquisitions, partially offset by higher marketing, administration and research costs ($22 million, primarily marketing). Volume for the third quarter of 2002 increased 3.8% over the third quarter of 2001. After adjusting for the impact of businesses held for sale (the basis of presentation for all of the following KFI volume comparisons), volume increased 4.2%. In Europe, Middle East and Africa, volume increased over the third quarter of 2001, driven by acquisitions, growth in several markets including France, Italy, the United Kingdom, Russia, the Middle East, and an improvement in Germany. In beverages, volume increased, driven by growth inboth coffee and refreshment beverages. Snacks volumeincreased, drivendecreased, impacted byhigher confectionery volume reflecting new product introductionsthe national strike in Venezuela andconfectionery acquisitionsthe shift inRussia and Poland,Easter shipments, partially offset bylowerbiscuits volumeresulting from price competitiongrowth inGermany. Cheese volume increased, driven by growth across the region, except in Germanymany markets, including Brazil, Central America, Australia, Southeast Asia andAustria.China. In grocery, volume declined in Latin America due to the divestiture of a bakery ingredients business.Financial Services
Business Environment
As a result of a recent strategic review of its business, Philip Morris Capital Corporation (“PMCC”) is shifting its strategic focus from an emphasis on new lease investments to maximizing gains from asset sales and generating cash flows from its current portfolio of leased assets. This decision will enable PMCC to realize these gains and enhance cash flow through an orderly and systematic disposition of assets over an extended period of time. The new strategy will result in reduced operating companies income over time, due to the lack of new lease investments, partially offset by gains on asset sales and lease terminations.
Among other leasing activities, PMCC leases a number of aircraft, predominantly to major United States carriers. At March 31, 2003, approximately 25%, or $2.3 billion of PMCC’s investment in finance leases related to aircraft.
On March 31, 2003, US Airways Group, Inc. (“US Airways”) emerged from Chapter 11 bankruptcy protection. PMCC currently leases 16 Airbus A319 aircraft to US Airways under long-term leveraged leases, which expire
-42-
in 2018 and 2019. The aircraft were leased in 1998 and 1999 and represent an investment in finance leases of $137 million, which equals 1.5% of PMCC’s portfolio of finance assets, at March 31, 2003. Pursuant to an agreement reached between PMCC and US Airways, these leases were affirmed by US Airways when it emerged from bankruptcy. This agreement resulted in a $13 million write-off against PMCC’s allowance for losses during the first quarter of 2003 and a reduction of $7 million of lease income which will be recognized over the remaining terms of the leases.
On December 9, 2002, United Air Lines Inc. (“UAL”) filed for Chapter 11 bankruptcy protection. At that time, PMCC leased 24 Boeing 757 aircraft to UAL, 22 under long-term leveraged leases and two under long-term single investor leases. Subsequently, PMCC purchased $239 million of senior nonrecourse debt on 16 of the aircraft under leveraged leases, which were then treated as single investor leases for accounting purposes. As of February 28, 2003, PMCC entered into an agreement with UAL to amend these 16 leases as well as the two single investor leases. Among other modifications, the subordinated debt outstanding on these 16 leveraged leases was cancelled by UAL. As of March 31, 2003, PMCC’s aggregate exposure to UAL totaled $617 million, which equals 6.7% of PMCC’s portfolio of finance assets at March 31, 2003. PMCC continues to negotiate with UAL as UAL continues its efforts to restructure and emerge from bankruptcy.
PMCC also leases twenty-eight MD-80 aircraft to American Airlines, Inc. (“American”) under long-term leveraged leases. The aircraft represent an investment in finance leases of $241 million, which equals 2.6% of PMCC’s portfolio of finance assets at March 31, 2003. In connection with American’s efforts to avoid a bankruptcy filing, PMCC, American and the leveraged lease lenders entered into an agreement in May 2003 to restructure the leases on fourteen of the aircraft. This agreement is conditioned on, among other things, American not seeking protection under the bankruptcy laws and on American receiving certain concessions from its employees and other creditors. The agreement will become effective when American provides an officer’s certificate demonstrating the required level of concessions. This is expected to occur shortly. The agreement, as presently written, will result in a $28 million write-off against PMCC’s allowance for losses that will be recorded when the agreement becomes effective. Leases on the remaining fourteen aircraft were unchanged.
In recognition of the economic downturn in the airline industry, PMCC increased its allowance for losses by $290 million in the fourth quarter of 2002. It is possible that further adverse developments in the airline industry may occur, which might require PMCC to record an additional allowance for losses in future periods.
Operating Results
2003
2002
(in millions)
Net revenues:
Quarter ended March 31,
$
116
$
117
Operating companies income:
Quarter ended March 31,
$
83
$
71
PMCC’s net revenues for the first quarter of 2003 decreased $1 million (0.9%) from the first quarter of 2002. Operating companies income increased $12 million (16.9%) over the comparable period in 2002, due primarily to
higher spoonable dressings volume in Germany and Italy. Volume for convenient meals alsoincreaseddue 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 several markets and the acquisition of a biscuits company in Australia, partially offset by declines in certain countries due to the impact of weak economies. Beverages volume increased, due primarily to growth in powdered beverages in Brazil, China and Venezuela, benefitingincome fromnew product introductions. Cheese volume decreased, due to lower sales in Latin America and the Philippines. Grocery volume was lower, due primarily to lower sales in Latin America and Asia Pacific. Snacks volume increased, driven primarily by gains in biscuits due to line extensions, geographic expansion and the acquisition in Australia, partially offset by lower volume in Argentina, Indonesia and China. Convenient meals volume increased due to higher volume in Argentina. Financial Services - ------------------ Operating Results
2002 2001 ---- ---- (in millions)Net revenues: Nine months ended September 30, $379 $321 ==== ==== Quarter ended September 30, $114 $110 ==== ==== Operating companies income: Nine months ended September 30, $257 $215 ==== ==== Quarter ended September 30, $ 82 $ 75 ==== ====-46-Philip Morris Capital Corporation's ("PMCC") net revenues and operating companies income for the first nine months of 2002 increased $58 million (18.1%) and $42 million (19.5%), respectively, over the first nine months of 2001. These increases were due primarily to growth in leasing activities and gains derived from PMCC's finance asset portfolio, including a significant gain during the second quarter from the early termination of a lease. During the third quarter of 2002, net revenues and operating companies income increased $4 million (3.6%) and $7 million (9.3%), respectively, over the third quarter of 2001, due primarily to the growth inleasing activities.Financial Review
- ----------------Net Cash Provided by Operating Activities
- -----------------------------------------During the first
nine monthsquarter of2002,2003, net cash provided by operating activities was$9.9$2.2 billion compared with$7.9$1.1 billion during the comparable20012002 period. The increase is due primarily to the timing of payments for tobacco litigation settlement agreements, which were made in April of 2003 and in March of 2002. Partially offsetting this increase were higher pension plan contributions and lower netearnings and the 2001 litigation related payment of escrow bonds for domestic tobacco.earnings.Net Cash Used in Investing Activities
- -------------------------------------One element of the growth strategy of
the Company's operatingALG’s subsidiaries is to strengthen their brand portfolios through active programs of selective acquisitions and divestitures.The Company'sALG’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.-43-
During the first
nine monthsquarter of2002,2003, net cash used in investing activities was$1.4 billion,$444 million, compared with$1.7 billion$290 million during the firstnine monthsquarter of2001.2002. Thedecreaseincrease over the first quarter of 2002 reflectslower levels of cash used for acquisitions in 2002 and the cash provided by the 2002 divestiture of several North American food businesses,higher capital expenditures, as well as a loweruseslevel ofcash byproceeds received from theCompany's financial services business.sales of businesses and finance assets in 2003.Net Cash Used in Financing Activities
- -------------------------------------During the first
nine monthsquarter of2002,2003, net cash used in financing activities was$8.6 billion,$933 million, compared with$6.7 billion$857 million during the firstnine monthsquarter of2001.2002. Thisdifferenceincrease was due primarily toan increase in cash used during 2002 to repurchase Philip Morristhe higher amount of dividends paid on Altria Group, Inc. common stockand to pay dividends on Philip Morris common stock. During 2002, Miller borrowed $2.0 billion under a one-year bank term loan agreement. At the closing of the Miller transaction on July 9, 2002, the Company received 430 million shares of SABMillerinexchange for Miller. The Miller borrowing was outstanding as of the closing of the Miller transaction. In addition, during 2002, Kraft issued $2.5 billion of global bonds. The debt repayments made during 2002 exceeded the aggregate debt issuances. 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.2003.Debt and Liquidity
- ------------------Debt
- The Company's—Altria Group, Inc.’s total debt (consumer products and financial services) was$19.7$24.8 billion and$22.1$23.3 billion atSeptember 30, 2002March 31, 2003 and December 31,2001,2002, respectively. Total consumer products debt was$17.6$22.7 billion and$20.1$21.2 billion atSeptember 30, 2002March 31, 2003 and December 31,2001,2002, respectively. AtSeptember 30, 2002March 31, 2003 and December 31,2001, the Company's2002, Altria Group, Inc.’s ratio of consumer products debt to total equity was0.821.13 and1.02,1.09, respectively. The ratio of total debt to total equity was0.921.23 and1.131.20 atSeptember 30, 2002March 31, 2003 and December 31,2001,2002, respectively.In April 2002,Credit Ratings—Following a $10.1 billion judgment on March 21, 2003 against PM USA in thePrice litigation which is discussed in Note 10, the three major credit rating agencies took a series of ratings actions resulting in the lowering of ALG’s short-term and long-term debt ratings. Between March 21, 2003 and early May 2003, Moody’s lowered ALG’s short-term debt rating from “P-1” to “P-2” and its long-term debt rating from “A2” to “Baa2” with negative outlook. S&P lowered ALG’s short-term debt rating from “A-1” to “A-2” and its long-term debt rating from “A-” to “BBB” while maintaining these ratings on credit watch with negative implications. Fitch lowered ALG’s short-term debt rating from “F-1” to “F-2” and its long-term debt rating from “A” to “BBB”, with negative outlook.
While Kraft
filedis not aForm S-3 shelf registration statement with the Securitiesparty to, andExchange Commission, under which Kraft may sell debt securities and/or warrantshas no exposure to,purchase debt securities in one or more offerings upthis litigation, its credit ratings were also lowered to atotal 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 atlesser degree. As arate of 5.25% and $1.5 billion of 10-year notes bearing interest at a rate of 6.25%. At September 30, 2002, Kraft had $2.5 billion of capacity remaining under its shelf registration statement. In May 2002, Miller -47-borrowed $2.0 billion under a one-year bank term loan agreement. At the closingresult of theMiller transaction on July 9, 2002, the Company received 430 million sharesrating agencies’ actions, borrowing costs for ALG and Kraft have increased. None ofSABMillerALG’s or Kraft’s debt agreements require accelerated repayment as a result of a decrease inexchange for Miller. The Miller borrowing was outstanding as of the closing of the Miller transaction. The Company does not guarantee the debt of Miller or Kraft.credit ratings.-44-
Credit Lines
- At September 30, 2002, the Company—Both Kraft andits subsidiaries maintainedALG maintain revolving creditlines with a number of lending institutions amounting to approximately $15.2 billion. Certain of these credit lines werefacilities that they have historically used to support$574 millionthe issuance of commercial paper. However, as a result of the recent rating agencies actions, ALG’s and Kraft’s access to the commercial paperborrowings at September 30, 2002, the proceeds of which were used for general corporate purposes. A portion of these lines is also usedmarket was eliminated. Subsequently, in April 2003, ALG and Kraft began tomeet the short-termborrow against existing credit facilities to repay maturing commercial paper and to fund normal working capitalneedsneeds. Information has been provided as ofthe Company's international businesses. In July 2002, $7.0 billion (of which $4.0 billion was for the sole use of Kraft) of 364-day revolving credit facilities were terminatedMay 6, 2003 to provide additional information about changes in ALG’s andwere 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 JulyKraft’s debt structure subsequent to March 31, 2003. AtSeptember 30, 2002,March 31, 2003 and at May 6, 2003, credit lines for ALG and Kraft, and theCompany's credit facilities also included $7.0 billion (of which $2.0 billion is for the sole userelated activity were as follows (in billions ofKraft) of 5-yeardollars):
ALG
Credit Lines
at March 31, 2003
at May 6, 2003
Type
Amount
Drawn
Commercial
Paper
Outstanding
Lines
Available
Amount
Drawn
Commercial
Paper
Outstanding
Lines
Available
364-day
$
3.0
$
—
$
—
$
3.0
$
—
$
1.3
$
1.7
Multi-year
5.0
3.1
1.9
5.0
$
8.0
$
—
$
3.1
$
4.9
$
5.0
$
1.3
$
1.7
Kraft
at March 31, 2003
at May 6, 2003
Type
Credit Lines
Amount
Drawn
Commercial
Paper
Outstanding
Lines
Available
Amount
Drawn
Commercial
Paper
Outstanding
Lines
Available
364-day
$
3.0
$
—
$
0.6
$
2.4
$
0.2
$
1.3
$
1.5
Multi-year
2.0
2.0
2.0
$
5.0
$
—
$
2.6
$
2.4
$
2.2
$
1.3
$
1.5
The ALG revolving credit
facilities expiring in July 2006. The Philip Morrisfacilities require the maintenance of a fixed charges coverageratio andratio. The Kraft revolving credit facilities, which are for the sole use of Kraft,facilitiesrequire the maintenance of a minimum net worth.Philip MorrisALG and Kraftexceeded thesemet their respective covenants atSeptember 30, 2002March 31, 2003 anddo not currently anticipate any difficulty in continuingexpect toexceed these covenant requirements.continue to meet their respective covenants. The foregoing revolving credit facilities do not include any other financial tests, any credit rating triggers or any provisions that could require the posting of collateral.The majorityEach of theCompany's remaining364-day facilities expires in July 2003, while the multi-year facilities expire in July 2006. ALG and Kraft will begin negotiating new 364-day facilities during the second quarter of 2003. However, given recent credit rating agencies actions, the outcome of these negotiations is uncertain.In addition to the above, certain international subsidiaries of ALG and Kraft maintain uncommitted credit lines
expire within one year. The 5-year revolvingto meet the short-term working capital needs of the international businesses. These creditfacilities enable the Companylines, which amounted toreclassify short-term debt on a long-term basis. At September 30, 2002,approximately $1.4 billion for ALG subsidiaries (other than Kraft) and approximately $0.6 billion for Kraft subsidiaries, are for the sole use ofshort-termALG’s and Kraft’s international businesses. At March 31, 2003, borrowings on these lines amounted to approximately $0.2 billion each for the international subsidiaries of ALG (other than Kraft) and Kraft.Guarantees—As discussed in Note 10, Altria Group, Inc. had third-party guarantees, which are primarily derived from acquisition and divestiture activities, approximating $253 million, of which $209 million have no expiration dates. The remainder expire through 2012, with $26 million expiring through March 31, 2004. Altria Group, Inc. is required to perform under these guarantees in the event that
the Company intendsa third-party fails torefinance were reclassified as long-term debt, as compared with $3.5 billionmake contractual payments or achieve performance measures. Altria Group, Inc. has recorded a liability of $88 million atDecemberMarch 31,2001. The Company expects2003 relating tocontinue 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. Guarantees - At September 30, 2002, the Companythese guarantees. In addition, at March 31, 2003, Altria Group, Inc. was contingently liable for $1.2 billion of guaranteesand commitments of $1.3 billion,related to its own performance, consisting of the following:o $0.8$0.8 billion of guarantees of excise tax and import duties related to international shipments of tobacco products. In these agreements, a financial institution provides a guarantee of tax payments to respective governments. PMI then issues a guarantee to the respective financial institution for the payment of the taxes. These are revolving facilities that are integral to the shipment of tobaccoproducts in international markets, and the underlying taxes payable are recorded on the Company's consolidated balance sheet. o $0.4 billion, primarily a guarantee for pension funding related to the Miller transaction and a surety bond issued to a non-U.S. governmental entity related to capacity expansion commitments at an international tobacco facility. The surety bond expires in 2002. o $0.1-45-
products in international markets, and the underlying taxes payable are recorded on Altria Group, Inc.’s consolidated balance sheet. $0.4 billion of other guarantees related to the tobacco and food businesses.Although
the Company'sAltria Group, Inc.’s guarantees of its own performance are frequently short-term in nature, the short-term guarantees 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 onthe Company'sAltria Group, Inc.’s liquidity.Litigation Escrow Deposits
-—As discussed in Note8. Contingencies,10, on May 7, 2001, the trial court in theEngle class action approved a stipulation and agreed order among PMInc.,USA, 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, PMInc.USA 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, PMInc.USA also placed $1.2 billion into an interest-bearing escrow account, which will be returned to PMInc.USA should it prevail in its appeal of the case. The $1.2 billion escrow-48-account is included in the September 30, 2002March 31, 2003 and December 31,2001 condensed2002 consolidated balance sheets as other assets. Interest income on the $1.2 billion escrow account is paid to PMInc.USA quarterly and is being recorded as earned, in interest and other debt expense, net, in the condensed consolidated statements of earnings.Tobacco Litigation Settlement Payments -In addition, with respect to certain adverse verdicts currently on appeal (excluding amounts relating to theEngle case and thePrice litigation discussed below), PM USA has posted various forms of security totaling $364 million, the majority of which have been collateralized with cash deposits, to obtain stays of judgments pending appeals. These cash deposits are included in other assets on the condensed consolidated balance sheets.As discussed in Note
8. Contingencies,10, thePrice case, in which PM USA was the defendant, commenced in January 2003 and was tried before a judge rather than a jury. In March 2003, the judge found in favor of the plaintiff class and awarded approximately $7.1 billion in compensatory damages and $3 billion in punitive damages. At the request of PM USA, the judge stayed enforcement of the judgment for 30 days. Thereafter, under the judgment, enforcement would have been stayed only if an appeal bond in the amount of $12 billion had been presented and approved. On April 14, 2003, the judge reduced the bond that PM USA must provide and stayed enforcement of the judgment pending the completion of the appellate review. Under the judge’s order, PM USA will transfer possession of a pre-existing 7.0%, $6 billion long-term note from ALG to PM USA to an escrow account with an Illinois financial institution. (Since this note is the result of an intercompany financing arrangement, it does not appear on the consolidated balance sheet of Altria Group, Inc.) In addition, PM USA will make cash deposits with the clerk of the Madison County Circuit Court in the following amounts: beginning October 1, 2003, an amount equal to the interest earned by PM USA on the ALG note (presently, $210 million every six months), an additional $800 million in four equal quarterly installments between September 2003 and June 2004 and the payments of the principal of the notes which are due in April 2008, 2009 and 2010. (Cash payments into the account will be presented as other assets on the consolidated balance sheet.) If PM USA prevails on appeal, the escrowed note and all cash deposited with the court will be returned to PM USA, with accrued interest less an administrative fee payable to the court.Tobacco Litigation Settlement Payments—As discussed in Note 10, PM USA, along with other domestic tobacco companies, has entered into
tobacco litigation settlement agreementsState 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 settlingplaintiffs' attorneys'plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million, as well as an additional $250 millioneach yearin2002 and2003. These payment obligations are the several and not joint obligations of each settling defendant. PMInc.'sUSA’s portion of ongoing adjusted payments and legal fees is based on its relative share of the settlingmanufacturers'manufacturers’ domestic cigarette shipments, including roll-your-own cigarettes, in the year preceding that in which the payment is due. Accordingly, PMInc.USA records itsportionsportion of ongoing settlement payments as part of cost of sales as product is shipped.-46-
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.,USA, 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 (in20022003 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 eachmanufacturer'smanufacturer’s relative market share. PMInc.USA records its portion of these payments as part of cost of sales as product is shipped.During
the nine months ended September 30, 2002 and 2001, andthe quarters endedSeptember 30,March 31, 2003 and 2002,and 2001,PMInc.USA recognized$4.1$1.1 billion and$4.5 billion, respectively, and $1.3 billion and $1.4$1.5 billion, respectively, as part of cost of sales attributable to the foregoing settlement obligations.As discussed above under
"Tobacco--Business“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 ofthe Company,ALG, PMInc.USA and PMI. Assuming there are no material adverse developments in the legislative and litigation environment,the CompanyAltria Group, Inc. expects its cash flow from operationsand its access to global capital marketsto provide sufficient liquidity to meet the ongoing needs of the business.LeveragedLeases
- As part of its lease portfolio,—PMCCinvestsholds investments in leveraged leases and direct finance leases. AtSeptember 30, 2002, PMCC'sMarch 31, 2003, PMCC’s net finance receivable of$7.5$7.4 billion in leveraged leases, which is included inthe Company'sAltria Group, Inc.’s condensed consolidated balance sheet as part of finance assets, net, is comprised of total lease payments receivable ($28.228.3 billion) and the residual value of assets under lease ($2.72.3 billion), reduced bynon-recoursenonrecourse third-party debt ($19.4 billion) and unearned income ($4.03.8 billion). PMCC has no obligation for the payment of thenon-recoursenonrecourse 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 isnon-recoursenonrecourse to all other assets of PMCC orthe Company.Altria Group, Inc. As required by accountingprinciplesstandards generally accepted in the United States of America("(“U.S.GAAP"GAAP”), thenon-recoursenonrecourse third-party debt has been offset against the related rentals receivableand the residual value of the property,and has been presented on a net basis, within finance assets, net, inthe Company'sAltria Group, Inc.’s condensed consolidated balance sheets.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 16 Airbus A319 aircraft to US Air under long-term leveraged leases, which expire in 2018 and 2019. The aircraft were leased in -49-1998 and 1999 and represent aAt March 31, 2003, PMCC’s net finance receivable in direct finance leases of
$150 million,$1.8 billion, whichequals 1.7% of PMCC's portfolio ofis also included in finance assets, netat September 30, 2002. PMCC continues to evaluatein Altria Group, Inc.’s condensed consolidated balance sheet, is comprised of lease payments receivable ($2.2 billion) and theeffectresidual value ofthe US Air bankruptcy filing and ceased recordingassets under lease ($0.1 billion) reduced by unearned incomeon these leases as of the date of the bankruptcy filing, pending US Air's effort to restructure with the assistance of a government loan guarantee. In addition, PMCC currently leases 24 Boeing 757 aircraft to United Air Lines Inc. ("UAL"), 22 under long-term leveraged leases that expire in 2014 and two under long-term single investor leases that expire in 2011. The net finance receivable for the 22 aircraft under leveraged leases is $333 million, and $53 million for the two aircraft under single investor leases, for an aggregate net finance receivable of $386 million, which equals 4.5% of PMCC's portfolio of finance($0.5 billion). Finance assets, net atSeptember 30, 2002. UALMarch 31, 2003 alsohas appliedincludes an allowance fora government loan guarantee and PMCC is closely monitoring the situation.losses ($0.4 billion).Equity and Dividends
- -------------------- The CompanyDuring the first quarters of 2003 and 2002, ALG repurchased
93.518.7 million and63.521.5 million shares, respectively, of its common stockduring the first nine months of 2002 and 2001, respectively,at a cost of$4.6 billion$689 million and$3.0$1.1 billion, respectively. During the first quarter of 2003, ALG completed its three-year, $10 billion share repurchase program and began a one-year, $3 billion share repurchase program. AtSeptember 30, 2002,March 31, 2003, cumulative repurchases underits previously announced $10the $3 billion authority totaled163.17.0 million shares at an aggregate cost of$7.9 billion. The Company has$241 million. Following the rating agencies actions, discussed above in “Credit Ratings,” ALG announced that it would suspend itsintention to accelerateshare repurchase program until such time as itsrate of share repurchases during the second half of 2002 by utilizing approximately $1.7 billion of cash flowaccess to theCompany 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.capital markets is restored.On June 21, 2002,
Kraft's boardKraft’s Board ofdirectorsDirectors approved the repurchase from time to time of up to $500 million ofKraft'sKraft’s Class A common stock solely to satisfy the obligations of Kraft to provide shares under its 2001 Performance Incentive Plan and its 2001 Compensation Plan for non-employeedirectors, and other plans where options to purchase Kraft's Class A common stock are granted to employees of Kraft. As of September 30, 2002,directors. During the quarter ended March 31, 2003, Krafthadrepurchased2.22.7 million shares of its Class A common stock at a cost of$85.0$82.5 million.ConcurrentConcurrently with
Kraft's IPO,Kraft’s initial public offering (“IPO”), certainPhilip Morrisemployees of Altria Group, Inc. (other than Kraft and its subsidiaries) received a one-time grant of options to purchase shares ofKraft'sKraft’s Class A common stock held bythe CompanyAltria Group, Inc. at the IPO price of $31.00 per share.In order to satisfy the obligation and retain its current percentage ownership of Kraft, the Company plansAt March 31, 2003, employees held options to purchase approximately 1.6 million shares ofKraft'sKraft’s Class A common stock from Altria Group, Inc. In order to completely satisfy the obligation and maintain its percentage ownership of Kraft, Altria-47-
Group, Inc. purchased approximately 1.6 million shares of Kraft’s Class A common stock in open market transactions during 2002.
In January 2003, Altria Group, Inc. granted approximately 2.3 million shares of restricted stock to eligible U.S.-based employees of Altria Group, Inc. and also issued to eligible non-U.S. employees rights to receive approximately 1.5 million equivalent shares. Restrictions on the
remaindershares lapse in the first quarter of2002.2006.Dividends paid in the first
nine monthsquarter of 2003 and 2002and 2001were$3.73$1.3 billion and$3.5$1.25 billion, respectively, an increase of6.4%4.9%, reflecting a higher dividend rate in2002,2003, partially offset by a lower number of shares outstanding as a result ofongoingshare repurchases. During the third quarter of 2002,the Company'sAltria Group, Inc.’s Board of Directors approved a 10.3% increase in the quarterly dividend rate to $0.64 per share. As a result, the present annualized dividend rate is $2.56 per share.Market Risk
- ----------- The CompanyAltria Group, Inc. operates globally, with manufacturing and sales facilities in various locations around the world, and utilizes certain financial instruments to manage its foreign currency
interest rateand commodity exposures, which primarily relate to forecasted transactions and debt. Derivative financial instruments are used bythe Company,Altria Group, Inc., principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates and commodity prices,and interest rates,by creating offsetting exposures.The CompanyAltria Group, Inc. is not a party to leveragedderivatives. For a derivative to qualify as a hedge at inceptionderivatives 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 -50-and throughout the hedged period. The Companyby policy, does not use derivative financial instruments for speculative purposes.Substantially allA substantial portion of
the Company'sAltria Group, Inc.’s derivative financial instruments are effective as hedges under U.S. GAAP. Accordingly,the Company increased accumulated other comprehensive losses by $72 million during the first nine months of 2002. This reflects a decrease in the fair value of derivatives of $143 million, partially offset by deferred losses transferred to earnings of $71 million. For the three months ended September 30, 2002, the CompanyAltria Group, Inc. decreased accumulated other comprehensive losses by$55 million.$30 million during the first quarter of 2003. This reflects an increase in the fair value of derivatives of$63$28 million and deferred losses transferred to earnings of $2 million. During the first quarter of 2002, Altria Group, Inc. decreased accumulated other comprehensive losses by $42 million. This reflects deferred losses transferred to earnings of $92 million, partially offset bydeferred gains transferred to earningsa decrease in the fair value of$8derivatives during the first quarter of 2002 of $50 million. The fair value of all derivative financial instruments has been calculated based onactivemarket quotes.Foreign exchange
rates. The Companyrates. Altria Group, Inc. 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 whichthe CompanyAltria Group, Inc. is exposed include the Japanese yen, the Swiss franc and the euro. AtSeptember 30, 2002March 31, 2003 and December 31,2001, the Company2002, Altria Group, Inc. had option and forward foreign exchange contracts with aggregate notional amounts of$8.5$12.5 billion and$3.7$10.1 billion, respectively, which were comprised of contracts for the purchaseorand sale of foreign currencies.The CompanyIncluded in the foreign currency aggregate notional amounts at March 31, 2003 and December 31, 2002, were $2.3 billion and $2.6 billion, respectively, of equal and offsetting foreign currency positions, which do not qualify as hedges and that will not result in any net gain or loss. In addition, Altria Group, Inc. uses foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swapsprimarilytypically convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity.ForeignA substantial portion of the foreign currency swap agreements are accounted for as cash flow hedges.At September 30, 2002The unrealized gain (loss) relating to foreign currency swap agreements that do not qualify for hedge accounting treatment under U.S. GAAP was insignificant as of March 31, 2003 and December 31,2001,2002. At March 31, 2003 and December 31, 2002, the notional amounts of foreign currency swap agreements aggregated $2.4 billion and $2.5 billion,and $2.3 billion,respectively.The CompanyAltria Group, Inc. also
usesdesignates certain foreign currency denominated debt as net investment hedges of foreign operations.At September 30,During the quarters ended March 31, 2003 and 2002,a losslosses of$127$65 million, net of income taxes, and gains of$68$1 million, net of income taxes, respectively, which represented effective hedges of net investments,waswere reported as a component of accumulated other comprehensivelossesearnings (losses) within currency translation adjustments.Commodities. The Company-48-
Commodities. Kraft is exposed to price risk related to forecasted purchases of certain commodities used as raw
materials by the Company's businesses.materials. Accordingly,the CompanyKraft uses commodity forward contracts as cash flow hedges, primarily for coffee, cocoa, milkcheeseandwheat.cheese. Commodity futures and options are also used to hedge the price of certain commodities, including milk, coffee, cocoa, wheat, corn, sugar and soybean oil. AtSeptember 30, 2002March 31, 2003 and December 31,2001, the Company2002, Kraft had net long commodity positions of$486$773 million and$589$544 million, respectively.-----------------In general, commodity forward contracts qualify for the normal purchase exception under U.S. GAAP. The effective portion of unrealized gains and losses on commodity futures and option contracts is deferred as a component of accumulated other comprehensive earnings (losses) and is recognized as a component of cost of sales when the related inventory is sold. Unrealized gains or losses on net commodity positions were immaterial at March 31, 2003 and December 31, 2002.Use of the above-mentioned financial instruments has not had a material impact on
the Company'sAltria Group, Inc.’s consolidated financial position atSeptember 30, 2002March 31, 2003 and December 31,2001,2002, orthe Company'sAltria Group, Inc.’s consolidated results of operations for thenine andthree months endedSeptember 30, 2002March 31, 2003 or the year ended December 31,2001. -----------------2002.Contingencies
- -------------See Note
810 to the Condensed Consolidated Financial Statements for a discussion of contingencies.New Accounting Standards
- ------------------------ On July 30, 2002,In April 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In general, SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. Altria Group, Inc. does not currently expect the adoption of SFAS No. 149 to have a material impact on its 2003 consolidated financial statements.
Effective January 1, 2003, Altria Group, Inc. adopted SFAS No. 146,
"Accounting“Accounting for Costs Associated with Exit or DisposalActivities."Activities” for exit or disposal activities initiated after December 31, 2002. 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. -51-Accordingly, the Company will apply the provisionsThe adoption of SFAS No. 146prospectively 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 as follows for 2001 had the provisions of the new standards been applied as of January 1, 2001:
Nine Months Ended Three Months Ended September 30, 2001 September 30, 2001 ------------------ ------------------ (in millions, except per share data)Net earnings, as previously reported $6,396 $2,328 Adjustment for amortization of goodwill 752 250 ------ ------ Net earnings, as adjusted $7,148 $2,578 ====== ====== Diluted EPS, as previously reported $2.88 $1.06 Adjustment for amortization of goodwill 0.34 0.11 ----- ----- Diluted EPS, as adjusted $3.22 $1.17 ===== =====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 standarddid not have a material impact onthe Company'sAltria Group, Inc.’s consolidated financial position, results of operations or cashflows.flows for the period ended March 31, 2003.Effective January 1, 2003, Altria Group, Inc. adopted FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Interpretation No. 45 required the disclosure of certain guarantees existing at December 31, 2002. In addition, Interpretation No. 45 required the recognition of a liability for the fair value of the obligation of qualifying guarantee activities that are initiated or modified after December 31, 2002. Accordingly, Altria Group, Inc. has applied the recognition provisions of Interpretation No. 45 to guarantee activities initiated after December 31, 2002. Adoption of Interpretation No. 45 as of January 1, 2003 did not have a material impact on Altria Group, Inc.’s consolidated financial statements. See Note 10, for a further discussion of guarantees.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual return or both. Interpretation No. 46 also provides criteria for determining
-49-
whether an entity is a variable interest entity subject to consolidation. Interpretation No. 46 requires immediate consolidation of variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, consolidation is required on July 1, 2003. ALG’s financial services subsidiary, PMCC, uses various legal entity formations, such as owner trusts, grantor trusts, limited liability companies and partnerships to purchase and hold assets which are leased to third parties. Most of these entities have historically been and are currently consolidated entities of PMCC. Altria Group, Inc. is currently evaluating the impact, if any, of adoption of the provisions of Interpretation No. 46 on July 1, 2003. However, Altria Group, Inc. does not currently expect the adoption of Interpretation No. 46 to have a material impact on its consolidated financial statements.
In November 2002, the
Company adoptedEmerging Issues Task Force("EITF"(“EITF”)Issue No. 00-14, "Accounting for Certain Sales Incentives" andissued EITF Issue No.00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller00-21, “Revenue Arrangements with Multiple Deliverables,” which addresses certain aspects of theVendor's Products." Theaccounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF Issue No. 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. EITF Issue No. 00-21 is effective for Altria Group, Inc. for revenue arrangements entered into beginning July 1, 2003. Altria Group, Inc. does not expect the adoption of EITFIssuesIssue No.00-14 and No. 00-25 resulted in00-21 to have areduction of revenues of approximately $7.0 billion and $2.2 billion in the first nine months and the third quarter of 2001, respectively. In addition, the adoption reduced marketing, administration and research costs in the first nine months and the third quarter of 2001 by approximately $7.6 billion and $2.4 billion, respectively. Cost of sales increased in the first nine months and the third quarter of 2001 by approximately $467 million and $160 million, respectively, and excise taxes on products increased by approximately $171 million and $57 million, respectively. The adoption of these EITF Issues had nomaterial impact onnet earnings or basic and diluted EPS.its 2003 consolidated financial statements.Cautionary Factors That May Affect Future Results
- -------------------------------------------------Forward-Looking and Cautionary Statements
We* may from time to time make written or oral forward-looking statements, including statements contained in filings with the Securities and Exchange Commission
("SEC"(“SEC”), in reports to shareholders and in press releases- ---------------- * This section uses the terms "we," "our" and "us" when it is not necessary to distinguish among the Company and its various operating subsidiaries or when any distinction is clear from the context. -52-and investor webcasts. You can identify these forward-looking statements by use of words such as "strategy," "expects," "continues," "plans," "anticipates," "believes," "will," "estimates," "intends," "projects," "goals," "targets"“strategy,” “expects,” “continues,” “plans,” “anticipates,” “believes,” “will,” “estimates,” “intends,” “projects,” “goals,” “targets” and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in
the Company'sAltria Group, Inc.’s securities. In connection with the"safe harbor"“safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in the"Business Environment"“Business Environment” sections preceding our discussion of operating results of oursubsidiaries' tobacco businesses and food and beveragesubsidiaries’ businesses. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time.Tobacco Related
Litigation.Litigation. There is substantial litigation pending in the United States and in foreign jurisdictions arising out of the tobacco businesses of PMInc.USA andPhilip Morris International.PMI. We anticipate that new cases will continue to be filed. In some cases, plaintiffs claim damages, including punitive damages, ranging into the billions of dollars. Although, to date,weour tobacco subsidiaries have never had to pay a judgment in a tobacco related case, there are presentlynine12 cases on appeal in which verdicts were returned againstus,PM USA, including
* This section uses the terms “we,” “our” and “us” when it is not necessary to distinguish among ALG and its various operating subsidiaries or when any distinction is clear from the context. -50-
a $74 billion verdict
against PM Inc.in theEngle case in Florida andfour verdicts against PM Inc.a compensatory and punitive damages verdict totaling approximately $10.1 billion inCaliforniathePrice case inthe aggregate amount of $31.1 billion.Illinois. In order to prevent a plaintiff from seeking to collect a judgment while the verdict is being appealed,wethe defendant must post an appeal bond,typicallyfrequently in the amount of the judgment or more, or negotiate an alternative arrangement with plaintiffs. In the event of future losses at trial, we may not always be able to obtain the required bond or to negotiate an acceptable alternative arrangement.The present litigation environment is substantially uncertain, and it is possible that our business, volume, results of operations, cash flows or financial position could be materially affected by an unfavorable outcome of pending litigation, including certain of the verdicts against us that are on appeal. We intend to continue vigorously defending all tobacco related litigation, although we may settle particular cases if we believe it is in the best interest of our shareholders to do so. Please see
"Note 8. Contingencies"Note 10 for a detailed discussion oftobacco relatedtobacco-related litigation.Anti-Tobacco Action in the Public and Private
Sectors.Sectors. Our tobacco subsidiaries face significant governmental action aimed at reducing the incidence of smoking and seeking to hold us responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volume, and we expect this decline to continue.Excise
Taxes.Taxes. Substantial excise tax increases have been and continue to be imposed on cigarettes in the United States at the federal, state and local levels, as well as in foreign jurisdictions. The resulting price increases have caused, and may continue to cause, consumers to shift from premium to discount brands and to cease or reduce smoking.Increasing Competition in the Domestic Tobacco
Market.Market. Settlements of certain tobacco litigation in the United States, combined with excise tax increases, have resulted in substantial cigarette price increases. PMInc.USA faces increased competition from lowest priced brands sold by certain domestic and foreign manufacturers that enjoy cost advantages because they are not making payments under the settlements or related state escrow legislation. Additional competition results from diversion into the domestic market of cigarettes intended for sale outside the United States, the sale of counterfeit cigarettes by third parties and increasing imports of foreign lowest-53-priced brands. Recently, the competitive environment has become even more challenging, characterized by weak economic conditions, erosion of consumer confidence, a continued influx of cheap products, and higher prices due to higher state excise taxes and list price increases. As a result, the lowest priced products of manufacturers of numerous small share brands have increased their market share, putting pressure on the industry'sindustry’s premium segment. If these competitive factors continue and if the disparity in price between our premium brands and ourcompetitors'competitors’ lowest priced brands continues to increase, sales from the premium segment, PMInc.'sUSA’s most profitable category, may continue to shift to the discount segment. Steps that PMInc.USA may take to reduce the price disparity, such as increasing promotional spending, may reduce the profitability of its premium brands.Governmental
Investigations.Investigations. From time to time, our tobacco subsidiaries are subject to governmental investigations on a range of matters. Ongoing investigations include allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain international markets and allegations of false and misleading usage of the terms"Lights"“Lights” and"Ultra Lights"“Ultra Lights” in brand descriptors. We cannot predict the outcome of those investigations or whether additional investigations may be commenced, and it is possible that our business could be materially affected by an unfavorable outcome of pending or future investigations.New Tobacco Product
Technologies.Technologies. Our tobacco subsidiaries continue to seek ways to develop and to commercialize new product technologies that may reduce the risk of smoking. Their goal is to reduce harmful constituents in tobacco smoke while continuing to offer adult smokers products that meet their taste expectations. We cannot guarantee that our tobacco subsidiaries will succeed in these efforts. If they do not succeed, but one or more of their competitors do,theyour tobacco subsidiaries may be at a competitive disadvantage.-51-
Foreign
Currency.Currency. Our international food and tobacco subsidiaries conduct their businesses in local currency and, for purposes of financial reporting, their results are translated into U.S. dollars based on average exchange rates prevailing during a reporting period. During times of a strengthening U.S. dollar, our reported net revenues and operating companies income will be reduced because the local currency will translate into fewer U.S. dollars.Competition and Economic
Downturns.Downturns. Each of our consumer products subsidiaries is subject to intense competition, changes in consumer preferences and local economic conditions. To be successful, they must continue:oto promote brand equity successfully;oto anticipate and respond to new consumer trends;oto 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;oto improve productivity; andoto respond effectively to changing prices for their raw materials.The willingness of consumers to purchase premium cigarette brands and premium food and beverage brands depends in part on local economic conditions. In periods of economic uncertainty, consumers tend to purchase more private label and other economy brands and the volume of our consumer products subsidiaries could suffer accordingly.
Our finance subsidiary, PMCC, holds investments in finance leases, principally in transportation, power generation and manufacturing equipment and facilities. Its lessees are also subject to intense competition and economic conditions. If counterparties to PMCC’s leases fail to manage through difficult economic and competitive conditions, PMCC may have to increase its allowance for losses, which would adversely affect our profitability.
Grocery Trade
Consolidation.Consolidation. As the retail grocery trade continues to consolidate and retailers grow larger and become more sophisticated, they demand lower pricing and increased promotional programs. Further, these customers are reducing their inventories and increasing their emphasis on private label products. If Kraft fails to use its scale, marketing expertise, branded products and category leadership positions to respond to these trends, its volume growth could slow or it may need to lower prices or increase promotional support of its products, any of which would adversely affect profitability.-54-Continued Need to Add Food and Beverage Products in Faster Growing and More Profitable
Categories.Categories. The food and beverageindustry'sindustry’s growth potential is constrained by population growth.Kraft'sKraft’s success depends in part on its ability to grow its business faster than populations are growing in the markets that it serves. One way to achieve that growth is to enhance its portfolio by adding products that are in faster growing and more profitable categories. If Kraft does not succeed in making these enhancements, its volume growth may slow, which would adversely affect our profitability.Strengthening Brand Portfolios Through Acquisitions and
Divestitures.Divestitures. One element of the growth strategy of Kraft andPM InternationalPMI is to strengthen their brand portfolios through active programs of selective acquisitions and divestitures. These 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. Acquisition opportunities are limited and acquisitions present risks of failing to achieve efficient and effective integration, strategic objectives and anticipated revenue improvements and cost savings. There can be no assurance that we will be able to continue to acquire attractive businesses on favorable terms or that all future acquisitions will be quickly accretive to earnings.-52-
Raw Material
Prices.Prices. The raw materials used by our consumer products subsidiaries are largely commodities that experience price volatility caused by external conditions, commodity market fluctuations, currency fluctuations and changes in governmental agricultural programs. Commodity price changes may result in unexpected increases in raw material and packaging cost, and our operating subsidiaries may be unable to increase their prices to offset these increased costs without suffering reduced volume, net revenue and operating companies income. We do not fully hedge against changes in commodity prices and our hedging procedures may not work as planned.Food Safety and Quality
Concerns.Concerns. We could be adversely affected if consumers inKraft'sKraft’s principal markets lose confidence in the safety and quality of certain food products. Adverse publicity about these types of concerns, like the recent publicity about genetically modified organisms and"mad“mad cowdisease"disease” in Europe, whether or not valid, may discourage consumers from buyingKraft'sKraft’s products or cause production and delivery disruptions. In addition, Kraft may need to recall some of its products if they become adulterated or misbranded. Kraft may also be liable if the consumption of any of its products causes injury. A widespread product recall or a significant product liability judgment could cause products to be unavailable for a period of time and a loss of consumer confidence inKraft'sKraft’s food products and could have a material adverse effect onKraft'sKraft’s business.-55-Financial Flexibility. Altria Group, Inc.’s financial flexibility may be affected by its current inability to access credit markets for short-term and long-term borrowings on terms as favorable as those that existed prior to recent actions by credit rating agencies.
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Item 4. Controls and Procedures.
Within the 90 days prior to the filing date of this report,
the CompanyAltria Group, Inc. carried out an evaluation, under the supervision and with the participation ofthe Company'sAltria Group, Inc.’s management, includingthe Company'sALG’s Chairman and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of the design and operation ofthe Company'sAltria Group, Inc.’s disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation,the Company'sALG’s Chairman and Chief Executive Officer, and Chief Financial Officer concluded thatthe Company'sAltria Group, Inc.’s disclosure controls and procedures are effective in timely alerting them to material information relating tothe CompanyAltria Group, Inc. (including its consolidated subsidiaries) required to be included inthe Company'sALG’s periodic SEC filings. Since the date of the evaluation, there have been no significant changes inthe Company'sAltria Group, Inc.’s internal controls or in other factors that could significantly affect the controls.-56--54-
Part
II -II—OTHER INFORMATIONSee Note
8.10.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 againstthe CompanyAltria Group, Inc. and its subsidiaries. See alsoTobacco-BusinessEnvironment—Governmental Investigations and Exhibits 99.1 and 99.2 to this report.Item
5. Other Information.4. Submission of Matters to a Vote of Security Holders.Altria Group, Inc.’s annual meeting of stockholders was held in Richmond, Virginia on April 24, 2003. 1,646,883,940 shares of Common Stock, 81.0% of outstanding shares, were represented in person or by proxy.
The
Audit Committee has reviewed and approved the non-audit servicestwelve directors listed below were elected tobe provided by thea one-year term expiring in 2004.
Number of Shares
For
Withheld
Elizabeth E. Bailey
1,616,168,342
30,715,598
Mathis Cabiallavetta
1,624,654,346
22,229,594
Louis C. Camilleri
1,620,867,535
26,016,405
Jane Evans
1,623,631,092
23,252,848
J. Dudley Fishburn
1,616,427,898
30,456,042
Robert E. R. Huntley
1,615,683,510
31,200,430
Thomas W. Jones
1,624,921,521
21,962,419
Billie Jean King
1,264,828,262
382,055,678
Lucio A. Noto
1,616,298,796
30,585,144
John S. Reed
1,616,478,991
30,404,949
Carlos Slim Helú
1,389,553,533
257,330,407
Stephen M. Wolf
1,615,190,505
31,693,435
The selection of PricewaterhouseCoopers LLP as independent accountants
during 2002 to assure compliance with the Company'swas approved: 1,578,969,464 shares voted in favor; 52,291,403 shares voted against andthe Committee's policies restricting the independent accountants from performing services that might impair their independence.15,623,073 shares abstained.One stockholder proposal was approved:
Stockholder Proposal 1—Shareholder Vote On Poison Pills: 1,260,270,764 shares voted in favor; 18,069,486 shares voted against and 368,543,690 shares abstained (including broker non-votes).
Five stockholder proposals were defeated:
Stockholder Proposal 2—Cigarette Sales Over The Internet: 53,896,938 shares voted in favor; 1,129,518,356 shares voted against and 463,468,646 shares abstained (including broker non-votes).
Stockholder Proposal 3—Youth Smoking/Philip Morris: 93,416,401 shares voted in favor; 1,109,551,941 shares voted against and 443,915,598 shares abstained (including broker non-votes).
Stockholder Proposal 4—Warnings Related Health Risks Of Smoking “Light” Brands: 79,154,151 shares voted in favor; 1,123,423,891 shares voted against and 444,305,898 shares abstained (including broker non-votes).
Stockholder Proposal 5—Report On Programs To Keep From Smuggling: 75,385,435 shares voted in favor; 1,127,296,094 shares voted against and 444,202,411 shares abstained (including broker non-votes).
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Stockholder Proposal 6—Change Of Auditing Firm Every Four (4) Years: 63,865,786 shares voted in favor; 1,208,631,097 shares voted against and 374,387,057 shares abstained (including broker non-votes).
Item 6. Exhibits and Reports on Form
8-K (a) Exhibits 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 Form8-K.The Registrant filed a Current Report on Form 8-K on August 13, 2002 covering Item 9 (Regulation FD Disclosure) in connection with the required certifications pursuant to (a) 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and (b) SEC Commission Order No. 4-460. -57-
(a) Exhibits
3
Amended By-Laws.
4
5-Year Revolving Credit Agreement dated as of July 24, 2001, among Altria Group, Inc., the Initial Lenders named therein, The Chase Manhattan Bank and Citibank, N.A. as Administrative Agents, Credit Suisse First Boston and Deutsche Bank AG New York Branch and/or Cayman Islands Branch as Syndication Agents, ABN AMRO Bank N.V., BNP Paribas, Dresdner Bank AG, New York and Grand Cayman Branches and HSBC Bank USA as Arrangers and Documentation Agents.
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.
99.3
Additional Exhibit.
(b) Reports on Form 8-K. The Registrant filed (i) a Current Report on Form 8-K on January 29, 2003 covering Item 5 (Other Events) relating to the name change from Philip Morris Companies Inc. to Altria Group, Inc., (ii) a Current Report on Form 8-K on January 29, 2003 covering Item 5 (Other Events) and Item 7 (Financial Statements and Exhibits) containing Altria Group, Inc.’s consolidated financial statements as of and for the year ended December 31, 2002; (iii) a Current Report on Form 8-K on April 15, 2003 covering Item 5 (Other Events) and Item 7 (Financial Statements and Exhibits) containing Altria Group, Inc.’s press release dated April 14, 2003 which related to the trial court approval of an Order on Defendant’s Request for Reduction of Bond and Stay of Enforcement of the Judgment inPrice,et al. v. Philip Morris Incorporated in Illinois; and (iv) furnished a Current Report on Form 8-K on April 16, 2003 covering Item 7 (Financial Statements and Exhibits) containing Altria Group, Inc.’s earnings release dated April 16, 2003. -56-
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 November 13, 2002 -58-
ALTRIA GROUP, INC.
/s/ DINYAR S. DEVITRE
Dinyar S. Devitre,
Senior Vice President and
Chief Financial Officer
May 15, 2003
-57-
Certifications
I, Louis C. Camilleri, Chairman and Chief Executive Officer of
Philip Morris CompaniesAltria Group, Inc., certify that:1. I have reviewed this quarterly report on Form 10-Q of Philip Morris Companies Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
1. I have reviewed this quarterly report on Form 10-Q of Altria Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date:
November 13, 2002 /s/ LOUIS C. CAMILLERI ------------------------ Louis C. Camilleri, Chairman and Chief Executive Officer -59-May 15, 2003
/s/ LOUIS C. CAMILLERI
Louis C. Camilleri,
Chairman and Chief Executive Officer
-58-
I, Dinyar S. Devitre, Senior Vice President and Chief Financial Officer of
Philip Morris CompaniesAltria Group, Inc., certify that:1. I have reviewed this quarterly report on Form 10-Q of Philip Morris Companies Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
1. I have reviewed this quarterly report on Form 10-Q of Altria Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date:
November 13, 2002 /s/ DINYAR S. DEVITRE ---------------------- Dinyar S. Devitre, Senior Vice President and Chief Financial Officer -60-
/s/ DINYAR S. DEVITRE |
Dinyar S. Devitre, Senior Vice President and Chief Financial Officer |
-59-