Reynolds American Inc.
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2005
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For
the transition period from to
Commission file number: 1-32258
Reynolds American Inc.
(Exact name of registrant as specified in its charter)
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North Carolina
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20-0546644 |
(State or other jurisdiction of
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(I.R.S. Employer Identification Number) |
incorporation or organization) |
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401 North Main Street
Winston-Salem, NC 27101
(Address of principal executive offices) (Zip Code)
(336) 741-2000
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed from 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 (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YES o NO þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date: 147,406,576 shares of common stock, par value $.0001 per share, as
of October 14, 2005
PART
I Financial Information
Item 1. Financial Statements
REYNOLDS
AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
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For the Three Months |
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For the Nine Months |
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Ended September 30, |
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Ended September 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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Net
sales1 |
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$ |
2,024 |
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$ |
1,781 |
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$ |
5,827 |
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$ |
4,351 |
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Net sales, related party |
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125 |
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85 |
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382 |
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85 |
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2,149 |
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1,866 |
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6,209 |
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4,436 |
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Costs and expenses: |
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Cost of products sold1, 2 |
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1,384 |
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1,139 |
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3,736 |
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2,647 |
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Selling, general and administrative expenses |
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399 |
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377 |
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1,175 |
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970 |
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Loss on sale of assets |
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25 |
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Amortization expense |
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9 |
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11 |
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33 |
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11 |
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Restructuring and asset impairment charges |
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(7 |
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(1 |
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(25 |
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Operating income |
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357 |
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346 |
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1,241 |
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833 |
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Interest and debt expense |
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31 |
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21 |
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81 |
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62 |
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Interest income |
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(23 |
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(7 |
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(53 |
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(16 |
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Other (income) expense, net |
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7 |
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(1 |
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14 |
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4 |
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Income from continuing operations before income taxes |
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342 |
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333 |
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1,199 |
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783 |
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Provision for income taxes |
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129 |
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43 |
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454 |
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221 |
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Income from continuing operations |
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213 |
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290 |
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745 |
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562 |
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Discontinued operations: |
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Gain on sale of discontinued businesses, net of income taxes |
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1 |
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Income before extraordinary item |
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213 |
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290 |
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745 |
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563 |
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Extraordinary item gain on acquisition |
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49 |
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49 |
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Net income |
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$ |
213 |
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$ |
339 |
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$ |
745 |
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$ |
612 |
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Basic income per share: |
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Income from continuing operations |
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$ |
1.45 |
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$ |
2.29 |
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$ |
5.05 |
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$ |
5.70 |
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Gain on sale of discontinued businesses |
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.01 |
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Extraordinary item gain on acquisition |
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.38 |
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.50 |
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Net income |
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$ |
1.45 |
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$ |
2.67 |
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$ |
5.05 |
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$ |
6.21 |
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Diluted income per share: |
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Income from continuing operations |
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$ |
1.44 |
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$ |
2.28 |
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$ |
5.05 |
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$ |
5.66 |
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Gain on sale of discontinued businesses |
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.01 |
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Extraordinary item gain on acquisition |
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.38 |
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.49 |
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Net income |
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$ |
1.44 |
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$ |
2.66 |
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$ |
5.05 |
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$ |
6.16 |
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Dividends declared per share |
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$ |
1.05 |
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$ |
0.95 |
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$ |
2.95 |
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$ |
2.85 |
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1 |
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Excludes excise taxes of $573 million and $525 million for the three months ended
September 30, 2005 and 2004, respectively, and $1.6 billion and $1.3 billion for the nine
months ended September 30, 2005 and 2004, respectively. |
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2 |
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See Master Settlement Agreement and Federal Tobacco Buyout Expenses in note 1. |
See
Notes to Condensed Consolidated Financial Statements (Unaudited)
3
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in
Millions)
(Unaudited)
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For the Nine Months Ended |
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September 30, |
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2005 |
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2004 |
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Cash flows from (used in) operating activities: |
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Net income |
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$ |
745 |
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$ |
612 |
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Less gain from discontinued operations |
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(1 |
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Adjustments to reconcile to net cash flows from (used in)
operating activities: |
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Depreciation and amortization |
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146 |
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83 |
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Restructuring and asset impairment charges, net of cash payments |
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(52 |
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(109 |
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Payments related to acquisition restructuring |
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(60 |
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(56 |
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Deferred income tax expense (benefit) |
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28 |
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(125 |
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Extraordinary item gain on acquisition |
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(49 |
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Other changes, that provided (used) cash: |
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Accounts and notes receivable |
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16 |
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(147 |
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Inventories |
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155 |
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(27 |
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Accounts payable and accrued liabilities including income
taxes and other working capital |
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258 |
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227 |
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Tobacco settlement and related expenses |
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(211 |
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71 |
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Pension and postretirement |
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(230 |
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(75 |
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Other, net |
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56 |
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85 |
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Net cash flows from operating activities |
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851 |
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489 |
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Cash flows from (used in) investing activities: |
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Capital expenditures |
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(74 |
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(50 |
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Acquisition, net of cash acquired |
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204 |
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Distribution from equity investees |
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3 |
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5 |
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Purchases of short-term investments |
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(7,791 |
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(3,318 |
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Proceeds from short-term investments |
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7,148 |
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3,551 |
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Purchases of long-term investments |
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(10 |
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Proceeds from sale of business |
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48 |
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Other, net |
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3 |
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(38 |
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Net cash flows (used in) from investing activities |
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(663 |
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344 |
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Cash flows from (used in) financing activities: |
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Repurchase of common stock |
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(3 |
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(38 |
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Repayment of long-term debt |
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(360 |
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(56 |
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Issuance of long-term debt |
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499 |
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Deferred debt issuance costs |
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(6 |
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Debt retirement costs |
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(7 |
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Dividends paid on common stock |
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(420 |
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(243 |
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Proceeds from exercise of stock options |
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2 |
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33 |
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Net cash flows used in financing activities |
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(295 |
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(304 |
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Net change in cash and cash equivalents |
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(107 |
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529 |
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Cash and cash equivalents at beginning of period |
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1,499 |
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970 |
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Cash and cash equivalents at end of period |
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$ |
1,392 |
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$ |
1,499 |
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Income taxes paid, net of refunds |
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$ |
108 |
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$ |
33 |
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Interest paid |
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$ |
57 |
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$ |
42 |
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Tobacco settlement and related expense payments |
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$ |
2,177 |
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$ |
1,521 |
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See Notes to Condensed Consolidated Financial Statements (Unaudited)
4
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in
Millions)
(Unaudited)
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September 30, |
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December 31, |
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2005 |
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2004 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
1,392 |
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$ |
1,499 |
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Short-term investments |
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1,118 |
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473 |
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Accounts and notes receivable, net of allowance (2005 $7; 2004 $7) |
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128 |
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102 |
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Accounts receivable, related party |
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38 |
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80 |
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Inventories |
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1,110 |
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1,265 |
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Deferred income taxes |
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939 |
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941 |
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Prepaid expenses |
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106 |
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212 |
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Assets held for sale |
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3 |
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52 |
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Total current assets |
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4,834 |
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4,624 |
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Property, plant and equipment, net of accumulated
depreciation (2005 $1,445; 2004 $1,374) |
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1,084 |
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1,129 |
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Trademarks, net of accumulated amortization (2005 $500; 2004 $487) |
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2,390 |
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2,403 |
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Goodwill |
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5,685 |
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5,685 |
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Other intangibles, net of accumulated amortization (2005 $38; 2004 $18) |
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186 |
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206 |
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Other assets and deferred charges |
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337 |
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381 |
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$ |
14,516 |
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$ |
14,428 |
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Liabilities and shareholders equity |
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Current liabilities: |
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Accounts payable |
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$ |
83 |
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$ |
70 |
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Tobacco settlement and related accruals |
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2,174 |
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2,381 |
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Other current liabilities |
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1,691 |
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1,543 |
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Due to related party |
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14 |
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Current maturities of long-term debt |
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191 |
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50 |
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Liabilities related to assets held for sale |
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11 |
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Total current liabilities |
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4,153 |
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4,055 |
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Long-term debt (less current maturities) |
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1,564 |
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1,595 |
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Deferred income taxes |
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|
676 |
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|
805 |
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Long-term retirement benefits |
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1,597 |
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|
1,469 |
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Other noncurrent liabilities |
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277 |
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328 |
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Commitments and contingencies: |
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Shareholders equity: |
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Common stock
(shares issued: 2005 147,406,576; 2004 147,364,450) |
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Paid-in capital |
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8,683 |
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8,682 |
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Accumulated deficit |
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(1,751 |
) |
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(2,061 |
) |
Accumulated other comprehensive loss, net of tax (2005 $365; 2004
$238) |
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(683 |
) |
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|
(445 |
) |
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Total shareholders equity |
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6,249 |
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|
|
6,176 |
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$ |
14,516 |
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$ |
14,428 |
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See Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note
1Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim condensed consolidated financial statements (unaudited) have been
prepared in accordance with accounting principles generally accepted in the United States of
America, referred to as U.S. GAAP, for interim financial information and, in managements opinion,
contain all adjustments, consisting only of normal recurring items, necessary for a fair
presentation of the results for the periods presented. Accordingly, they do not include all of the
information and footnotes required by U.S. GAAP for complete financial statements. For interim
reporting purposes, certain costs and expenses are charged to operations in proportion to the
estimated total annual amount expected to be incurred primarily based on sales volumes. The
results for the interim period ended September 30, 2005, are not necessarily indicative of the
results that may be expected for the year ending December 31, 2005.
The condensed consolidated financial statements (unaudited) include the accounts of Reynolds
American Inc., referred to as RAI, and its wholly owned subsidiaries. RAIs wholly owned
subsidiaries include its operating subsidiaries, R. J. Reynolds Tobacco Company, Santa Fe Natural
Tobacco Company, Inc., referred to as Santa Fe, Lane Limited, referred to as Lane, and R. J.
Reynolds Global Products, Inc., referred to as GPI.
RAI was created to facilitate the July 30, 2004, transactions to combine the U.S. assets,
liabilities and operations of Brown & Williamson Tobacco Corporation, now known as Brown &
Williamson Holdings, Inc., referred to as B&W, an indirect, wholly owned subsidiary of British
American Tobacco p.l.c., referred to as BAT, with R. J. Reynolds Tobacco Company, a wholly owned
operating subsidiary of R. J. Reynolds Tobacco Holdings, Inc., referred to as RJR. As a result of
the business combination, B&W owns approximately 42% of RAIs outstanding common stock, and
previous RJR stockholders were issued shares of RAI common stock in exchange for their existing
shares of RJR common stock, resulting in their ownership of approximately 58% of RAIs common stock
outstanding. Also, as part of the combination transactions, RAI acquired from an indirect
subsidiary of BAT the capital stock of Cigarette Manufacturers Supplies Inc., referred to as CMSI,
which owns all of the capital stock of Lane, and RJR became a wholly owned subsidiary of RAI.
References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco Company, a
New Jersey corporation and a wholly owned subsidiary of RJR. References to RJR Tobacco on and
subsequent to July 30, 2004, relate to the combined U.S. assets, liabilities and operations of B&W
and R. J. Reynolds Tobacco Company. Concurrent with the completion of the combination
transactions, RJR Tobacco became a North Carolina corporation, and an indirect, wholly owned
operating subsidiary of RAI.
The equity method is used to account for investments in businesses that RAI does not control,
but has the ability to significantly influence operating and financial policies. The cost method
is used to account for investments in which RAI does not have the ability to significantly
influence operating and financial policies. RAI has no investments in entities greater than 20%
for which it accounts by the cost method, and has no investments in entities greater than 50% for
which it accounts by the equity method. All material intercompany balances have been eliminated.
The condensed consolidated financial statements (unaudited) should be read in conjunction with
the consolidated financial statements and related footnotes, which appear in RAIs Annual Report on
Form 10-K/A for the year ended December 31, 2004. Certain reclassifications were made to conform
prior years financial statements to the current presentation, one of which was to increase net
cash flows from investing activities by $234 million for the nine-month period ended September 30,
2004, in the condensed consolidated statements of cash flows due to the reclassification of auction
rate notes from cash equivalents to short-term investments. The reclassification did not impact
previously reported net income, working capital or cash flows from operations.
All dollar amounts are presented in millions unless otherwise noted.
6
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Master Settlement Agreement and Federal Tobacco Buyout Expenses
Cost of products sold includes the following components for MSA settlement and federal tobacco
buyout expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months Ended |
|
|
For The Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
Ongoing settlement |
|
$ |
717 |
|
|
$ |
652 |
|
|
$ |
2,014 |
|
|
$ |
1,592 |
|
Phase II growers liability offset |
|
|
|
|
|
|
|
|
|
|
(79 |
) |
|
|
|
|
Phase II
growers expense |
|
|
39 |
|
|
|
|
|
|
|
39 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total settlement expense |
|
$ |
756 |
|
|
$ |
652 |
|
|
$ |
1,974 |
|
|
$ |
1,592 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout |
|
$ |
67 |
|
|
$ |
|
|
|
$ |
202 |
|
|
$ |
|
|
Federal quota tobacco stock liquidation
assessment |
|
|
74 |
|
|
|
|
|
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense |
|
$ |
141 |
|
|
$ |
|
|
|
$ |
283 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For additional information, see Governmental Health-Care Cost Recovery Cases MSA and Other
State Settlement Agreements and Tobacco Buyout Legislation in note 7.
Intangible Assets
The changes in the carrying amount of trademarks during the nine months ended September 30,
2005, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR
Tobacco |
|
|
Santa Fe |
|
|
Lane |
|
|
Consolidated |
|
|
|
Indefinite |
|
|
Finite |
|
|
Indefinite |
|
|
Indefinite |
|
|
|
|
|
|
|
Life |
|
|
Life |
|
|
Life |
|
|
Life |
|
|
|
|
|
Balance as of January 1, 2005 |
|
$ |
2,144 |
|
|
$ |
79 |
|
|
$ |
155 |
|
|
$ |
25 |
|
|
$ |
2,403 |
|
Amortization expense |
|
|
|
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30,
2005 |
|
$ |
2,144 |
|
|
$ |
66 |
|
|
$ |
155 |
|
|
$ |
25 |
|
|
$ |
2,390 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the carrying amount of goodwill during the nine months ended September 30,
2005, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
|
Santa Fe |
|
|
Lane |
|
|
Consolidated |
|
Balance as of January 1, 2005 |
|
$ |
5,321 |
|
|
$ |
224 |
|
|
$ |
140 |
|
|
$ |
5,685 |
|
Adjustment to 2004
acquisition restructuring
reserve, net of tax |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
Adjustment to deferred tax |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30, 2005 |
|
$ |
5,320 |
|
|
$ |
224 |
|
|
$ |
141 |
|
|
$ |
5,685 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the carrying amount of other intangibles during the nine months ended September
30, 2005, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
|
Lane |
|
|
Consolidated |
|
|
|
Indefinite |
|
|
|
|
|
|
Indefinite |
|
|
|
|
|
|
|
Life |
|
|
Finite Life |
|
|
Life |
|
|
|
|
|
Balance as of January 1, 2005 |
|
$ |
16 |
|
|
$ |
155 |
|
|
$ |
35 |
|
|
$ |
206 |
|
Amortization expense |
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30,
2005 |
|
$ |
16 |
|
|
$ |
135 |
|
|
$ |
35 |
|
|
$ |
186 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Other intangibles include acquired distribution agreements with indefinite lives. Details of
finite-lived intangible assets as of September 30, 2005, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
Gross |
|
|
Amortization |
|
|
Net |
|
|
Consumer database |
|
$ |
3 |
|
|
$ |
3 |
|
|
$ |
|
|
Customer contracts |
|
|
16 |
|
|
|
16 |
|
|
|
|
|
Contract manufacturing |
|
|
151 |
|
|
|
18 |
|
|
|
133 |
|
Technology-based |
|
|
3 |
|
|
|
1 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
Total other intangibles |
|
|
173 |
|
|
|
38 |
|
|
|
135 |
|
Trademarks |
|
|
85 |
|
|
|
19 |
|
|
|
66 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
258 |
|
|
$ |
57 |
|
|
$ |
201 |
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2005, the estimated remaining amortization expense associated with
finite-lived intangible assets in each of the next five years is as follows:
|
|
|
|
|
Year |
|
Amount |
|
Remainder of 2005 |
|
$ |
7 |
|
2006 |
|
|
30 |
|
2007 |
|
|
27 |
|
2008 |
|
|
25 |
|
2009 |
|
|
22 |
|
2010 |
|
|
21 |
|
Thereafter |
|
|
69 |
|
|
|
|
|
|
|
$ |
201 |
|
|
|
|
|
Stock-Based Compensation
All of RJRs compensation costs related to employee stock awards that were granted prior to
January 1, 2003, were recognized using the intrinsic value-based method under the provisions of
Accounting Principles Board, referred to as APB, Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. Compensation costs related to grants or modifications of
existing grants subsequent to January 1, 2003, are recognized under the fair value method of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as
amended. All compensation costs related to employee stock plans for all grant dates are disclosed
under the provisions of SFAS No. 123, as amended. Compensation costs on grants that vest pro rata
are recognized over the life of each award in the series as if it had its own separate vesting
period. All intrinsic value-based employee stock awards vested concurrent with the completion of
the combination transactions on July 30, 2004. Therefore, there is no pro forma stock-based
employee compensation disclosure for the three and nine months ended September 30, 2005. For the
three and nine months ended September 30, 2004, the effect on net income and income per share if
RJR and RAI had applied the fair value recognition provision of SFAS No. 123 is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three |
|
|
For the Nine |
|
|
|
Months Ended |
|
|
Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2004 |
|
|
2004 |
|
Net income as reported |
|
$ |
339 |
|
|
$ |
612 |
|
Add: Stock-based employee
compensation expense included in
reported net income, net of tax |
|
|
12 |
|
|
|
17 |
|
Deduct: Stock-based employee
compensation expense determined
under fair value-based method for
all awards, net of tax |
|
|
10 |
|
|
|
15 |
|
|
|
|
|
|
|
|
Pro forma net income |
|
$ |
341 |
|
|
$ |
614 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
Basic as reported |
|
$ |
2.67 |
|
|
$ |
6.21 |
|
Basic pro forma |
|
$ |
2.69 |
|
|
$ |
6.23 |
|
|
|
|
|
|
|
|
|
|
Diluted as reported |
|
$ |
2.66 |
|
|
$ |
6.16 |
|
Diluted pro forma |
|
$ |
2.68 |
|
|
$ |
6.18 |
|
8
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Pension and Postretirement
Recognized gains or losses include changes in the amount of either the benefit obligation or
the market-related value of plan assets resulting from experience different from that assumed or
from changes in assumptions. The minimum amortization of unrecognized gains or losses, as
described in SFAS No. 87, Employers Accounting for Pensions, is included in pension expense.
Prior service costs, which are changes in benefit obligations due to plan amendments, are amortized
on a straight-line basis over the average remaining service period for active employees. The
market-related value of plan assets recognizes changes in fair value in a systematic and rational
manner over five years.
Components of net benefit cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months Ended |
|
|
For The Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
Pension Benefits |
|
|
Benefits |
|
|
Pension Benefits |
|
|
Benefits |
|
|
|
2005 |
|
|
20041 |
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
20041 |
|
|
2005 |
|
|
2004 |
|
Service cost |
|
$ |
12 |
|
|
$ |
14 |
|
|
$ |
2 |
|
|
$ |
1 |
|
|
$ |
38 |
|
|
$ |
29 |
|
|
$ |
5 |
|
|
$ |
3 |
|
Interest cost |
|
|
76 |
|
|
|
66 |
|
|
|
21 |
|
|
|
18 |
|
|
|
229 |
|
|
|
158 |
|
|
|
63 |
|
|
|
42 |
|
Expected return on plan assets |
|
|
(85 |
) |
|
|
(71 |
) |
|
|
(7 |
) |
|
|
(4 |
) |
|
|
(249 |
) |
|
|
(168 |
) |
|
|
(19 |
) |
|
|
(4 |
) |
Amortization of transition asset |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2 |
) |
Amortization of prior service
cost |
|
|
1 |
|
|
|
1 |
|
|
|
(3 |
) |
|
|
(5 |
) |
|
|
2 |
|
|
|
2 |
|
|
|
(12 |
) |
|
|
(14 |
) |
Amortization of net loss |
|
|
18 |
|
|
|
12 |
|
|
|
6 |
|
|
|
3 |
|
|
|
53 |
|
|
|
37 |
|
|
|
16 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost |
|
|
22 |
|
|
|
22 |
|
|
|
19 |
|
|
|
13 |
|
|
|
73 |
|
|
|
58 |
|
|
|
53 |
|
|
|
40 |
|
Curtailment/special benefits |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
3 |
|
|
|
|
|
|
|
(13 |
) |
|
|
11 |
|
Settlements |
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total benefit cost |
|
$ |
23 |
|
|
$ |
25 |
|
|
$ |
22 |
|
|
$ |
15 |
|
|
$ |
78 |
|
|
$ |
61 |
|
|
$ |
46 |
|
|
$ |
51 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Excludes a $3 million adjustment for 2003 net benefit income related to
the retention of 850 positions, primarily in sales. See note 2 for further information. |
As a result of the sale of RJR Tobaccos packaging operations on May 2, 2005, and the
termination of the packaging employees, RAI remeasured certain plan assets and benefit obligations
utilizing a discount rate of 5.7%, resulting in an additional minimum liability of $362 million and
a reduction in other comprehensive income of $235 million, net of tax. The curtailment/special
benefits related to this transaction were $3 million pension expense and $13 million postretirement
income, included as a component of the net $25 million loss on sale of assets during the second
quarter of 2005.
Employer contributions
RAI disclosed in its financial statements for the year ended December 31, 2004, that it
expected to contribute $208 million to its pension plans in 2005. To reach a desired funding level
in its pension plans, RAI increased its contributions to $283 million during the first nine months
of 2005, and expects to contribute an additional $1 million in the fourth quarter of 2005.
Recently Issued Accounting Pronouncements
In September 2005, the Financial Accounting Standards Boards Emerging Issues Task Force
reached a consensus on Issue No. 04-13, Inventory Exchanges. EITF No. 04-13 requires two or more
inventory transactions with the same party to be considered a single nonmonetary transaction
subject to APB Opinion No. 29, Accounting for Nonmonetary Transactions, if the transactions were
entered into in contemplation of one another. EITF No. 04-13 is effective for RAI for new
arrangements entered into after April 1, 2006. RAI does not expect the adoption of EITF No. 04-13
to have a material impact on its financial position, results of operations or cash flows.
In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which
replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim
Financial Statements. SFAS No. 154 requires retrospective application to prior periods financial
statements of voluntary changes in accounting principle and changes required by new accounting
standards when the standard does not include
9
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
specific transition provisions, unless it is impracticable to do so. SFAS No. 154 defines
retrospective application as the application of a different accounting principle to prior
accounting periods as if that principle had always been used, and redefines restatement as the
revising of previously issued financial statements to reflect the correction of an error. SFAS No.
154 is effective for RAI as of January 1, 2006. RAI does not expect the adoption of SFAS No. 154
to have a material impact on its financial position, results of operations or cash flows.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations, referred to as FIN No. 47. FIN No. 47 clarifies SFAS No. 143, Accounting
for Asset Retirement Obligations, relating to obligations to perform an asset retirement activity
in which the timing and the method of settlement is conditional upon a future event. FIN No. 47
requires a liability for the fair value of a conditional asset retirement obligation to be
recognized when incurred if the fair value of the liability can be reasonably estimated. FIN No.
47 is effective for RAI no later than December 31, 2005. RAI has not yet determined the impact of
the adoption of FIN No. 47 on its financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs an amendment of ARB No. 43,
Chapter 4. This statement clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted materials. Accounting Research Bulletin No. 43 allowed some of
these costs to be carried as inventory, whereas SFAS No. 151 requires these costs to be recognized
as expenses when incurred. Additionally, SFAS No. 151 requires that the allocation of fixed
production overheads to the costs of conversion be based on the normal capacity of the production
facilities. SFAS No. 151 is effective for RAI as of January 1, 2006. RAI does not expect the
adoption of SFAS No. 151 to have a material impact on its financial position, results of operations
or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-an amendment
to APB Opinion No. 29. This statement requires exchanges of similar productive assets to now be
accounted for at fair value, the basic principle for nonmonetary transactions, unless the exchange
lacks commercial substance. SFAS No. 153 is effective for RAI as of January 1, 2006. RAI does not
expect the adoption of SFAS No. 153 to have a material impact on its financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment. This statement is a
revision of SFAS No. 123 and supersedes APB No. 25, Accounting for Stock Issued to Employees, and
its related implementation guidance. SFAS No. 123(R) addresses all forms of share-based payment
awards, including shares issued under employee stock purchase plans, stock options, restricted
stock and stock appreciation rights. SFAS No. 123(R) is effective for RAI as of January 1, 2006.
RAI does not expect the adoption of SFAS No. 123(R) to have a material impact on its financial
position, results of operations or cash flows primarily because all of RAIs outstanding stock options are
fully vested.
Note
2Restructuring and Asset Impairment Charges
2004 Acquisition Restructuring Costs
The components of the 2004 acquisition restructuring costs accrued and utilized were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
|
|
|
|
|
|
|
Severance and |
|
|
Relocation/ |
|
|
|
|
|
|
Benefits |
|
|
Exit Costs |
|
|
Total |
|
Original accrual |
|
$ |
171 |
|
|
$ |
101 |
|
|
$ |
272 |
|
Utilized in 2004 |
|
|
(60 |
) |
|
|
(26 |
) |
|
|
(86 |
) |
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004 |
|
|
111 |
|
|
|
75 |
|
|
|
186 |
|
Utilized in 2005 |
|
|
(35 |
) |
|
|
(25 |
) |
|
|
(60 |
) |
Adjustment to goodwill |
|
|
2 |
|
|
|
(3 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
78 |
|
|
$ |
47 |
|
|
$ |
125 |
|
|
|
|
|
|
|
|
|
|
|
In connection with the allocation of the cost of the business combination as to assets
acquired and liabilities assumed, RJR Tobacco accrued restructuring costs of $272 million in 2004.
Of these costs, $171 million relate to the severance of approximately 2,450 former B&W employees in
operations, sales and corporate functions of which 1,419 have been terminated as of September 30,
2005. Other accruals include the cost to relocate former B&W employees retained and transferred
from facilities that are being exited. Additionally, other exit costs include contract
terminations and the closure of the acquired headquarters, a leased facility in Louisville,
Kentucky, as well as the closure of a leased
10
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
warehouse and certain leased sales offices, net of expected sub-lease income.
During the
second quarter of 2005, RJR Tobacco determined that, under the 2004
acquisition restructuring plan, approximately 30 additional former B&W
employees would be severed, which resulted in an accrual of $2 million. A contract termination
related to former B&W operations increased exit costs $1 million. A reduction in relocation/exit
costs of $4 million reflects fewer former B&W employee transfers and sub-lease income on closed
facilities.
As of September 30, 2005, $146 million of the accrued amount had been paid. In the condensed
consolidated balance sheet (unaudited) as of September 30, 2005, $80 million is included in other
current liabilities and $45 million is included in other noncurrent liabilities.
2003 Restructuring and Asset Impairment Charges
The components of the 2003 restructuring and asset impairment charges recorded and utilized
were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance |
|
|
|
|
|
|
Contract |
|
|
|
|
|
|
and |
|
|
Asset |
|
|
Termination/ |
|
|
|
|
|
|
Benefits |
|
|
Impairment |
|
|
Exit Costs |
|
|
Total |
|
Original charge |
|
$ |
292 |
|
|
$ |
28 |
|
|
$ |
53 |
|
|
$ |
373 |
|
Utilized in 2003 |
|
|
(92 |
) |
|
|
(28 |
) |
|
|
(52 |
) |
|
|
(172 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2003 |
|
|
200 |
|
|
|
|
|
|
|
1 |
|
|
|
201 |
|
Incurred in 2004 |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
1 |
|
Utilized in 2004 |
|
|
(91 |
) |
|
|
|
|
|
|
(2 |
) |
|
|
(93 |
) |
Adjusted in 2004 |
|
|
(34 |
) |
|
|
|
|
|
|
|
|
|
|
(34 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004 |
|
|
75 |
|
|
|
|
|
|
|
|
|
|
|
75 |
|
Utilized in 2005 |
|
|
(49 |
) |
|
|
|
|
|
|
|
|
|
|
(49 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
26 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During 2003, in response to continuing challenges of an intensely competitive environment, RJR
and RJR Tobacco incurred restructuring and asset impairment charges of $373 million, or $225
million after tax. Of these charges, RJR Tobacco incurred $287 million related to severance and
benefits, $28 million related to asset impairments, primarily reflecting abandonment of certain
merchandising fixtures not yet shipped to retailers, and $34 million related to professional fees
for valuation and consulting services, as well as the discontinuation of certain event-marketing
programs and other associated exit costs. The remaining $24 million was incurred by RJR.
During 2004, RJR Tobacco decided that approximately 750 sales positions that were expected to
be outsourced would not be eliminated and had approximately 100 other less-than-expected workforce
reductions, primarily in manufacturing. Accordingly, associated severance and related benefits of
$34 million, or $20 million after tax, was reversed from the restructuring charge during 2004.
After the adjustments during 2004, the workforce reduction was approximately 22%, or
approximately 1,680 full-time employees, in operations and corporate functions. The workforce
reduction was substantially completed during the fourth quarter of 2004. The remaining accrual
represents severance that will be paid through 2007.
The cash portion of the restructuring and asset impairment charges to date is approximately
$225 million, of which $171 million relates to employee severance costs and $54 million relates to
exit costs. As of September 30, 2005, $199 million of this amount had been paid. Of the $115
million non-cash portion of the charges, $87 million related to benefit charges and $28 million
related to asset impairments. In the condensed consolidated balance sheet (unaudited) as of
September 30, 2005, $21 million is included in other current liabilities and $5 million is included
in other noncurrent liabilities. No significant additional charges are expected to be incurred in
connection with the 2003 restructuring plan.
11
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
2002 Restructuring and Asset Impairment Charges
The components of the 2002 restructuring and asset impairment charges recorded and utilized
were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance |
|
|
|
|
|
|
Contract |
|
|
|
|
|
|
and |
|
|
Asset |
|
|
Termination/ |
|
|
|
|
|
|
Benefits |
|
|
Impairment |
|
|
Exit Costs |
|
|
Total |
|
Original charge |
|
$ |
102 |
|
|
$ |
115 |
|
|
$ |
7 |
|
|
$ |
224 |
|
Utilized in 2002 |
|
|
(44 |
) |
|
|
(115 |
) |
|
|
(2 |
) |
|
|
(161 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2002 |
|
|
58 |
|
|
|
|
|
|
|
5 |
|
|
|
63 |
|
Utilized in 2003 |
|
|
(27 |
) |
|
|
|
|
|
|
|
|
|
|
(27 |
) |
Adjusted in 2003 |
|
|
(2 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2003 |
|
|
29 |
|
|
|
|
|
|
|
2 |
|
|
|
31 |
|
Incurred in 2004 |
|
|
|
|
|
|
40 |
|
|
|
|
|
|
|
40 |
|
Utilized in 2004 |
|
|
(23 |
) |
|
|
(40 |
) |
|
|
|
|
|
|
(63 |
) |
Adjusted in 2004 |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004 |
|
|
4 |
|
|
|
|
|
|
|
2 |
|
|
|
6 |
|
Utilized in 2005 |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
(2 |
) |
Adjusted in 2005 |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
2 |
|
|
$ |
|
|
|
$ |
1 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2002, RJR Tobacco recorded a pre-tax restructuring charge of $224 million, $135 million
after tax, in response to changing competitive practices within the tobacco industry.
During 2004, RJR Tobacco reversed $2 million for employee severance and benefits, due to
less-than-expected workforce reductions. As adjusted, the employee severance and benefits relate
to the elimination of approximately 500 full-time positions in operations support and corporate
functions, which were substantially completed as of December 31, 2004.
The asset impairment resulted from the remeasurement of the non-tobacco businesses at the
lower of their carrying value or fair value less cost to sell. Based on the results of
negotiations, a revaluation of the fair value of RJR Tobaccos
packaging business resulted in additional impairment of $40 million in the fourth quarter of 2004.
Assets held for sale and liabilities related to assets held for sale in the condensed
consolidated balance sheets are classified in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. As of September 30, 2005, the carrying amounts of
the major classes of assets and liabilities in the disposal group included $3 million of property,
plant and equipment and other. As of December 31, 2004, the carrying amounts of the major classes
of assets and liabilities in the disposal group included $14 million of accounts receivable, $31
million of inventories, $7 million of property, plant and equipment and other, and $11 million of
accounts payable and accrued liabilities. RJR Tobacco completed the sale of one of the non-tobacco
businesses in the second quarter of 2003. On May 2, 2005, RJR Tobacco completed the sale of its
packaging operations to a consortium of five packaging companies for $48 million, including cash of
$30 million and short-term notes receivable of $18 million. As of September 30, 2005, cash has
been received for the full amount of the notes receivable. In connection with this sale
transaction, during the second quarter of 2005, RJR Tobacco recorded a net loss on sale of assets
of $25 million within operating income.
RJR Tobacco agreed to provide severance and related benefits to employees who would not
receive offers for ongoing employment from the consortium of buyers. Accordingly, the loss
includes approximately $28 million for severance and related benefits to be paid by RJR Tobacco to
approximately 185 employees out of approximately 740 employees who served the packaging operations
at the time of disposition. RJR Tobacco also agreed to provide a transition bonus to eligible
employees who continue to work during the transition period, which is expected to be up to 24
months. The termination of the packaging employees triggered a remeasurement of the plan assets
and benefit obligations of certain of RAIs pension and postretirement plans. The remeasurement
resulted in an additional minimum liability of $362 million and a one-time net curtailment gain of
$10 million, reflecting $3 million of pension expense and $13 million of postretirement income.
Pursuant to various exclusive requirements-based supply contracts, with terms of seven to nine
years, entered into between the
12
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
buyers and RJR Tobacco, RJR Tobacco will continue to obtain its
packaging materials from certain of the buyers. As a result of certain transitional supply
pricing, which is above current market prices, $14 million was accrued as part of the loss. As a
result, anticipated purchases over the transition period will be recorded at approximate current
market prices. Of the charges incurred during the second quarter of
2005 related to the sale of the packaging business,
$14 million
of these accruals were included in other current liabilities and $17 million were included in other
noncurrent liabilities, in the condensed consolidated balance sheet (unaudited) as of September 30, 2005,
Contract termination and exit costs included certain contract terminations and lease
terminations of 15 sales offices. Exit costs also included the separation of the non-tobacco
businesses held for sale. During 2003, $5 million of the charge was reversed, reflecting
less-than-expected workforce reductions and exit costs of field sales offices. During 2005, $1
million of the charge was reversed relating to the sale of the packaging operations.
The cash portion of the 2002 restructuring and asset impairment charges is expected to be $55
million and primarily relates to employee severance costs. As of September 30, 2005, $52 million
of this amount had been paid. The $201 million non-cash portion included $44 million related to
employee benefits, $155 million related to asset impairments and $2 million related to the
write-off of prepaid promotional rights that were terminated. In the condensed consolidated
balance sheet (unaudited) as of September 30, 2005, $3 million is included in other current
liabilities.
Note 3Income Per Share
The components of the calculation of income per share were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Income from continuing operations |
|
$ |
213 |
|
|
$ |
290 |
|
|
$ |
745 |
|
|
$ |
562 |
|
Gain on sale of discontinued businesses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
213 |
|
|
$ |
339 |
|
|
$ |
745 |
|
|
$ |
612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares, in thousands1 |
|
|
147,396 |
|
|
|
126,885 |
|
|
|
147,388 |
|
|
|
98,549 |
|
Effect of dilutive potential shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options |
|
|
188 |
|
|
|
455 |
|
|
|
193 |
|
|
|
533 |
|
Restricted stock |
|
|
|
|
|
|
127 |
|
|
|
|
|
|
|
269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares, in thousands |
|
|
147,584 |
|
|
|
127,467 |
|
|
|
147,581 |
|
|
|
99,351 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Outstanding shares of contingently issuable restricted stock of 0.3 million and 0.5
million were excluded from the share calculations for the three- and nine-month periods ended
September 30, 2004, respectively, as the related vesting provisions had not yet been met. |
Note 4Inventories
The major components of inventories were:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Leaf tobacco |
|
$ |
877 |
|
|
$ |
1,033 |
|
Raw materials |
|
|
34 |
|
|
|
38 |
|
Work in process |
|
|
55 |
|
|
|
65 |
|
Finished products |
|
|
175 |
|
|
|
190 |
|
Other |
|
|
34 |
|
|
|
44 |
|
|
|
|
|
|
|
|
Total |
|
|
1,175 |
|
|
|
1,370 |
|
Less LIFO allowance |
|
|
65 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
$ |
1,110 |
|
|
$ |
1,265 |
|
|
|
|
|
|
|
|
13
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
RAI recorded $1 million of income and $6 million of expense from expected LIFO layer
liquidations for the three- and nine-month periods ended September 30, 2005, respectively. RAI
will perform its annual LIFO inventory valuation at December 31, 2005, and interim periods
represent an estimate of the expected annual valuation.
Note
5Financial Instruments
RJR uses interest rate swaps to manage interest rate risk on a portion of its debt
obligations. When entered into, these financial instruments are designated as hedges of underlying
exposures. During 2002, RJR entered into interest rate swap agreements to modify the interest
characteristics of $1.25 billion, a portion of its publicly registered notes, with fixed rates of
6.5% to 7.75%, due in 2006 to 2012, so that the interest payable effectively becomes variable. In
the third quarter of 2005, swaps were settled related to the $310 million of notes due in 2006 that
were purchased in response to RJRs tender offer. See note 6 for additional information. As of
September 30, 2005, the average interest rate on RJRs $1.7 billion long-term debt was 6.5% after
the effect of the swaps. The interest rate swaps notional amounts and termination dates match
those of the outstanding notes. As of September 30, 2005, these fair value hedges were perfectly
effective, resulting in no recognized net gain or loss. The unrealized gain on the hedges resulting
from the change in the hedges fair value was $30 million and $61 million at September 30, 2005 and
December 31, 2004, respectively, included in other assets and deferred charges and $1 million
included in prepaid expenses at September 30, 2005, and is equal to the increase in the fair value
of the hedged long-term debt.
Under certain conditions, including RJRs guaranteed secured debt rating remaining either one
level below BBB- by S&P or Baa3 by Moodys, or lower, any fair value that results in a liability
position of the interest rate swaps will require full collateralization with cash or securities.
In addition, because RJR and the guarantors, including RAI and RJR Tobacco, have pledged
substantially all of their assets, including the stock of certain of their subsidiaries, to secure
their obligations under RJRs revolving credit facility, as amended and restated, such pledge also
has secured their obligations under these interest rate swap agreements.
Note 6Long-Term Debt and Borrowing Arrangements
Long-term debt consisted of:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
8.50%-9.25% unsecured notes, due 2007 to 2013 |
|
$ |
89 |
|
|
$ |
139 |
|
7.75% guaranteed, unsecured notes, due 2006 |
|
|
191 |
|
|
|
|
|
6.5%-7.875% guaranteed, secured notes, due 2007 to 2015 |
|
|
1,475 |
|
|
|
1,506 |
|
|
|
|
|
|
|
|
|
|
|
1,755 |
|
|
|
1,645 |
|
|
|
|
|
|
|
|
|
|
Current
maturities of long-term debt |
|
|
(191 |
) |
|
|
(50 |
) |
|
|
|
|
|
|
|
|
|
$ |
1,564 |
|
|
$ |
1,595 |
|
|
|
|
|
|
|
|
As of September 30, 2005, the maturities of long-term debt, net of discount and excluding fair
value adjustments associated with interest rate swaps of $31 million, are as follows:
|
|
|
|
|
Year |
|
Amount |
|
Current maturities |
|
$ |
190 |
|
2007 |
|
|
329 |
|
2009 |
|
|
199 |
|
2010 |
|
|
299 |
|
Thereafter |
|
|
707 |
|
|
|
|
|
|
|
$ |
1,724 |
|
|
|
|
|
In June 2005, RJR completed a private offering, referred to as the Private Offering, of $300
million of 6.5% secured notes due July 15, 2010, and $200 million of 7.3% secured notes due July
15, 2015. The Private Offering requires RJR to pay additional interest on the foregoing notes at
an annual rate of 0.5% if it fails to comply with certain of its obligations under a registration
rights agreement covering such notes, including completion of an exchange offer for publicly
registered notes no later than February 24, 2006.
In conjunction with the Private Offering, RJR commenced in June 2005, a cash tender offer,
referred to as the Offer, for any and all of its then outstanding $500 million of 7.75% secured
notes due May 15, 2006, referred to as the 2006 Notes, and a consent solicitation to amend the
related indenture. The consents were solicited to approve indenture amendments, referred to as the
Amendments, which eliminated substantially all of the restrictive covenants and one of
14
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
the events of default with respect to the 2006 Notes. RJR used a portion of the proceeds from
the Private Offering to extinguish $310 million of the 2006 Notes tendered pursuant to the Offer in
July 2005. The remainder of the Private Offering proceeds will be maintained and used to pay at
maturity the 2006 Notes that were not tendered in the Offer, or at RJRs discretion, to redeem the
2006 Notes. In accordance with the terms of the Amendments, the outstanding 2006 Notes that were
not tendered in the Offer are no longer secured, but remain guaranteed by RAI and certain of RJRs
subsidiaries, as described below. In the third quarter of 2005, RJR recorded $7 million of net
costs related to the extinguishment of the 2006 Notes, including the impact of settled swaps.
Unlike RJRs other non-bank debt, RJRs secured notes, as well as the 2006 Notes that were not
extinguished pursuant to the Offer, are guaranteed by certain of RJRs subsidiaries, including RJR
Tobacco, and its parent, RAI, which entities also guarantee RJRs obligations under RJRs credit
facility, described below.
Any guarantor that is released from its guarantee under RJRs credit facility also will be
released automatically from its guarantee of RJRs notes. RJRs secured notes and the related
guarantees are secured by the stock of RJR and the subsidiary guarantors and certain of their
subsidiaries, indebtedness of subsidiaries of RJR and the guarantors, to the extent owed to RJR or
a guarantor, and principal property of RJR and the subsidiary guarantors. These assets constitute
a portion of the security for the obligations of RJR and the guarantors under RJRs credit
facility. If these assets are no longer pledged as security for the obligations of RJR and the
guarantors under RJRs credit facility, or any other indebtedness of RJR, they will be released
automatically as security for RJRs secured notes and the related guarantees. Under the terms of
RJRs credit facility, the security therefor will be released automatically at such time that
certain debt of RJR is rated investment grade by each of Moodys and S&P. RAIs stock in Santa Fe
and CMSI, the parent company of Lane, is excluded from the collateral securing RAIs guarantee of
RJRs secured notes and credit facility. Generally, the terms of RJRs guaranteed secured notes
restrict the pledge of collateral, sale/leaseback transactions and the transfer of all or
substantially all of the assets of RJR and its subsidiaries.
Moodys rating of RJRs guaranteed, secured notes is Ba2, negative outlook, and S&Ps rating
is BB+, negative outlook.
As of September 30, 2005, RJR had $1.45 billion of guaranteed, secured notes outstanding, with
fixed annual interest rates of 6.5% to 7.875%, due in 2007 through 2015 and $190 million of
guaranteed, unsecured notes outstanding, at a fixed annual interest rate of 7.75% due in 2006. In
addition, as of September 30, 2005, RJR had $89 million of notes outstanding which were neither
secured nor guaranteed, at fixed annual interest rates of 8.5% to 9.25%, due in 2007 through 2013.
At its option, RJR may redeem any or all of its outstanding notes, in whole or in part at any time,
subject to the payment of a make-whole premium.
RJR uses interest rate swaps to manage interest rate risk on a portion of its debt
obligations. Under certain conditions, including RJRs guaranteed, secured debt remaining either
one level below BBB- by S&P or Baa3 by Moodys, or lower, any fair value that results in a
liability position of the interest rate swaps will require full collateralization with cash or
securities. In addition, because RJR and the guarantors, including RAI and RJR Tobacco, have
pledged substantially all of their assets, including the stock of certain of their subsidiaries, to
secure their obligations under RJRs credit facility, such pledge also has secured their
obligations under these interest rate swap agreements.
RJRs revolving credit facility with a syndicate of banks has a committed amount of $486
million through January 2007. RJR can use the full credit facility to obtain loans or letters of
credit, at its option.
Under the terms of the credit facility, RJR is not required to maintain compensating balances;
however, RJR pays commitment fees of 1.5% per annum of the credit facility committed amount.
Borrowings under the credit facility bear interest at rates based upon the prime rate, the federal
funds rate or LIBOR plus, in each case, an applicable interest margin based upon the credit rating
assigned to RJRs long-term guaranteed, secured debt. The credit facility has restrictive
covenants that limit RAIs ability to pay dividends and repurchase stock, and limits RAI and its
subsidiaries ability to incur indebtedness, engage in transactions with affiliates, create liens,
acquire, sell or dispose of specific assets and engage in specified mergers or consolidations.
Under the credit facility, RAIs cumulative dividends and share repurchases generally may not
exceed the sum of $500 million plus 75% of cumulative adjusted cash net income. RJRs credit
facility is secured by substantially all of RJRs assets, including RJRs stock in RJR Tobacco.
Also, certain of RJRs subsidiaries, including RJR Tobacco, and RJRs parent, RAI, have guaranteed
RJRs obligations under the credit facility and have pledged substantially all of their assets to
secure such guarantees. The collateral securing RJRs credit facility, and the related guarantees,
will be released automatically in certain circumstances. At September
15
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
30, 2005, RJR had $26 million in letters of credit outstanding under the credit facility. No
borrowings were outstanding, and the remaining $460 million of the credit facility was available
for borrowing.
RJR has a $30 million uncommitted, unsecured line of credit with one bank. No borrowings were
outstanding on this line of credit at September 30, 2005.
RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed
by their indebtedness at September 30, 2005.
Note 7Commitments and Contingencies
Litigation Affecting the Cigarette Industry
Overview
Introduction
Various legal proceedings, including litigation claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of, or exposure to, RAIs operating
subsidiaries products, are pending or may be instituted against RJR Tobacco or its affiliates,
including RAI and RJR, or indemnitees, including B&W. In connection with the business combination
of RJR Tobacco and the U.S. cigarette and tobacco business of B&W on July 30, 2004, RJR Tobacco
agreed to indemnify B&W and its affiliates against, among other things, any litigation liabilities,
costs and expenses incurred by B&W or its affiliates arising out of the U.S. cigarette and tobacco
business of B&W. Accordingly, the cases discussed below include cases brought solely against RJR
Tobacco and its affiliates, including RAI and RJR; cases brought against both RJR Tobacco, its
affiliates and B&W; and cases brought solely against B&W and assumed by RJR Tobacco in the business
combination. See note 1 above for further discussion of the business combination of RJR Tobacco
and the U.S. cigarette and tobacco business of B&W.
During the third quarter of 2005, 16 tobacco-related cases were served against RJR Tobacco or
its affiliates or indemnitees, including B&W. On September 30, 2005, there were 1,323 cases
(including approximately 1,009 individual smoker cases pending in West Virginia state court as a
consolidated action) pending against RJR Tobacco or its affiliates or indemnitees, including B&W,
as compared with 1,330 on September 30, 2004, pending against RJR Tobacco or its affiliates or
indemnitees, including B&W, and 1,595 on September 30, 2003, pending against RJR Tobacco or its
affiliates or indemnitees, without reference to B&W.
As of October 14, 2005, 1,329 tobacco-related cases were pending against RJR Tobacco or its
affiliates or indemnitees: 1,316 in the United States; seven in Puerto Rico; one in Israel; four
in Canada and one in the Virgin Islands. Of the 1,329 total cases, 38 cases are pending against
B&W that are not also pending against RJR Tobacco. The U.S. case number does not include the 2,650
Broin II cases, which involve individual flight attendants alleging injuries as a result of
exposure to environmental tobacco smoke, referred to as ETS or secondhand smoke, in aircraft
cabins, pending as of October 14, 2005, and discussed below. The following table lists the number
of U.S. tobacco-related cases by state that were pending against RJR Tobacco or its affiliates or
indemnitees as of October 14, 2005:
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
West Virginia |
|
|
1,014 |
* |
Florida |
|
|
93 |
|
Mississippi |
|
|
51 |
|
Missouri |
|
|
30 |
|
New York |
|
|
27 |
|
Louisiana |
|
|
23 |
|
California |
|
|
15 |
|
Maryland |
|
|
14 |
|
Illinois |
|
|
9 |
|
Alabama |
|
|
5 |
|
Pennsylvania |
|
|
4 |
|
Washington |
|
|
4 |
|
Georgia |
|
|
3 |
|
Connecticut |
|
|
3 |
|
16
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
District of Columbia |
|
|
2 |
|
Tennessee |
|
|
2 |
|
Texas |
|
|
2 |
|
Michigan |
|
|
2 |
|
Minnesota |
|
|
2 |
|
Oregon |
|
|
2 |
|
Delaware |
|
|
2 |
|
Ohio |
|
|
1 |
|
Kansas |
|
|
1 |
|
North Carolina |
|
|
1 |
|
New Mexico |
|
|
1 |
|
South Dakota |
|
|
1 |
|
Massachusetts |
|
|
1 |
|
Indiana |
|
|
1 |
|
|
|
|
|
|
Total |
|
|
1,316 |
|
|
|
|
|
|
|
|
|
* |
|
1,009 of the 1,014 cases are pending as a consolidated action. |
Of the 1,316 pending U.S. cases, 50 are pending in federal court, 1,265 in state court and one
in tribal court.
The following table lists the categories of the U.S. tobacco-related cases currently pending
against RJR Tobacco or its affiliates or indemnitees as of October 14, 2005, compared with the
number of cases pending against RJR Tobacco, its affiliates or indemnities as of July 15, 2005, as
reported in RAIs Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2005, filed
August 4, 2005, and a cross-reference to the discussion of each case type.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in |
|
|
|
|
RJR Tobaccos |
|
Number of |
|
|
|
|
Case Numbers as of |
|
Cases Since |
|
|
Case Type |
|
October 14, 2005 |
|
July 15, 2005 |
|
Page Reference |
Individual Smoking and Health |
|
|
1,272 |
|
|
-45 |
|
|
25 |
|
Flight Attendant ETS (Broin II) |
|
|
2,650 |
|
|
+1 |
|
|
26 |
|
Class-Action |
|
|
22 |
|
|
No Change |
|
|
27 |
|
Governmental Health-Care Cost Recovery |
|
|
4 |
|
|
+1 |
|
|
31 |
|
Other Health-Care Cost Recovery and
Aggregated Claims |
|
|
3 |
|
|
+1 |
|
|
35 |
|
Master Settlement Agreement-Enforcement
and Validity |
|
|
2 |
|
|
No Change |
|
|
36 |
|
Asbestos Contribution |
|
|
1 |
|
|
No Change |
|
|
38 |
|
Antitrust |
|
|
6 |
|
|
-1 |
|
|
38 |
|
Other Litigation |
|
|
6 |
|
|
-1 |
|
|
39 |
|
In July 2000, a jury in the Florida state court case Engle v. R. J. Reynolds Tobacco Co.
rendered a punitive damages verdict in favor of the Florida class of plaintiffs of approximately
$145 billion, with approximately $36.3 billion and $17.6 billion being assigned to RJR Tobacco and
B&W, respectively. RJR Tobacco, B&W and the other defendants appealed this verdict. On May 21,
2003, Floridas Third District Court of Appeal reversed the trial courts final judgment and
remanded the case to the Miami-Dade County Circuit Court with instructions to decertify the class.
On October 23, 2003, the plaintiffs asked the Florida Supreme Court to review the case. On May 12,
2004, the Florida Supreme Court accepted the case. Oral argument occurred on November 3, 2004.
Although RJR Tobacco remains confident in the bases for appeal in this case, it cannot predict the
final outcome of the appellate process. See Class-Action Suits below for a further description
of the Engle case.
In November 1998, the major U.S. cigarette manufacturers, including RJR Tobacco and B&W,
entered into the Master Settlement Agreement, referred to as the MSA, with 46 U.S. states and
certain U.S. territories and possessions. These cigarette manufacturers previously settled four
other cases scheduled to come to trial, brought on behalf of Mississippi, Florida, Texas and
Minnesota, by separate agreements with each state. The MSA and other state settlement agreements:
17
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
settled all health-care cost recovery actions brought by, or on behalf of, the
settling jurisdictions; |
|
|
|
|
released the major U.S. cigarette manufacturers from various additional present and
potential future claims; |
|
|
|
|
imposed future payment obligations on RJR Tobacco, B&W and other major U.S.
cigarette manufacturers; and |
|
|
|
|
placed significant restrictions on their ability to market and sell cigarettes. |
The aggregate cash payments made by RJR Tobacco under the MSA and other state settlement
agreements were $1.8 billion in 2003 and $2.0 billion in 2004. These amounts do not include
payments made in connection with B&Ws U.S. brands prior to July 30, 2004. RJR Tobacco estimates
its payments, including payments made in connection with B&Ws U.S. brands acquired in the business
combination, will exceed $2.6 billion in 2005, $2.5 billion in each of 2006 and 2007 and $2.7
billion thereafter. However, these future payments will be subject to adjustments for, among other
things, the volume of cigarettes sold by RJR Tobacco, RJR Tobaccos market share and inflation. See
Governmental Health-Care Cost Recovery Cases MSA and Other State Settlement Agreements below
for a detailed discussion of the MSA and the other state settlement agreements, including RJR
Tobaccos monetary obligations under these agreements. RJR Tobacco records the allocation of
settlement charges as products are shipped.
Certain Terms and Phrases
Certain terms and phrases that are used in this disclosure may require some explanation. The
terms judgment or final judgment refer generally to the final decision of the court resolving
the dispute and determining the rights and obligations of the parties. At the trial court level,
for example, a final judgment generally is entered by the court after a jury verdict and after
post-verdict motions have been decided. Generally, the losing party can appeal a verdict only
after a final judgment has been entered by the trial court.
The term damages refers to the amount of money sought by a plaintiff in a complaint, or
awarded to a party by a jury, or in some cases by a judge. Compensatory damages are awarded to
compensate the prevailing party for actual losses suffered if liability is proved. In cases in
which there is a finding that a defendant has acted willfully, maliciously or fraudulently,
generally based on a higher burden of proof than is required for a finding of liability for
compensatory damages, a plaintiff also may be awarded punitive damages. Although damages may be
awarded at the trial court stage, a losing party generally may be protected from paying any damages
until all appellate avenues have been exhausted by posting a supersedeas bond. The amount of such
a bond is governed by the law of the relevant jurisdiction and generally is set at the amount of
damages plus some measure of statutory interest, modified at the discretion of the appropriate
court or subject to limits set by court or statute.
The term settlement refers to certain types of cases in which cigarette manufacturers,
including RJR Tobacco and B&W, have agreed to resolve disputes with certain plaintiffs without
resolving the case through trial. The principal terms of settlements entered into by RJR Tobacco
are explained in the following disclosure.
Accounting for Tobacco-Related Litigation Contingencies
In accordance with applicable accounting principles, RAI and RJR Tobacco will record any loss
concerning tobacco-related litigation at such time as an unfavorable outcome becomes probable and
the amount can be reasonably estimated. For the reasons set forth below, RAIs management
continues to conclude that the loss of any particular pending smoking and health tobacco litigation
claim against RJR Tobacco or its affiliates or indemnitees, including B&W, when viewed on an
individual basis, is not probable. RJR Tobacco and its affiliates believe that they have a number
of valid defenses to the smoking and health tobacco litigation claims against them, as well as
valid bases for appeal of adverse verdicts against them. RAI, RJR Tobacco and their affiliates and
indemnitees have, through their counsel, filed pleadings and memoranda in pending smoking and
health tobacco litigation that set forth and discuss a number of grounds and defenses that they and
their counsel believe have a valid basis in law and fact. Based on their experience in the smoking
and health tobacco litigation against them and the strength of the defenses available to them in
such litigation, RJR Tobacco and its affiliates believe that their successful defense of smoking
and health tobacco litigation in the past will continue in the future. Therefore, no liability for
pending smoking and health tobacco litigation currently is recorded in RAIs consolidated financial
statements. RJR has liabilities totaling $96 million that were recorded in 1999 in connection with
certain indemnification claims asserted by Japan Tobacco Inc., referred to as
18
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
JTI, against RJR and RJR Tobacco relating to certain activities of Northern Brands
International, Inc., a now inactive, indirect subsidiary of RAI formerly involved in the
international tobacco business. For further information on Northern Brands and related litigation
and the indemnification claims of JTI, see Other Litigation and Developments and Other
Contingencies and Guarantees.
RJR Tobacco and its affiliates and indemnitees continue to win the majority of smoking and
health tobacco litigation claims that reach trial, and a very high percentage of the
tobacco-related litigation claims brought against them continue to be dismissed at or before trial.
Generally, RJR Tobacco and its affiliates and indemnitees have not settled, and currently RJR
Tobacco and its affiliates do not intend to settle, any smoking and health tobacco litigation
claims. It is the policy of RJR Tobacco and its affiliates to vigorously defend all
tobacco-related litigation claims.
The only smoking and health tobacco litigation claims settled by RJR Tobacco and B&W involved:
|
|
|
the MSA and other settlement agreements with the states of Mississippi, Florida, Texas
and Minnesota, and the funding by various tobacco companies of a $5.2 billion trust fund
contemplated by the MSA to benefit tobacco growers; and |
|
|
|
|
the original Broin flight attendant case discussed below under Class-Action Suits. |
The DeLoach antitrust case, discussed below under Antitrust Cases, and certain MSA enforcement
actions, discussed below under MSAEnforcement and Validity, also were settled separately by RJR
Tobacco and B&W. Despite valid legal defenses, the decision to settle these matters resulted from
unique circumstances that RJR Tobacco believes does not apply to the other tobacco-related
litigation cases pending against RJR Tobacco, B&W and their respective affiliates.
The circumstances surrounding the MSA and other state settlement agreements and the funding of
a trust fund to benefit the tobacco growers are readily distinguishable from the current categories
of smoking and health cases involving RJR Tobacco, B&W and their respective affiliates. The claims
underlying the MSA and other state settlement agreements were brought on behalf of the states to
recover funds paid for health-care and medical and other assistance to state citizens suffering
from diseases and conditions allegedly related to tobacco use. The MSA and other state settlement
agreements settled all the health-care cost recovery actions brought by, or on behalf of, the
settling jurisdictions and contain releases of various additional present and future claims. In
accordance with the MSA, various tobacco companies agreed to fund a $5.2 billion trust fund to be
used to address the possible adverse economic impact of the MSA on tobacco growers. A discussion
of the MSA and other state settlement agreements, and a table depicting the related payment
schedule under these agreements, is set forth below under Governmental Health-Care Cost Recovery
Cases MSA and Other State Settlement Agreements.
The states were a unique set of plaintiffs and are not involved in any of the smoking and
health cases remaining against RJR Tobacco or its affiliates and indemnitees, including B&W.
Although RJR Tobacco, B&W and certain of their respective affiliates continue to be defendants in
health-care cost recovery cases similar in theory to the state cases but involving other
plaintiffs, such as hospitals, Native American tribes, and local and foreign governments, the vast
majority of such cases have been dismissed on legal grounds. Indeed, eight federal courts of
appeals have ruled uniformly that unions cannot successfully pursue such cases. As a result, no
union cases are pending against RJR Tobacco or its affiliates or indemnitees. RJR Tobacco and its
affiliates, including RAI, believe that the same legal principles that have resulted in dismissal
of union and other types of health-care cost recovery cases either at the trial court level or on
appeal should compel dismissal of the similar pending cases.
Additionally, in the United States Department of Justice case brought against various industry
members, including RJR Tobacco and B&W, discussed below under Governmental Health-Care Cost
Recovery Cases, the United States District Court for the District of Columbia granted the
non-Liggett defendants motion to dismiss the plaintiffs Medical Care Recovery Act and Medicare
Secondary Payer claims. In these particular claims, the federal government made arguments similar
to the states and sought to recover federal funds expended in providing health care to smokers who
have developed diseases and injuries alleged to be smoking-related. The only remaining claims in
this case involve alleged violations of the federal Racketeer Influenced and Corrupt Organizations
Act statute, referred to as RICO. Under this statute, the federal government sought disgorgement
of profits from the defendants in the amount of $280 billion. Overruling the trial court, the
United States Court of Appeals for the District of Columbia held that disgorgement is not an
available remedy. This ruling eliminates the governments claims for $280 billion and limits the
governments potential remedies principally to forward-looking relief, including measures such as
those already included in the MSA. On July 18, 2005, the government filed a petition for writ of
certiorari with the United States
19
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Supreme Court on this issue. Trial of the case concluded on June 9, 2005, and post-trial
submissions were completed on October 9, 2005. On October 17, 2005, the Supreme Court denied the
petition.
Similarly, the other cases settled by RJR Tobacco can be readily distinguished from existing
cases pending against RJR Tobacco and its affiliates and indemnitees, including B&W. The original
Broin case, discussed below under Class-Action Suits, was settled in the middle of trial during
discussions with the federal government concerning the possible settlement of the claims underlying
the MSA and other state settlement agreements, among other things. The Broin case was settled at
that time in an attempt to remove this case as a political distraction during the industrys
settlement discussions with the federal government and a belief that further Broin litigation would
be resolved by a settlement at the federal level.
The DeLoach case, discussed below under Antitrust Cases, was a unique antitrust case
brought by a unique class of plaintiffs: a class of all tobacco growers and tobacco allotment
holders. The class asserted that the defendants, including RJR Tobacco and B&W, engaged in
bid-rigging of U.S. burley and flue-cured tobacco auctions. Despite valid legal defenses, RJR
Tobacco and B&W separately settled this case to avoid a long and contentious trial with the tobacco
growers. The remaining antitrust cases pending against RJR Tobacco and B&W involve different types
of plaintiffs and different theories of recovery under the antitrust laws and should not be
affected by the settlement of the DeLoach case.
Finally, as discussed under MSAEnforcement and Validity, RJR Tobacco and B&W each has
settled cases brought by states concerning the enforcement of the MSA. Despite valid legal
defenses, these cases were settled to avoid further contentious litigation with the states
involved. Each MSA enforcement action involves alleged breaches of the MSA based on specific
actions taken by the particular defendant. Accordingly, any future MSA enforcement action will be
reviewed by RJR Tobacco on its own merits and should not be affected by the settlement of prior MSA
enforcement cases.
Even though RAIs management continues to conclude that the loss of any particular pending
smoking and health tobacco litigation claim against RJR Tobacco or its affiliates or indemnitees,
when viewed on an individual basis, is not probable, the possibility of material losses related to
tobacco litigation is more than remote. However, RAIs management is unable to predict the outcome
of such litigation or to reasonably estimate the amount or range of any possible loss, other than
with respect to certain indemnification claims asserted by JTI. Moreover, notwithstanding the
quality of defenses available to RJR Tobacco and its affiliates and indemnitees in
tobacco-related litigation matters, it is possible that RAIs results of operations, cash flows or
financial condition could be materially adversely affected by the ultimate outcome of certain
pending or future litigation matters. See Cautionary Statement Concerning Tobacco-Related
Litigation, below.
Theories of Recovery
The plaintiffs seek recovery on a variety of legal theories, including negligence, strict
liability in tort, design defect, special duty, voluntary undertaking, breach of warranty, failure
to warn, fraud, misrepresentation, unfair trade practices, conspiracy, unjust enrichment, medical
monitoring, public nuisance and violations of state and federal antitrust and RICO laws. In
certain of these cases, the plaintiffs claim that cigarette smoking exacerbated injuries caused by
exposure to asbestos.
The plaintiffs seek various forms of relief, including compensatory and punitive damages,
treble or multiple damages and statutory damages and penalties, creation of medical monitoring and
smoking cessation funds, disgorgement of profits, and injunctive and other equitable relief.
Although pleaded damages often are not determinable from a complaint, and the law governing the
pleading and calculation of damages varies from state to state and jurisdiction to jurisdiction,
compensatory and punitive damages have been specifically pleaded in a number of cases, sometimes in
amounts ranging into the hundreds of millions and even billions of dollars.
Defenses
The defenses raised by RJR Tobacco or its affiliates and indemnitees include, where applicable
and otherwise appropriate, preemption by the Federal Cigarette Labeling and Advertising Act of some
or all claims arising after 1969, the lack of any defect in the product, assumption of the risk,
contributory or comparative fault, lack of proximate cause, remoteness, lack of standing and
statutes of limitations or repose. RAI and RJR have asserted additional defenses, including
jurisdictional defenses, in many of the cases in which they are named.
20
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Scheduled Trials
Trial schedules are subject to change, and many cases are dismissed before trial. However, it
is likely that there will be an increased number of tobacco-related cases against RJR Tobacco or
its affiliates and indemnitees, some involving claims for amounts ranging possibly into the
hundreds of millions and even billions of dollars, coming to trial during 2006. The following
table lists the trial schedule, as of October 14, 2005, for RJR Tobacco or its affiliates and
indemnitees, including B&W, through September 30, 2006.
|
|
|
|
|
|
|
Trial Date |
|
Case Name/Type |
|
Defendant(s) |
|
Jurisdiction |
September 21, 2004
[Ongoing]
|
|
United States of America [DOJ] v.
Philip Morris USA Inc.
[Health-Care Reimbursement]
|
|
RJR Tobacco, B&W
|
|
United States District Court
(Washington, DC) |
|
|
|
|
|
|
|
January 2, 2006
|
|
City of St. Louis v. American
Tobacco Company, Inc.
[Health-Care Reimbursement]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
(St. Louis, MO) |
|
|
|
|
|
|
|
January 3, 2006
|
|
VanDenburg v. Brown & Williamson
Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Jackson County
(Independence, MO) |
|
|
|
|
|
|
|
January 23, 2006
|
|
Kimball v. R.J. Reynolds Tobacco
Co.
[Individual]
|
|
RJR Tobacco
|
|
United States District Court
Western District
(Bellingham, WA) |
|
|
|
|
|
|
|
April 24, 2006
|
|
Major v. R.J. Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
Superior Court
Los Angeles County
(Los Angeles, CA) |
|
|
|
|
|
|
|
April 24, 2006
|
|
Barriere v. Brown & Williamson
Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
United States District Court
Eastern District
(New Orleans, LA) |
|
|
|
|
|
|
|
June 5, 2006
|
|
Bell v. Brown & Williamson
Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Jackson County
(Independence, MO) |
|
|
|
|
|
|
|
June 19, 2006
|
|
Hughes v. A C and S, Inc.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Superior Court
San Francisco County
(San Francisco, CA) |
|
|
|
|
|
|
|
July 3, 2006
|
|
Dougherty v. Philip Morris, Inc.
[Individual/ETS]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Volusia County
(Jacksonville, FL) |
|
|
|
|
|
|
|
July 10, 2006
|
|
Falconer v. R.J. Reynolds Tobacco
Co.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Jackson County
(Kansas City, MO) |
|
|
|
|
|
|
|
August 15, 2006
|
|
DeGeorge v. Philip Morris USA,
Inc.
[Individual]
|
|
RJR Tobacco, B&W
|
|
United States District Court
Western District
Central Division
(Jefferson City, MO) |
|
|
|
|
|
|
|
September 1, 2006
|
|
Gerrity v. R.J. Reynolds Tobacco
Co.
[Individual]
|
|
RJR Tobacco
|
|
United States District Court
(New Haven, CT) |
|
|
|
|
|
|
|
September 5, 2006
|
|
Nuzum v. Brown & Williamson
Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Jackson County
(Independence, MO) |
Trial Results
Since January 1, 1999, 50 smoking and health and health-care cost recovery cases in which RJR
Tobacco or B&W were defendants have been tried. Verdicts in favor of RJR Tobacco, B&W and, in some
cases, RJR Tobacco, B&W and other defendants, were returned in 34 (including four mistrials)
cases, tried in Florida (10), New York (4), Missouri (3) Tennessee (3), Mississippi (2),
California (2), West Virginia (2), Ohio (2), Connecticut (1), Louisiana (1), New Jersey (1),
Pennsylvania (1), South Carolina (1) and Texas (1).
21
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Two cases were tried in the first quarter of 2005 in which RJR Tobacco or B&W was a defendant.
In Smith v. Brown and Williamson Tobacco Corp., a Missouri state court jury returned a
compensatory damages verdict of $2 million (reduced to $500,000 due to comparative fault) and a
punitive damages verdict of $20 million against B&W on February 1 and 2, 2005, respectively. On
May 23, 2005, the court denied B&Ws motion for judgment notwithstanding the verdict or,
alternatively, motion for a new trial. On June 1, 2005, B&W filed a notice of appeal in the
Missouri Court of Appeals. On March 18, 2005, in Rose v. Brown and Williamson Tobacco Corp., a New
York state court jury returned a verdict in favor of RJR Tobacco, but awarded $3.42 million in
compensatory damages against B&W and Philip Morris, of which $1.71 million was assigned to B&W. A
punitive damages verdict of $17 million against Philip Morris only was returned by the jury on
March 28, 2005. Oral argument on the post-trial motions occurred on October 7, 2005. B&W filed its
notice of appeal on August 18, 2005.
Two cases were tried in the second quarter of 2005 in which RJR Tobacco or B&W was a
defendant. In Swaty v. Philip Morris, Inc., a Broin II case, a Florida state court jury returned a
verdict in favor of the defendants, including RJR Tobacco and B&W, on May 3, 2005. The plaintiffs
motion for a new trial was denied on June 23, 2005. The plaintiff filed a notice of appeal on July
21, 2005. On June 20, 2005, in Rosen v. Brown and Williamson Tobacco Corp., an individual smoker
case, a New York state court judge granted B&Ws motion for directed verdict. On August 8, 2005,
the plaintiffs agreed not to appeal, and B&W agreed not to seek costs.
There were no cases tried in the third quarter of 2005 in which RJR Tobacco or B&W was a
defendant.
The following chart reflects the verdicts and post-trial developments in the smoking and
health cases that have been tried since January 1, 1999, in which juries have returned verdicts in
favor of the plaintiffs and against RJR Tobacco or B&W, or both. In addition, RJR Tobacco has been
fined $14.8 million in a lawsuit filed by the Attorney General of California, discussed below under
Other Litigation and Developments. RJR Tobacco is appealing the California case.
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
July 7, 1999-Phase I
April 7, 2000-Phase II
July 14, 2000-Phase
III
|
|
Engle v. R. J.
Reynolds Tobacco
Co.
[Class Action]
|
|
Circuit Court,
Miami-Dade County
(Miami, FL)
|
|
$12.7 million
compensatory
damages against all
the defendants;
$145 billion
punitive damages
against all the
defendants, of
which approximately
$36.3 billion and
$17.6 billion was
assigned to RJR
Tobacco and B&W,
respectively.
|
|
On May 21, 2003,
Floridas Third
District Court of
Appeal reversed the
trial court and
remanded the case
to the Miami-Dade
County Circuit
Court with
instructions to
decertify the
class. On May 12,
2004, the Florida
Supreme Court
agreed to review
the case. Oral
argument occurred
on November 3,
2004. The Florida
Supreme Court
decision is
pending. |
|
|
|
|
|
|
|
|
|
March 20, 2000
|
|
Whiteley v.
Raybestos-Manhattan,
Inc.
[Individual]
|
|
Superior Court,
San Francisco County
(San Francisco, CA)
|
|
$1.72 million
compensatory
damages against RJR
Tobacco and Philip
Morris; $20 million
punitive damages,
of which $10
million each was
assigned to RJR
Tobacco and Philip
Morris.
|
|
On April 7, 2004,
the California
Court of Appeal
reversed the
judgment and
remanded the case
for a new trial.
On June 3, 2005,
the parties filed a
stipulation to stay
the action until
December 13, 2005. |
|
|
|
|
|
|
|
|
|
October 12, 2000
|
|
Jones v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Circuit Court,
Hillsborough County
(Tampa, FL)
|
|
$200,000
compensatory
damages against RJR
Tobacco. B&W was
dismissed from the
case in September
2002, prior to
trial.
|
|
RJR Tobacco granted
new trial on
December 28, 2000;
new trial decision
affirmed by
Floridas Second
District Court of
Appeal on August
30, 2002. On April
27, 2005, the
Florida Supreme
Court denied
plaintiffs notice
of appeal without
prejudice. On May
25, 2005, the
plaintiff served a
notice of intent to
invoke
discretionary
jurisdiction. On
August 31, 2005,
the Florida Supreme
Court denied review
for lack of
jurisdiction. |
22
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
June 4, 2001
|
|
Blue Cross and Blue
Shield of New
Jersey v. Philip
Morris, Inc.
[Health-Care Cost
Recovery]
|
|
United States District Court,
Eastern District
(Brooklyn, NY)
|
|
$17.8 million
compensatory
damages against all
the defendants, of
which $6.6 million
and $2.8 million
was assigned to RJR
Tobacco and B&W,
respectively.
Judge subsequently
ordered the
plaintiffs
attorneys entitled
to $37.8 million in
fees.
|
|
On December 22,
2004, after the New
York Court of
Appeals determined
that third party
payer claims are
too remote under
New York law, the
U.S. Court of
Appeals for the
Second Circuit
reversed the
judgment. On
February 1, 2005,
the parties
stipulated to a
dismissal with
prejudice. |
|
|
|
|
|
|
|
|
|
December 12, 2001
|
|
Kenyon v. R. J.
Reynolds Tobacco
Co.
[Individual]
|
|
Circuit Court,
Hillsborough County
(Tampa, FL)
|
|
$165,000
compensatory
damages against RJR
Tobacco.
|
|
After exhausting
its state court
appeals, RJR
Tobacco paid the
plaintiff
approximately
$196,000 (judgment
plus interest). The
only issue
remaining in this
case is the amount
of attorneys fees
to be awarded to
plaintiffs
counsel. |
|
|
|
|
|
|
|
|
|
February 22, 2002
|
|
Burton v. R. J.
Reynolds Tobacco
Co.
[Individual]
|
|
United States District Court
(Kansas City, KS)
|
|
$198,000
compensatory
damages and $15
million punitive
damages against RJR
Tobacco.
|
|
On February 9,
2005, the U.S.
Court of Appeals
for the Tenth
Circuit reversed
the fraudulent
concealment verdict
in favor of the
plaintiff and
therefore reversed
the dependent award
of punitive damages
in its entirety.
The appeals court
affirmed the jurys
verdict on failure
to warn and thereby
upheld the
compensatory
damages award. On
May 17, 2005, the
U.S. District
Court entered a
second amended
judgment reflecting
the decision of the
court of appeals.
The judgment in
favor of plaintiff
was $196,416 plus
interest and costs.
RJR Tobacco
satisfied the
judgment on June
17, 2005. |
|
|
|
|
|
|
|
|
|
June 11, 2002
|
|
Lukacs v. R. J.
Reynolds Tobacco
Co.
[Engle class member]
|
|
Circuit Court,
Miami-Dade County
(Miami, FL)
|
|
$500,000 economic
damages, $24.5
million noneconomic
damages and $12.5
million loss of
consortium damages
against Philip
Morris, B&W and
Lorillard, of which
B&W was assigned
22.5% of liability.
Court has not
entered final
judgment for
damages. RJR
Tobacco was
dismissed from the
case in May 2002,
prior to trial.
|
|
Judge reduced
damages to $25.125
million of which
B&Ws share is
approximately $6
million. Final
judgment will be
entered only if the
Engle appeal is
resolved in favor
of the class. If a
judgment is
entered, B&W
intends to appeal. |
|
|
|
|
|
|
|
|
|
June 18, 2002
|
|
French v. Philip
Morris, Inc.
[Flight
Attendant-ETS
(Broin II)]
|
|
Circuit Court,
Miami-Dade County
(Miami, FL)
|
|
$5.5 million
compensatory
damages against all
the defendants;
reduced by judge to
$500,000 of which
$123,500 was
assigned to RJR
Tobacco and $82,000
was assigned to
B&W.
|
|
On December 22,
2004, the Florida
Third District
Court of Appeal
affirmed the
reduced judgment
and ordered the
trial court to hold
tobacco defendants
jointly and
severally liable.
The defendants
petition for
rehearing was
denied on April 13,
2005. On May 11,
2005, the
defendants filed a
notice of intent to
invoke the
discretionary
jurisdiction of the
Florida Supreme
Court.
Jurisdictional
briefing is
complete. |
23
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
September 25, 2002
|
|
Figueroa-Cruz v. R.
J. Reynolds Tobacco
Co.
[Individual]
|
|
United States District Court
(San Juan, Puerto Rico)
|
|
$500,000
compensatory
damages against RJR
Tobacco.
|
|
Judge granted RJR
Tobaccos motion
for judgment as a
matter of law on
October 9, 2002.
On October 28,
2003, the United
States Court of
Appeals for the
First Circuit
affirmed the trial
courts ruling.
The plaintiffs
petition for writ
of certiorari was
denied by the
United States
Supreme Court on
November 1, 2004. |
|
|
|
|
|
|
|
|
|
April 3, 2003
|
|
Eastman v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Circuit Court,
Hillsborough County
(Tampa, FL)
|
|
$3.26 million
compensatory
damages against
Philip Morris and
B&W, of which
$650,000 was
assigned to B&W.
The court
subsequently
awarded $870,000 in
fees to the
plaintiffs
attorneys.
|
|
After B&W exhausted
its state court
appeals, RJR
Tobacco, due to its
obligation to
indemnify B&W,
satisfied the
judgment and paid
the plaintiff
approximately $1.2
million (judgment
plus interest). |
|
|
|
|
|
|
|
|
|
May 23, 2003
|
|
Boerner v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
United States District Court,
Eastern District,
Western Division
(Little Rock, AR)
|
|
$4 million
compensatory
damages and $15
million punitive
damages against
B&W.
|
|
On January 7, 2005,
the U.S. Court of
Appeals for the
Eighth Circuit
affirmed the
judgment, but
reduced the
punitive damages
award to $5
million. RJR
Tobacco, due to its
obligation to
indemnify B&W,
satisfied the
judgment
(approximately $9.1
million) on
February 16, 2005. |
|
|
|
|
|
|
|
|
|
November 4, 2003
|
|
Thompson v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Circuit Court,
Jackson County
(Independence, MO)
|
|
$1.05 million
compensatory
damages against
Philip Morris and
B&W, of which
$209,351 was
assigned to B&W.
|
|
The defendants
post-trial motions
were denied on
February 26, 2004.
The defendants
appealed to the
Missouri Court of
Appeals. Briefing
is complete. Oral
argument is
scheduled for
November 3, 2005. |
|
|
|
|
|
|
|
|
|
December 18, 2003
|
|
Frankson v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Supreme Court,
Kings County
(Brooklyn, NY)
|
|
$350,000
compensatory
damages; 50% fault
assigned to B&W and
two industry
organizations; $20
million in punitive
damages, of which
$6 million was
assigned to B&W, $2
million to a
predecessor company
and $12 million to
two industry
organizations.
|
|
On January 21,
2005, the plaintiff
stipulated to the
courts reduction
in the amount of
punitive damages
from $20 million to
$5 million,
apportioned as
follows: $0 to
American Tobacco ;
$4 million to B&W ;
$500,000 to the
Counsel for Tobacco
Research and
$500,000 to the
Tobacco Institute .
On January 25,
2005, B&W noticed
its appeal.
Briefing is not yet
complete. |
|
|
|
|
|
|
|
|
|
May 21, 2004
|
|
Scott v. American
Tobacco Co.
[Class Action]
|
|
District Court,
Orleans Parish
(New Orleans, LA)
|
|
$591 million
against RJR
Tobacco, B&W,
Philip Morris,
Lorillard, and the
Tobacco Institute
for a smoking
cessation program.
|
|
On August 31, 2004,
the defendants
motion for judgment
notwithstanding the
verdict or, in the
alternative, for a
new trial was
denied. On
September 29, 2004,
the defendants
posted a $50
million bond and
noticed their
appeal. RJR
Tobacco posted $25
million toward the
bond. Briefing
is complete. Oral
argument has not
been scheduled. |
24
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
February 2, 2005
|
|
Smith v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Circuit Court,
Jackson County
(Independence, MO)
|
|
$2 million in
compensatory
damages (reduced to
$500,000 because of
jurys findings
that the plaintiff
was 75% at fault);
$20 million in
punitive damages.
|
|
On May 23, 2005,
the trial judge
denied B&Ws
post-trial motions.
On June 1, 2005,
B&W filed its
notice of appeal. |
|
|
|
|
|
|
|
|
|
March 18, 2005
|
|
Rose v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Supreme Court,
New York County
(Manhattan, NY)
|
|
RJR Tobacco found
not liable; $3.42
million in
compensatory
damages against B&W
and Philip Morris,
of which $1.71
million was
assigned to B&W;
$17 million in
punitive damages
against Philip
Morris only.
|
|
Oral argument of
the post-trial
motions occurred on
October 7, 2005.
On August 18, 2005,
B&W filed its
notice of appeal. |
Additionally, since January 1, 1999, verdicts have been returned in 19 smoking and health
cases in which RJR Tobacco, B&W, or their respective affiliates were not defendants. Verdicts were
returned in favor of the defendants in ten cases three in Florida, two in California, and one in
each of New Hampshire, New York, Pennsylvania, Rhode Island and Tennessee. Verdicts in favor of
the plaintiffs were returned in nine cases, four in California, and two in each of Florida and
Oregon and one in Illinois. The defendants appeals or post-trial motions are pending in these
cases.
Individual Smoking and Health Cases
As of October 14, 2005, 1,272 individual cases, including approximately 1,009 individual
smoker cases in West Virginia state court in a consolidated action, were pending in the United
States against RJR Tobacco, B&W, as its indemnitee, or both. This category of cases includes
smoking and health cases alleging personal injury brought by or on behalf of individual plaintiffs,
but does not include the Broin II cases discussed below. A total of 1,266 of the individual cases
are brought by or on behalf of individual smokers or their survivors, while the remaining six cases
are brought by or on behalf of individuals or their survivors alleging personal injury as a result
of exposure to ETS.
Below is a description of the individual smoking and health cases against RJR Tobacco or B&W,
or both, which went to trial or were decided or remained on appeal, since January 1, 2005.
On February 22, 2002, in Burton v. R. J. Reynolds Tobacco Co., a federal district court jury
in Kansas found in favor of RJR Tobacco and B&W on product defect and conspiracy claims, but found
for the plaintiff on failure to warn, failure to test and fraudulent concealment claims. The jury
apportioned 99% of the fault to RJR Tobacco and 1% to B&W. It awarded the plaintiff $198,400 in
compensatory damages, and determined that the plaintiff was entitled to punitive damages against
RJR Tobacco but not B&W. B&W was voluntarily dismissed on June 10, 2002. On June 21, 2002, the
trial court awarded the plaintiff $15 million in punitive damages. RJR Tobacco appealed to the
United States Court of Appeals for the Tenth Circuit and posted a supersedeas bond in the amount of
approximately $17 million. On February 9, 2005, the Tenth Circuit reversed the verdict in favor of
the plaintiff for fraudulent concealment and therefore reversed the dependent award of punitive
damages in its entirety. The appeals court affirmed the jurys verdict on failure to warn and
thereby upheld the compensatory damages award. On May 17, 2005, the United States District Court
entered a second amended judgment reflecting the court of appeals decision. The judgment in favor
of the plaintiff was $196,416 plus interest and costs. RJR Tobacco satisfied the judgment on June
17, 2005, and the supersedeas bond was released to RJR Tobacco on July 12, 2005.
On May 23, 2003, in Boerner v. Brown & Williamson Tobacco Corp., a federal district court jury
in Arkansas awarded $4 million in compensatory damages and $15 million in punitive damages against
B&W. The judge initially struck the punitive damage award but reinstated it on September 26, 2003.
The court denied B&Ws post-trial motions. B&W appealed to the United States Court of Appeals for
the Eighth Circuit, which, on January 7, 2005, affirmed the trial courts judgment, but reduced the
punitive damages award to $5 million. RJR Tobacco, due to its obligation to indemnify B&W,
satisfied the judgment on February 16, 2005.
25
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On August 15, 2003, a state court jury in Pennsylvania returned a verdict in favor of B&W in
Eiser v. Brown & Williamson Tobacco Corp. Oral argument on the plaintiffs appeal occurred on July
26, 2005. No decision has been reached.
On November 4, 2003, in Thompson v. Brown & Williamson Tobacco Corp., a Missouri state court
jury awarded $2.1 million in compensatory damages against B&W and Philip Morris. B&W was found to
be 10% at fault, Philip Morris was found to be 40% at fault, and the plaintiff was found to be 50%
at fault. As a result, B&Ws share of the final judgment was approximately $210,000. The
defendants post-trial motions were denied on February 26, 2004. The defendants appealed to the
Missouri Court of Appeals on March 8, 2004. Briefing is complete. Oral argument is scheduled for
November 3, 2005.
On December 18, 2003, in Frankson v. Brown & Williamson Tobacco Corp., a New York state court
jury awarded $350,000 in compensatory damages against B&W and two former tobacco industry
organizations, the Tobacco Institute and the Council for Tobacco Research. The defendants as a
group and the deceased smoker were each found to be 50% at fault. On January 8, 2004, the jury
awarded $20 million in punitive damages, of which $6 million was assigned to B&W, $2 million was
assigned to American Tobacco, a predecessor company to B&W, and $6 million was assigned to each of
the Council for Tobacco Research and the Tobacco Institute. On June 22, 2004, the trial judge
granted a new trial unless the parties consented to an increase in compensatory damages to $500,000
and a decrease in punitive damages to $5 million, of which $4 million would be assigned to B&W. On
January 21, 2005, the plaintiff stipulated to the reduction in punitive damages from $20 million to
$5 million, apportioned as follows: $0 to American Tobacco; $4 million to B&W ; and $500,000 to
each of the Council for Tobacco Research and the Tobacco Institute . On January 25, 2005, B&W
noticed its appeal. B&Ws opening brief was filed on September 22, 2005. Briefing is not yet
complete.
On February 1, 2005, a Missouri state court jury returned a split verdict in Smith v. Brown &
Williamson Tobacco Corp., finding in favor of B&W on two counts fraudulent concealment and
conspiracy, and finding in favor of the plaintiffs on the negligence count (which incorporates
failure to warn and product defect claims). The plaintiffs were awarded $2 million in
compensatory damages; however, the jury found the plaintiff to be 75% at fault (and B&W 25% at
fault), and thus the compensatory award was reduced to $500,000. The jury also found that there
were aggravating circumstances, which provided an entitlement to punitive damages. On February 2,
2005, the jury returned a verdict awarding the plaintiffs $20 million in punitive damages. On
March 10, 2005, B&W filed a motion for judgment notwithstanding the verdict, or in the
alternative, for a new trial. On May 23, 2005, the trial judge denied these motions. On June 1,
2005, B&W filed its notice of appeal. Pursuant to the business combination, RJR Tobacco will post
a supersedeas bond in the approximate amount of $24.3 million.
On March 18, 2005, in Rose v. Brown and Williamson Tobacco Corp., a New York state court jury
returned a verdict in favor of RJR Tobacco but returned a $3.42 million compensatory damages
verdict against B&W and Philip Morris, of which $1.71 million was assigned to B&W. A punitive
damages verdict of $17 million against Philip Morris only was returned by the jury on March 28,
2005. Oral argument on the post-trial motions occurred on October 7, 2005. On August 18, 2005,
B&W filed its notice of appeal.
On June 20, 2005, in Rosen v. Brown and Williamson Tobacco Corp., a New York state court judge
granted B&Ws motion for directed verdict. On August 15, 2005, the plaintiff agreed not to appeal
and B&W agreed not to seek costs.
Broin II Cases
As of October 14, 2005, there were 2,650 lawsuits pending in Florida brought by individual
flight attendants for personal injury as a result of illness allegedly caused by exposure to ETS in
airplane cabins, referred to as the Broin II cases. In these lawsuits, filed pursuant to the terms
of the settlement of the Broin v. Philip Morris, Inc. class action, discussed below under
Class-Action Suits, each individual flight attendant will be required to prove that he or she
has a disease and that the individuals exposure to ETS in airplane cabins caused the disease.
Under the terms of the Broin settlement, punitive damages are not available in these cases.
On October 5, 2000, Judge Robert Kaye entered an order applicable to all Broin II cases that
the terms of the Broin settlement agreement do not require the individual Broin II plaintiffs to
prove the elements of strict liability, breach of warranty or negligence. Under this order, there
is a rebuttable presumption in the plaintiffs favor on those elements, and the plaintiffs bear the
burden of proving that their alleged adverse health effects actually were caused by exposure to
ETS. Although the defendants still may prevail on causation and other theories, RJR Tobacco does
not
26
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
believe that the order is correct under Florida law or that it accurately reflects the intent
of the Broin settlement agreement. RJR Tobacco and B&W, along with the other defendants, initially
appealed this order in Jett v. Philip Morris, Inc., but the Florida Appellate courts refused to
hear the appeal. The propriety of Judge Kayes order was argued in the French appeal (discussed
below).
Below is a description of the Broin II cases against RJR Tobacco and B&W that went to trial or
were decided or remained on appeal, since January 1, 2005.
In French v. Philip Morris, Inc., a Florida state court jury found in favor of the plaintiff
on June 18, 2002, and awarded $5.5 million in compensatory damages. On September 13, 2002, the
trial judge reduced the damages award to $500,000, but denied the defendants remaining post-trial
motions. The defendants appealed the trial courts final judgment to the Third District Court of
Appeal of Florida. Judge Kayes order in Jett v. Philip Morris, Inc., referred to above, was
applied, and the defendants appealed that order, as well as other matters. On December 22, 2004,
the Florida Third District Court of Appeal affirmed the amended final judgment to the extent that
it found in favor of the plaintiff on liability, and awarded the remitted amount of damages. The
appellate court reversed the final judgments market share allocation of damages, and remanded with
instructions that the trial court enter a judgment finding the defendants jointly and severally
liable. The defendants petition for rehearing was denied on April 13, 2005. On May 11, 2005, the
defendants filed a notice of intent to invoke the discretionary jurisdiction of the Florida Supreme
Court. Jurisdictional briefing is complete.
In Janoff v. Philip Morris, Inc., a Florida state court jury found in favor of the defendants,
including RJR Tobacco and B&W, on September 5, 2002. On September 12, 2002, the plaintiff filed a
motion for a new trial, which the judge granted on January 8, 2003. The defendants appealed to the
Florida Third District Court of Appeal, which, on October 27, 2004, affirmed the trial courts
order granting a new trial. The defendants motion for rehearing was denied. The defendants filed
a notice of intent to invoke the discretionary jurisdiction of the Florida Supreme Court on June
17, 2005. On June 27, 2005, the defendants submitted their initial brief on jurisdiction. The
plaintiffs answer brief was filed on August 11, 2005.
In Swaty v. Philip Morris, Inc., a Florida state court jury found in favor of the defendants,
including RJR Tobacco and B&W, on May 3, 2005. On May 12, 2005, the plaintiff filed a motion for a
new trial, which was denied on June 23, 2005. On May 17, 2005, the court entered a final judgment
in favor of the defendants, including RJR Tobacco and B&W. The plaintiffs motion for a new trial
was denied on June 23, 2005. The plaintiff filed a notice of appeal on July 21, 2005.
Class-Action Suits
As of October 14, 2005, 22 class-action cases were pending in the United States against RJR
Tobacco or its affiliates or indemnitees, including B&W. In May 1996, in Castano v. American
Tobacco Co., the Fifth Circuit Court of Appeals overturned the certification of a nationwide class
of persons whose claims related to alleged addiction to tobacco products. Since this ruling by the
Fifth Circuit, most class-action suits have sought certification of statewide, rather than
nationwide, classes. Class-action suits based on claims similar to those asserted in Castano or
claims that class members are at a greater risk of injury or injured by the use of tobacco or
exposure to ETS are pending against RJR Tobacco and its affiliates and indemnitees, including B&W,
in state or federal courts in California, Florida, Illinois, Louisiana, Minnesota, Missouri, New
York, Oregon, Washington, and West Virginia. Cases in which classes have been certified or class
certification decisions are pending are discussed below.
The pending class actions against RJR Tobacco or its affiliates or indemnitees, including B&W,
include 11 cases alleging that the use of the terms lights and ultra lights constitutes unfair
and deceptive trade practices. Such suits are pending in state or federal courts in Florida,
Illinois, Louisiana, Minnesota, Missouri, New York and Washington. Each of these cases is discussed
below.
Finally, a number of unions and other third-party payers have filed health-care cost recovery
actions in the form of class actions. These cases are discussed separately below.
Few smoker class-action complaints have been certified or, if certified, have survived on
appeal. Seventeen federal courts that have considered the issue, including two courts of appeals,
and most state courts have rejected class certification in smoking and health cases. Only one
federal district court has certified a smoker class action In re Simon (II) Litigation which
was filed in the United States District Court for the Eastern District of New York before Judge
Weinstein. In Simon (II), on September 19, 2002, Judge Weinstein certified a nationwide mandatory,
non-opt-out punitive damages class. On February 14, 2003, the United States Court of Appeals for
the Second Circuit granted the defendants petition to review the class certification decision. On
May 6, 2005, the Second Circuit, in a unanimous
27
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
opinion, decertified the class. On May 19, 2005, the plaintiffs filed a petition for
rehearing en banc. On August 8, 2005, the Second Circuit denied plaintiffs petition for rehearing
and remanded the case for further proceedings to the District Court. On February 10, 2003, in
Simms v. Philip Morris, Inc., the United States District Court for the District of Columbia denied
certification of a proposed nationwide class of smokers who purchased cigarettes while underage.
The plaintiffs have filed several motions for reconsideration of the order that denied class
certification. A decision is pending.
Classes have been certified in several state court class-action cases in which either RJR
Tobacco or B&W is a defendant. On November 5, 1998, in Scott v. American Tobacco Co., a Louisiana
state appeals court affirmed the certification of a medical monitoring or smoking cessation class
of Louisiana residents who were smokers on or before May 24, 1996. On February 26, 1999, the
Louisiana Supreme Court denied the defendants petition for writ of certiorari or review. Jury
selection began on June 18, 2001 and was completed on September 23, 2002. Opening statements
occurred on January 21, 2003. On July 28, 2003, the jury returned a verdict in favor of the
defendants, including RJR Tobacco and B&W, on the plaintiffs claim for medical monitoring and
found that cigarettes were not defectively designed. In addition, however, the jury made certain
findings against the defendants, including RJR Tobacco and B&W, on claims relating to fraud,
conspiracy, marketing to minors and smoking cessation. With respect to these findings, this
portion of the trial did not determine liability as to any class member or class representative.
What primarily remained in the case was a class-wide claim that the defendants, including RJR
Tobacco and B&W, pay for a program to help people stop smoking. On March 31, 2004, phase two of
the trial began to address the scope and cost of smoking cessation programs. On May 21, 2004, the
jury returned a verdict in the amount of $591 million on the classs claim for a smoking cessation
program. On August 31, 2004, the defendants motion for judgment notwithstanding the
verdict or, in the alternative, for a new trial was denied. On September 29, 2004, the defendants
posted a $50 million bond (pursuant to legislation that limits the amount of the bond to $50
million collectively for MSA signatories) and noticed their appeal. RJR Tobacco posted $25 million
(i.e., the portions for RJR Tobacco and B&W) towards the bond. Briefing is complete, but oral
argument has not been scheduled.
In addition to the Scott case, two other medical monitoring class actions have been brought
against RJR Tobacco, B&W, and other cigarette manufacturers. In Blankenship v. American Tobacco
Co., the first tobacco-related medical monitoring class action to be certified and to reach trial,
a West Virginia state court jury found in favor of RJR Tobacco, B&W and other cigarette
manufacturers on November 14, 2001. The West Virginia Supreme Court affirmed the judgment for the
defendants on May 6, 2004. In Lowe v. Philip Morris, Inc., an Oregon state court judge dismissed
the medical monitoring complaint on November 4, 2003, for failure to state a claim. The plaintiffs
appealed, and oral argument before the Oregon Court of Appeals occurred on September 26, 2005.
Trial began in July 1998 in Florida state court in Engle v. R. J. Reynolds Tobacco Co., in
which a class consisting of Florida residents, or their survivors, alleges diseases or medical
conditions caused by their alleged addiction to cigarettes. On July 7, 1999, the jury found
against RJR Tobacco, B&W and the other cigarette-manufacturer defendants in the initial phase,
which included common issues related to certain elements of liability, general causation and a
potential award of, or entitlement to, punitive damages.
The second phase of the trial, which consisted of the claims of three of the named class
representatives, began on November 1, 1999. On April 7, 2000, the jury returned a verdict against
all the defendants. It awarded plaintiff Mary Farnan $2.85 million, the estate of plaintiff Angie
Della Vecchia $4.023 million and plaintiff Frank Amodeo $5.831 million. The jury also found,
however, that Frank Amodeo knew or should have known of his claim prior to May 5, 1990. RJR
Tobacco believes that the legal effect of that finding should be to bar his claim based on the
applicable statute of limitations.
The trial court also ordered the jury in the second phase of the trial to determine punitive
damages, if any, on a class-wide basis. On July 14, 2000, the jury returned a punitive damages
verdict in favor of the Florida class of approximately $145 billion against all the defendants,
with approximately $36.3 billion and $17.6 billion being assigned to RJR Tobacco and B&W,
respectively.
On July 24, 2000, the defendants, including RJR Tobacco and B&W, filed numerous post-verdict
motions, including motions for a new trial and to reduce the amount of the punitive damages
verdict. On November 6, 2000, the trial judge denied the post-trial motions and entered judgment.
In November 2000, RJR Tobacco and B&W posted appeal bonds in the amount of $100 million each, the
maximum amount required pursuant to a Florida bond cap statute enacted on May 9, 2000, and intended
to apply to the Engle case, and initiated the appeals process. On May 21, 2003, Floridas Third
District Court of Appeal reversed the trial courts final judgment and remanded the case to the
Miami-
28
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Dade County Circuit Court with instructions to decertify the class. On May 12, 2004, the
Florida Supreme Court agreed to review the case. Oral argument occurred on November 3, 2004. The
Florida Supreme Court has not yet ruled.
On May 7, 2001, three of the non-RJR Tobacco and non-B&W defendants entered into agreements
with the Engle class to deposit an additional $1.86 billion into separate escrow accounts to ensure
that the stay of execution in effect pursuant to the Florida bond cap statute will remain in effect
as to these three defendants throughout the appellate process, regardless of the results of a
challenge, if any, to the Florida bond statute. Approximately $700 million of the total amount
deposited by these three defendants is non-refundable and will go to the trial court to be
distributed, regardless of the result of the appeal. RJR Tobacco and B&W did not enter into a
similar agreement with the Engle class. Although RJR Tobacco cannot predict the outcome of any
possible challenges to the Florida bond statute, RJR Tobacco remains confident of the applicability
and validity of the statute in the Engle case.
RJR Tobacco and/or B&W have been named as a defendant(s) in several individual cases filed by
members of the Engle class. One such case, in which RJR Tobacco was dismissed prior to trial,
Lukacs v. Philip Morris, Inc., was tried against Philip Morris, Liggett and B&W, and resulted in a
verdict for the plaintiffs on June 11, 2002. The Florida state court jury awarded the plaintiffs a
total of $37.5 million in compensatory damages. The jury assigned 22.5% fault to B&W, 72.5% fault
to the other defendants and 5% fault to plaintiff John Lukacs. On April 1, 2003, the Miami-Dade
County Circuit Court granted in part the defendants motion for remittitur and reduced the jurys
award to plaintiff Yolanda Lukacs, on the loss of consortium claim, from $12.5 million to $0.125
million decreasing the total award to $25.125 million. No final judgment will be entered until the
Engle appeal is resolved, so the time to appeal this case has not yet begun to run.
On November 30, 2000, in Daniels v. Philip Morris Cos., Inc., a San Diego Superior Court judge
reversed a prior ruling and, based on a California unfair business practices statute, certified a
class consisting of all persons who, as California resident minors, smoked one or more cigarettes
in California between April 2, 1994 and December 1, 1999. The court granted the defendants
motions for summary judgment on preemption and First Amendment grounds and dismissed the action on
October 21, 2002. On October 6, 2004, the California Court of Appeal, Fourth Appellate District,
Division One, affirmed the trial courts dismissal. On November 8, 2004, the plaintiffs filed a
petition for review with the California Supreme Court. On February 26, 2005, the California Supreme
Court granted the petition. Briefing is complete.
On April 11, 2001, in Brown v. American Tobacco Co., Inc., the same judge in San Diego granted
in part the plaintiffs motion for class certification. The class is composed of residents of
California who smoked at least one of the defendants cigarettes from June 10, 1993 through April
23, 2001, and who were exposed to the defendants marketing and advertising activities in
California. Certification was granted as to the plaintiffs claims that the defendants violated §
17200 of the California Business and Professions Code pertaining to unfair competition. The court,
however, refused to certify the class under the California Legal Remedies Act. Class certification
on the plaintiffs common law claims was denied on April 10, 2000. The defendants, including RJR
Tobacco and B&W, filed their motion for summary judgment on January 31, 2003. On August 4, 2004,
the defendants motion for summary judgment was granted in part and denied in part. Following the
November 2004 passage of a proposition in California that changed the law regarding cases of this
nature, the defendants filed a motion to decertify the class. On March 7, 2005, the court issued a
ruling granting the defendants motion to decertify the class. On March 17, 2005, plaintiffs filed
a motion for reconsideration of the courts ruling decertifying the class. The trial judge denied
the plaintiffs motion on April 20, 2005. The plaintiffs filed a notice of appeal on May 19, 2005.
As noted above, lights class-action cases are pending against RJR Tobacco or B&W in Illinois
(2), Missouri (2), Minnesota (2), Louisiana (2), Florida (1), Washington (1) and New York (1). On
November 14, 2001, in Turner v. R. J. Reynolds Tobacco Co., an Illinois state court judge (Madison
County) certified a class defined as [a]ll persons who purchased defendants Doral Lights, Winston
Lights, Salem Lights and Camel Lights, in Illinois, for personal consumption, between the first
date that defendants sold Doral Lights, Winston Lights, Salem Lights and Camel Lights through the
date the court certifies this suit as a class action.... On June 6, 2003, RJR Tobacco filed a
motion to stay the case pending Philip Morris appeal of the Price v. Philip Morris case, which is
discussed below. On July 11, 2003, the judge denied the motion, and RJR Tobacco appealed to the
Illinois Fifth District Court of Appeals. The Court of Appeals denied this motion on October 17,
2003. However, on October 24, 2003, a justice on the Illinois Supreme Court ordered an emergency
stay of all proceedings pending review by the entire Illinois Supreme Court of RJR Tobaccos
emergency stay/supremacy order request filed on October 15, 2003. On November 5, 2003, the
Illinois Supreme Court granted RJR Tobaccos motion for a stay pending the courts final appeal
decision in Price. This case includes both RJR Tobacco and RJR as defendants.
29
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On December 18, 2001, in Howard v. Brown & Williamson Tobacco Corp., another Madison County,
Illinois state court judge certified a class defined as [a]ll persons who purchased Defendants
Misty Lights, GPC Lights, Capri Lights and Kool Lights cigarettes in Illinois for personal
consumption, from the first date that Defendant sold Misty Lights, GPC Lights, Capri Lights and
Kool Lights cigarettes in Illinois through this date. On June 6, 2003, the trial judge issued an
order staying all proceedings pending resolution of the Price v. Philip Morris case, discussed
below. The plaintiffs appealed this stay order to the Illinois Fifth District Court of Appeals,
which heard oral argument on October 7, 2003. The Court of Appeals affirmed the Circuit Courts
stay order on August 19, 2005.
A lights class-action case is pending in the same jurisdiction in Illinois against Philip
Morris, Price v. Philip Morris, Inc., formerly known as Miles v. Philip Morris, Inc. Trial began on
January 21, 2003. On March 21, 2003, the trial judge entered judgment against Philip Morris in the
amount of $7.1 billion in compensatory damages and $3 billion in punitive damages to the State of
Illinois. Based on Illinois law, the bond required to stay execution of the judgment was set
initially at $12 billion. Because of the difficulty of posting a bond of that magnitude, Philip
Morris pursued various avenues of relief from the $12 billion bond requirement. On April 14, 2003,
the trial judge reduced the amount of bond. He ordered the bond to be secured by $800 million,
payable in four equal quarterly installments beginning in September 2003, and a pre-existing $6
billion long-term note to be placed in escrow pending resolution of the case. The plaintiffs
appealed the judges decision to reduce the amount of the bond. On July 14, 2003, the appeals
court ruled that the trial judge exceeded his authority in reducing the bond and ordered the trial
judge to reinstate the original bond. On September 16, 2003, the Illinois Supreme Court ordered
that the reduced bond be reinstated and agreed to hear Philip Morris appeal without need for
intermediate appellate court review. The Price case remains in the Illinois Supreme Court. In the
event RJR Tobacco and its affiliates or indemnitees, including B&W, lose the Turner or Howard
cases, RJR Tobacco could face similar bonding difficulties depending upon the amount of damages
ordered, if any, which could have a material adverse effect on RJR Tobaccos, and consequently
RAIs, results of operations, cash flows or financial condition.
Two lights class-action cases are pending against RJR Tobacco or B&W in Missouri. On
December 31, 2003, in Collora v. R. J. Reynolds Tobacco Co., a Missouri state court judge in St.
Louis certified a class defined as [a]ll persons who purchased Defendants Camel Lights, Camel
Special Lights, Salem Lights and Winston Lights cigarettes in Missouri for personal consumption
between the first date the Defendants placed their Camel Lights, Camel Special Lights, Salem Lights
and Winston Lights cigarettes into the stream of commerce through the date of this Order. On
January 14, 2004, RJR and RJR Tobacco, the only named defendants, removed this case to the United
States District Court for the Eastern District of Missouri. On September 30, 2004, the case was
remanded to the Circuit Court for the City of St. Louis. On September 23, 2005, RJR Tobacco
removed the case to the United States District Court for the Eastern District of Missouri. The
defendants argue that the case is removable based on the United States Court of Appeals for the
Eighth Circuits August 25, 2005 decision in Watson v. Philip Morris Companies, Inc., which upheld
the federal officers removal statute as a basis for removal in lights cases. Similarly, in Black
v. Brown & Williamson Tobacco Corp., also pending in Missouri, B&W removed the case to the United
States District Court for the Eastern District of Missouri on September 23, 2005.
Schwab [McLaughlin] v. Philip Morris USA, Inc., a nationwide lights class action, was filed
on May 11, 2004, in the United States District Court for the Eastern District of New York before
Judge Weinstein, against RJR Tobacco and B&W, as well as other tobacco manufacturers. The
plaintiffs motion for class certification and summary judgment motions by both sides were heard on
September 12, 2005 and September 13, 2005. Although trial was scheduled to commence on January 9,
2006, Judge Weinstein has ordered that he will permit several months of additional discovery before
deciding the class certification issue.
RJR Tobacco and B&W respectively removed two Louisiana cases, Harper v. R. J. Reynolds Tobacco
Co. and Brown v. Brown & Williamson Tobacco Corp., to federal court. On January 27, 2005, the
federal judge denied the plaintiffs motions to remand in both cases.
In Dahl v. R. J. Reynolds Tobacco Co., a Minnesota state court judge dismissed the case on May
11, 2005 because the lights claims are preempted by the Federal Cigarette Labeling and
Advertising Act. On July 11, 2005, the plaintiffs filed a notice of appeal with the Minnesota
Court of Appeals for the Fourth Judicial District. On August 22, 2005, plaintiffs filed their
opening brief. On September 22, 2005, RJR Tobacco removed the case to the United States District
Court for the District of Minnesota, based on Watson v. Philip Morris Companies, Inc. (described
above). On October 17, 2005, the plaintiffs filed a motion to remand. In Thompson v. R.J.
Reynolds Tobacco Co., also pending in Minnesota, RJR Tobacco removed the case on September 23, 2005
to the United States District Court for the District of Minnesota. On October 21, 2005, the
plaintiffs filed a motion to remand.
30
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Finally, two lights class actions are in the class certification motion and discovery
process. These cases include Huntsberry v. R. J. Reynolds Tobacco Co. (Washington) and Rios v. R.
J. Reynolds Tobacco Co. (Florida).
RJR Tobacco, B&W and other cigarette manufacturer defendants settled one class-action suit,
Broin v. Philip Morris, Inc., in October 1997. This case had been brought in Florida state court
on behalf of all flight attendants of U.S. airlines alleged to be suffering from diseases or
ailments caused by exposure to ETS in airplane cabins. The settlement agreement required the
participating tobacco companies to pay a total of $300 million in three annual $100 million
installments, allocated among the companies by market share, to fund research on the early
detection and cure of diseases associated with tobacco smoke. It also required those companies to
pay a total of $49 million for the plaintiffs counsels fees and expenses. RJR Tobaccos portion
of these payments was approximately $86 million; B&Ws portion of these payments was approximately
$57 million. The settlement agreement bars class members from bringing aggregate claims or
obtaining punitive or exemplary damages and also bars individual claims to the extent that they are
based on fraud, misrepresentation, conspiracy to commit fraud or misrepresentation, RICO,
suppression, concealment or any other alleged intentional or willful conduct. The defendants
agreed that, in any individual case brought by a class member, the defendant will bear the burden
of proof with respect to whether ETS can cause certain specifically enumerated diseases, referred
to as general causation. With respect to all other issues relating to liability, including
whether an individual plaintiffs disease was caused by his or her exposure to ETS in aircraft
cabins, referred to as specific causation, the individual plaintiff will have the burden of
proof. Floridas Third District Court of Appeal denied various challenges to this settlement on
March 24, 1999, and subsequently denied motions to reconsider. On September 7, 1999, the Florida
Supreme Court dismissed all proceedings, and the settlement and judgment became final. The Broin
II cases, discussed above, arose out of the settlement of this case.
Governmental Health-Care Cost Recovery Cases
MSA and Other State Settlement Agreements
In June 1994, the Mississippi attorney general brought an action, Moore v. American Tobacco
Co., against various industry members, including RJR Tobacco and B&W. This case was brought on
behalf of the state to recover state funds paid for health-care, and medical and other assistance
to state citizens suffering from diseases and conditions allegedly related to tobacco use. Most
other states, through their attorneys general or other state agencies, sued RJR Tobacco, B&W and
other U.S. cigarette manufacturers based on similar theories. The cigarette manufacturer
defendants, including RJR Tobacco and B&W, settled the first four of these cases scheduled for
trial Mississippi, Florida, Texas and Minnesota by separate agreements between each state and
those manufacturers in each case.
On November 23, 1998, the major U.S. cigarette manufacturers, including RJR Tobacco and B&W,
entered into the MSA with attorneys general representing the remaining 46 states, the District of
Columbia, Puerto Rico, Guam, the Virgin Islands, American Samoa and the Northern Marianas. The MSA
became effective on November 12, 1999, and settled all the health-care cost recovery actions
brought by, or on behalf of, the settling jurisdictions and contained releases of various
additional present and future claims.
In the settling jurisdictions, the MSA released RJR Tobacco, B&W, and their affiliates and
indemnitees, including RAI, from:
|
|
|
all claims of the settling states and their respective political subdivisions and
other recipients of state health-care funds, relating to past conduct arising out of
the use, sale, distribution, manufacture, development, advertising, marketing or health
effects of, the exposure to, or research, statements or warnings about, tobacco
products; and |
|
|
|
|
all monetary claims of the settling states and their respective political
subdivisions and other recipients of state health-care funds, relating to future
conduct arising out of the use of or exposure to, tobacco products that have been
manufactured in the ordinary course of business. |
31
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Set forth below are tables depicting the unadjusted tobacco industry settlement payment
schedule and the settlement payment schedule for RAIs operating subsidiaries under the MSA and
other state settlement agreements and related information for 2003 and beyond:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003 |
|
|
2004 |
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008+ |
|
|
|
|
|
|
|
|
|
|
|
(Dollars in Millions) |
|
|
|
|
|
|
|
|
|
|
Unadjusted Original Participating Manufacturers
Settlement Payment Schedule |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Four States Settlements:(1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mississippi Annual Payment |
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
Florida Annual Payment |
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
Texas Annual Payment |
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
Minnesota Annual Payment |
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
Minnesota Initial Payment |
|
|
122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Most Favored Nations Agreement (MS, FL, TX) |
|
|
609 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining States Settlement: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Initial Payments(1) |
|
|
2,701 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Payments(1) |
|
|
5,691 |
|
|
|
7,004 |
|
|
|
7,004 |
|
|
|
7,004 |
|
|
|
7,004 |
|
|
|
7,126 |
|
Additional Annual Payments (through 2017)(1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
861 |
|
Base Foundation Funding (through 2008) |
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
Additional Foundation Payments |
|
|
300 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Growers Trust ($295-2009 and 2010) (2) |
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
Offset by federal tobacco buyout (2) |
|
|
|
|
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
Minnesota Blue Cross and Blue Shield |
|
|
57 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
11,365 |
|
|
$ |
8,389 |
|
|
$ |
8,389 |
|
|
$ |
8,389 |
|
|
$ |
8,389 |
|
|
$ |
9,372 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAIs
Operating Subsidiaries Settlement Expenses
and Payment Schedule |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobaccos settlement expenses(3) |
|
$ |
1,925 |
|
|
$ |
2,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobaccos cash payments(3) |
|
$ |
1,819 |
|
|
$ |
2,037 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating subsidiaries settlement expenses |
|
$ |
9 |
|
|
$ |
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating subsidiaries cash payments |
|
$ |
7 |
|
|
$ |
9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobaccos expected settlement expenses |
|
|
|
|
|
|
|
|
> |
$ |
2,580 |
|
> |
$ |
2,550 |
|
> |
$ |
2,780 |
|
> |
$ |
2,700 |
|
RJR Tobaccos expected cash payments |
|
|
|
|
|
|
|
|
> |
$ |
2,700 |
|
> |
$ |
2,600 |
|
> |
$ |
2,600 |
|
> |
$ |
2,700 |
|
|
|
|
(1) |
|
Subject to adjustments for changes in sales volume, inflation and other factors. All
payments are to be allocated among the companies on the basis of relative market share. |
|
(2) |
|
The Growers Trust payments scheduled to expire in 2010 will be offset by obligations
resulting from the federal tobacco buyout legislation, not included in this table, signed in
October 2004. See -Tobacco Buyout Legislation. |
|
(3) |
|
These amounts do not include expenses or payments made in connection with B&Ws brands prior
to July 30, 2004. |
The MSA also contains provisions restricting the marketing of cigarettes. Among these
provisions are restrictions or prohibitions on the use of cartoon characters, brand-name
sponsorships, brand-name non-tobacco products, outdoor and transit brand advertising, payments for
product placement, free sampling and lobbying. The MSA also required the dissolution of three
industry-sponsored research and trade organizations.
The MSA and other state settlement agreements have materially adversely affected RJR Tobaccos
shipment volumes. RAI believes that these settlement obligations may materially adversely affect
the results of operations, cash flows or financial position of RAI and RJR Tobacco in future
periods. The degree of the adverse impact will depend, among other things, on the rate of decline
in U.S. cigarette sales in the premium and discount categories, RJR Tobaccos share of the domestic
premium and discount cigarette categories, and the effect of any resulting cost advantage of
manufacturers not subject to the MSA and other state settlement agreements.
Department of Justice Case
On September 22, 1999, the United States Department of Justice brought an action in the United
States District Court for the District of Columbia against various industry members, including RJR
Tobacco and B&W. The government sought to recover federal funds expended in providing health care
to smokers who have developed diseases
32
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
and injuries alleged to be smoking-related, and, in addition, seeks, pursuant to the federal
RICO statute, disgorgement of profits the government contends were earned as a consequence of a
RICO racketeering enterprise. On December 27, 1999, the defendants filed a motion to dismiss,
challenging all counts included in the action brought by the DOJ. On June 6, 2000, the trial court
heard oral argument on the motion. On September 28, 2000, Judge Gladys Kessler of the United
States District Court for the District of Columbia granted the non-Liggett defendants motion to
dismiss the plaintiffs Medical Care Recovery Act claim and Medicare Secondary Payer claim. The
court denied the motion with respect to the RICO claims.
On May 23, 2003, Judge Kessler denied the defendants first motion for partial summary
judgment, which sought legal preclusion of many aspects of the DOJs lawsuit regarding advertising,
marketing, promotion and warning claims. The court simultaneously granted partial summary judgment
for the government on certain affirmative defenses.
Each side filed additional summary judgment motions in the fall of 2003. The defendants as a
group filed a total of nine additional summary judgment motions. The government filed six
additional summary judgment motions, including motions regarding various affirmative defenses
(including those affirmative defenses addressing the standard for seeking disgorgement under RICO).
Rulings on the various motions are summarized below:
|
|
|
On January 23, 2004, the court granted the governments motion for partial summary
judgment on the defendants equitable defenses of waiver, equitable estoppel, laches,
unclean hands and in pari delicto. Although the order dismissed these particular
affirmative defenses, it did not address or limit the evidence that may be introduced
regarding the remaining RICO claims nor did it address the applicability of the legal
doctrines to issues related to equitable relief should liability be established. |
|
|
|
|
On February 2, 2004, Judge Kessler granted the industrys motion to prevent the
government from adding 650 alleged Racketeering Acts to the 148 alleged Racketeering
Acts previously identified by the government. |
|
|
|
|
On February 24, 2004, Judge Kessler denied the defendants motion for partial
summary judgment on claims that the defendants advertised, marketed and promoted
cigarettes to youth, and fraudulently denied such conduct. |
|
|
|
|
On March 10, 2004, Judge Kessler granted in part and denied in part the plaintiffs
motion for partial summary judgment regarding certain of the defendants affirmative
defenses. In particular, the court granted the plaintiffs motion regarding defenses
based upon the Ex Post Facto clause of the United States Constitution, but denied the
motion (without prejudice) regarding defenses to the governments disgorgement claim
based upon the Excessive Fines clause of the United States Constitution and the
standard for disgorgement set forth in United States v. Carson. |
|
|
|
|
On March 17, 2004, Judge Kessler denied the defendants motion for summary judgment
on the grounds that the governments RICO claims violate separation of powers. |
|
|
|
|
On May 6, 2004, Judge Kessler denied the defendants motion for summary judgment on
the grounds that there is no reasonable likelihood of future RICO violations. |
|
|
|
|
On May 6, 2004, Judge Kessler granted the governments motion for partial summary
judgment regarding certain of the defendants affirmative defenses. In particular, the
court dismissed defenses to the effect that the governments claims are prohibited by
the Tenth Amendment to the United States Constitution and the Separation of Powers
doctrine. The court also ruled that the defendants may be held jointly and severally
liable for disgorgement in the event that that remedy is ordered by the court at trial. |
|
|
|
|
On May 6, 2004, Judge Kessler denied the governments motion for partial summary
judgment that sought to establish that the defendants had caused certain mailings and
wire transmissions. |
|
|
|
|
On May 21, 2004, Judge Kessler denied the defendants motion for partial summary
judgment to dismiss the governments disgorgement claim. On June 25, 2004, Judge
Kessler granted the defendants the right to seek an immediate appeal of that order. On
July 15, 2004, the United States Court of Appeals for the District of Columbia Circuit
accepted the appeal of Judge Kesslers disgorgement ruling. On February 4, |
33
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
2005, the appeals court ruled that disgorgement is not an available remedy in this case.
This ruling eliminates the governments claim for $280 billion and limits the
governments potential remedies principally to forward-looking relief, including
measures such as those already included in the MSA. The governments petition for panel
rehearing and for rehearing en banc was denied on April 19, 2005. On July 18, 2005, the
government filed a petition for writ of certiorari with the United States Supreme Court.
On October 17, 2005, the Supreme Court denied the petition. |
|
|
|
|
On July 15, 2004, Judge Kessler granted in part the governments motion for partial
summary judgment dismissing certain technical RICO affirmative defenses. |
The bench (non-jury) trial began on September 21, 2004, and closing arguments concluded on
June 10, 2005. Also on June 10, 2005, Judge Kessler ordered that the parties file a variety of
post-trial submissions. On July 22, 2005, Judge Kessler granted a motion to intervene filed by six
organizations, including the American Cancer Society, to allow them to contribute their
perspective on what appropriate and legally permissible remedies may be imposed should liability be
found. On August 15, 2005, the parties filed their proposed findings of fact. Post-trial
briefing was completed on October 9, 2005.
Local Government Cases
Some local government entities have filed lawsuits based largely on the same theories and
seeking the same relief as the state attorneys general cases. As of July 15, 2005, there were no
such cases pending. On August 8, 2001, in County of Cook v. Philip Morris, Inc., the Circuit Court
of Cook County, Illinois, granted the defendants motion for judgment on the pleadings based on
remoteness grounds and dismissed the plaintiffs complaint in its entirety. On September 28, 2004,
the Illinois Appellate Court affirmed the trial courts dismissal. The plaintiffs petition asking
the Illinois Supreme Court to review the case was denied on January 27, 2005.
International Cases
A number of foreign countries have filed suit in state and federal courts in the United States
against RJR Tobacco, B&W and other tobacco industry defendants to recover funds for health-care,
medical and other assistance paid by those foreign governments to their citizens. In Venezuela v.
Philip Morris Cos., Inc., Floridas Third District Court of Appeal affirmed the trial courts
dismissal on October 1, 2002. Venezuela filed a notice to invoke the discretionary jurisdiction of
the Florida Supreme Court. The Florida Supreme Court declined Venezuelas petition for review. The
court further indicated that it would not entertain a motion for rehearing. In light of the
Venezuela decision, on August 25, 2003, the Circuit Court of Miami-Dade County, Florida, granted
the defendants motion for judgment on the pleadings in two additional cases brought by foreign
sovereigns Republic of Tajikistan v. Brooke Group Ltd., Inc. and State of Tocantins, Brazil v.
Brooke Group Ltd., Inc. This ruling led 22 other foreign nations to dismiss their cases.
There are four health-care reimbursement cases currently pending against RJR Tobacco and its
affiliates or indemnitees, including B&W, in the United States, both in Louisiana: Republic of
Panama v. The American Tobacco Co. and State of Sao Paulo v. The American Tobacco Co. The cases
were consolidated and then dismissed by the trial court on the basis that Louisiana is not an
appropriate forum. The plaintiffs have asked the trial court for reconsideration and, at the same
time, noticed an appeal to the Louisiana Court of Appeals. On July 26, 2005, the plaintiffs
motion for new trial or alternately reconsideration of the judgment was denied. These plaintiffs
filed new cases in the Superior Court for the State of Delaware in and for New Castle County on
July 19, 2005. Two other health-care reimbursement cases are pending against RJR Tobacco or B&W
outside the United States, one in each of Canada and Israel. Other foreign governments and
entities have stated that they are considering filing such actions in the United States.
On November 12, 1998, the government of British Columbia enacted legislation creating a civil
cause of action permitting the government to directly recoup the costs of health-care benefits
incurred for B.C. residents arising from tobacco-related disease. The government filed suit. The
defendants include both Canadian defendants served in B.C. and numerous foreign defendants served
ex juris, including RJR Tobacco. Three Canadian defendants brought separate actions challenging
the constitutionality of the legislation. In addition, 16 foreign defendants (including RJR
Tobacco) moved to set aside service ex juris. On February 21, 2000, the Supreme Court of British
Columbia ruled that the government had overstepped its constitutional powers. The governments
action was dismissed, and service ex juris was set aside for that reason. The government did not
appeal. Instead, the government enacted a revised statute and brought a new action. Again, three
Canadian defendants brought separate actions challenging the legislation on constitutional grounds
and eight foreign defendants (including RJR Tobacco) moved to set aside service ex juris. On June
5, 2003, the
34
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
governments action was dismissed, and service ex juris was set aside. The government
appealed. On May 20, 2004, the Court of Appeal held that the statute was constitutionally valid and
remitted the ex juris motions to the trial court for further consideration. On June 22, 2004, the
Canadian defendants, as well as three ex juris defendants, applied for leave to appeal the issue of
the validity of the legislation to the Supreme Court of Canada. On December 16, 2004, the Supreme
Court agreed to hear the appeal of the validity of the statute. On September 28, 2005, the Supreme
Court ruled that the statute is constitutionally valid, therefore dismissing the appeals and
vacating the stay of proceedings that was granted on January 21, 2005. On June 23, 2005, the trial
court found that service was proper. On July 19, 2005, RJR Tobacco filed its notice of appeal of
this ruling. The appellate hearing on this motion is scheduled for February 1, 2 and 3, 2006.
Pursuant to the terms of the 1999 sale of RJRs international tobacco business, JTI assumed
RJR Tobaccos liability, if any, in the health-care cost recovery cases brought by foreign
countries.
Other Health-Care Cost Recovery and Aggregated Claims Cases
As of October 14, 2005, three other health-care cost recovery cases were pending in the United
States against RJR Tobacco, B&W, as its indemnitee, or both.
Although the MSA settled some of the most potentially burdensome health-care cost recovery
actions, many other such cases have been brought by other types of plaintiffs. Unions, groups of
health-care insurers, a private entity that purported to self-insure its employee health-care
programs, Native American tribes, hospitals, universities, taxpayers and senior associations have
advanced claims similar to those found in the governmental health-care cost recovery actions.
These cases largely have been unsuccessful on remoteness grounds, which means that one who pays an
injured persons medical expenses is legally too remote to maintain an action against the person
allegedly responsible for the injury.
Union Cases
As of October 14, 2005, there were no pending lawsuits by union trust funds against cigarette
manufacturers.
Numerous trial court judges have dismissed union trust fund cases on remoteness grounds. The
first and only union case to go to trial to date was Iron Workers Local No. 17 v. Philip Morris,
Inc., which was tried in federal court in Ohio. On March 18, 1999, the jury returned a unanimous
verdict for the defendants, including RJR Tobacco and B&W. The plaintiffs dismissed their appeal
of the verdict.
Since March 1999, the United States Courts of Appeals for the Second, Third, Fifth, Seventh,
Eighth, Ninth, Eleventh and District of Columbia Circuits all have ruled in favor of the tobacco
industry in similar union cases. The United States Supreme Court has denied petitions for
certiorari filed by unions in cases from the Second, Third, Ninth and District of Columbia
Circuits.
Insurance-Related Cases
As of October 14, 2005, there were no insurance-related cases pending against RJR Tobacco and
B&W.
On June 6, 2001, in Blue Cross and Blue Shield of New Jersey, Inc. v. Philip Morris, Inc., a
federal court jury in Brooklyn returned a verdict in favor of RJR Tobacco, B&W and other tobacco
defendants on common law fraud and civil RICO claims, but found for the plaintiff, Empire Blue
Cross and Blue Shield, referred to as Empire, on a claim under a New York state deceptive business
practices statute. Empire pursued its claims against the defendants on behalf of itself directly,
as well as on behalf of its insureds under a theory of subrogation. The jury verdict on the direct
claim was approximately $17.8 million, and the verdict on the subrogated claim was approximately
$11.8 million. RJR Tobaccos portion of these amounts is $6.6 million and $4.4 million,
respectively; B&Ws portion of these amounts is $2.8 million and $1.9 million, respectively. The
New York statute under which Empire recovered does not provide for punitive damages, but does allow
for recovery of reasonable attorneys fees. On February 28, 2002, Judge Weinstein awarded the
plaintiffs counsel approximately $38 million in attorneys fees.
The defendants, including RJR Tobacco and B&W, appealed to the United States Court of Appeals
for the Second Circuit. On September 16, 2003, the Second Circuit reversed the judgment for Empire
on its subrogation claim and reserved ruling on Empires direct claim pending resolution by the New
York Court of Appeals of two state law questions: are third party payer claims too remote and, if
not, is individual proof required. On October 19, 2004, the New York Court of Appeals determined
that such third-party claims are too remote to permit suit under N.Y. Gen. Bus. Law § 349.
Accordingly, the United States Court of Appeals reversed the judgment on December 22, 2004. On
February 1, 2005, all the plaintiffs, including Empire, voluntarily dismissed their claims with
prejudice.
35
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Native American Tribe Cases
As of October 14, 2005, one Native American tribe case was pending before a tribal court in
South Dakota against RJR Tobacco and B&W, Crow Creek Sioux Tribe v. American Tobacco Co.
Hospital Cases
As of October 14, 2005, one case brought by one or more hospitals was pending against
cigarette manufacturers, including RJR Tobacco and B&W: City of St. Louis v. American Tobacco Co.,
Inc., pending in the Circuit Court of the City of St. Louis, Missouri. This case seeks recovery of
costs expended by hospitals on behalf of patients who suffer, or have suffered, from illnesses
allegedly resulting from the use of cigarettes. On June 28, 2005, the court granted defendants
motion for summary judgment as to claims for damages which accrued prior to November 16, 1993. The
claims for damages which accrued after November 16, 1993, are still pending. In County of McHenry
v. Philip Morris, Inc., the Circuit Court of Cook County, Illinois granted plaintiffs voluntary
dismissal with prejudice on February 28, 2005.
Taxpayer Cases
As of October 14, 2005, there were no taxpayer cases pending against cigarette manufacturers,
including RJR Tobacco and B&W. All three prior cases, Mason v. American Tobacco Co., Anderson v.
American Tobacco Co., Inc. and Temple v. R. J. Reynolds Tobacco Co., were dismissed by the trial
courts.
Other Cases
On August 4, 2005, the United Seniors Association filed a case against the major U.S.
cigarette manufacturers, including RJR Tobacco and B&W, in the United States District Court for the
District of Massachusetts. The plaintiff is bringing the action as a private attorney general
pursuant to the private cause of action provisions of the Medicare as Secondary Payer statute. The
case seeks to recover for the Medicare program all of the expenditures that the Medicare program
made from August 4, 1999, to present for the health care services rendered to Medicares
beneficiaries for the treatment of diseases attributable to smoking including, but not limited to,
coronary heart disease, chronic obstructive pulmonary disease, lung cancer, emphysema, peripheral
vascular disease and atherosclerosis.
MSA-Enforcement and Validity
As of October 14, 2005, there were two cases pending against RJR Tobacco or B&W concerning the
enforcement and validity of the MSA and other state settlement agreements. In addition, as
discussed below, on July 26, 2005, a third such case was filed against RJR Tobacco.
On April 7, 2004, a class action lawsuit, Sanders v. Philip Morris USA, Inc., was filed in the
Superior Court of Los Angeles County against RJR, RJR Tobacco, Philip Morris, Altria and B&W. The
case was brought on behalf of California residents who purchased cigarettes in California from
April 2, 2000 to the present. The plaintiff generally alleged that the MSA was anticompetitive in
that the defendants used the terms of the MSA to reduce competition and to raise the price of
cigarettes. The plaintiff voluntarily dismissed this state court case, and on June 9, 2004, filed
a new action in the United States District Court for the Northern District of California. The
defendants are RJR Tobacco, B&W, Philip Morris, Lorillard and Bill Lockyer (in his capacity as the
Attorney General for the State of California). As in the prior state law complaint, the plaintiff
complains about alleged anticompetitive portions of the MSA. The plaintiff asserts claims for
declaratory and injunctive relief based on preemption and Supremacy Clause grounds (alleging that
the MSA supposedly is inconsistent with the federal antitrust laws), for injunctive relief based on
claimed violations of the Sherman Act, for damages and injunctive relief based on claimed
violations of Californias state antitrust law (the Cartwright Act), for an accounting of profits
based on claimed statutory and common law theories of unfair competition, and for restitution based
on claimed unjust enrichment. On March 29, 2005, the United States District Court for the Northern
District of California granted the defendants motion to dismiss with prejudice. The plaintiffs
notice of appeal was filed on April 18, 2005. The plaintiffs opening appellate brief was filed on
August 18, 2005. The defendants response brief was filed on October 20, 2005.
On May 27, 2004, the State of Texas filed a motion to enforce B&Ws 1998 settlement agreement
with that state. The motion alleges that B&W owes the state some $16.4 million in past settlement
payments, plus interest, with respect to cigarettes that B&W contract manufactured for Star
Tobacco, Inc. The motion also alleges that B&Ws entry into the business combination agreement
with RJR violates a provision of the Texas settlement agreement that requires all parties to the
settlement agreement to consent to its assignment. The motion asks the court to award damages,
order an accounting, and prohibit B&W from assigning the settlement agreement without the consent
of the state. B&W filed a response to the motion on June 21, 2004, and a hearing was held on June
24, 2004. On March 28, 2005, the United
36
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
States District Court for the District of Texas, Texarkana Division, entered final judgment in
favor of B&W. On April 27, 2005, the State of Texas filed a notice of appeal to the United States
Court of Appeals for the Fifth Circuit. The appellants brief was filed on August 23, 2005.
In addition, on March 28, 2005, the National Association of Attorneys General, referred to as
NAAG, sent a notice, signed by 40 Attorneys General, referred to as the Notice, that one or more of
the states intend to initiate proceedings against RJR Tobacco for violating Section III(r) of the
MSA in its advertisements for Eclipse cigarettes and for violations of the various Consent Decrees
implementing the MSA and/or consumer fraud statutes in various states. The Attorneys General
allege, among other things, that RJR Tobacco has engaged in unfair and deceptive acts and practices
by publishing false or misleading claims about its Eclipse brand cigarettes, failed to disclose
material facts and/or engaged in deceptive or unfair practices in marketing and selling Eclipse
brand cigarettes. RJR Tobacco met with NAAG representatives in early June 2005 to discuss issues
raised in the Notice. On July 26, 2005, the Vermont Attorney General filed suit alleging that
certain Eclipse advertising violates both the MSA and the Vermont Consumer Fraud Statute. RJR
Tobacco filed its answer to the complaint on October 11, 2005.
On April 13, 2005, the Mississippi Attorney General notified B&W of its intent to seek
approximately $3.9 million in additional payments under the Mississippi Settlement Agreement. The
Mississippi Attorney General asserts that B&W failed to report in its net operating profit or its
shipments cigarettes manufactured by B&W under contract for Star Tobacco or its parent, Star
Scientific, Inc. On April 28, 2005, B&W advised the state that it did not owe the state any money.
On August 11, 2005, the Mississippi Attorney General filed a Notice of Violation, Motion to
Enforce Settlement Agreement, and Request for an Accounting by Defendant Brown & Williamson
Holdings, Inc., formerly known as Brown & Williamson Tobacco Corporation. In this filing,
Mississippi estimated that its damages now exceed $5.0 million. RJR Tobacco intends to oppose this
motion.
In California v. R. J. Reynolds Tobacco Co., the State of California alleged, in the context
of the placement of print advertising, that RJR Tobacco was in violation of the prohibition in the
MSA against taking any action, directly or indirectly, to target youth. In a decision issued on
July 12, 2002, the trial judge found that although youth may not have been directly targeted ...
RJR indirectly targeted youth, thereby violating the MSA. In addition, the judge issued a $20
million fine. RJR Tobacco appealed this ruling to the California Court of Appeal, Fourth Appellate
District, which on February 25, 2004, affirmed the trial courts finding, but reversed as to the
amount of the fine and remanded for further proceedings. The parties ultimately settled the case,
and RJR Tobacco paid approximately $11.4 million in civil penalties and $5.9 million in attorneys
fees. Additionally, RJR Tobacco agreed to avoid advertising in magazines with at least 15% teen
readership.
On March 26, 2004, the Attorney General of Maine alleged that B&Ws Kool Mixx advertising
campaign violated the MSAs prohibitions on youth targeting, placement of tobacco brand names in
media and tobacco brand name merchandise. On May 7, 2004, the Attorney General of New York, on
behalf of himself and 30 other state attorneys general, served a notice of intent to initiate
enforcement proceedings over B&Ws Kool Mixx advertising campaign if the states claims were not
resolved within 30 days from the date of the letter. On May 25, 2004, B&W received a cease and
desist letter from the Attorney General of Illinois asking B&W to refrain from distributing
purported brand name merchandise and transmitting a Kool Mixx DJ competition over the Internet.
On June 15, 2004, the state of New York sued, seeking a fine of $15.4 million and preliminary and
permanent injunctions barring the Kool Mixx program. At a preliminary injunction hearing on June
17, 2004, the court refused to prohibit the Kool Mixx DJ competitions scheduled to take place in
New York, but ordered B&W, pending final determination of the states motion, to suspend its House
of Menthol web site, eliminate references to Kool Mixx on its toll-free telephone lines, and
refrain from using elements of its current Kool Mixx advertising. The states of Maryland and
Illinois filed similar motions in their courts on June 29, 2004, and July 22, 2004, respectively.
On October 5, 2004, RJR Tobacco and its affiliates and indemnitees, including B&W, settled the
three pending motions with the Attorneys General of New York, Illinois and Maryland. The
companies admitted no wrongdoing in the settlement agreement. Pursuant to the agreement, RJR
Tobacco paid a total of $1.5 million, $1.46 million of which will be paid to four not-for-profit
organizations for youth smoking prevention programs. In addition, RJR Tobacco agreed to certain
restrictions on selected elements of marketing support for future Kool Mixx promotions. The New
York Supreme Court approved the agreement on October 15, 2004; the Circuit Court for Baltimore City
approved the agreement on October 7, 2004; and the Circuit Court of Cook County, Illinois, approved
the agreement on October 13, 2004.
37
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Asbestos Contribution Cases
As of October 14, 2005, one lawsuit was pending against RJR Tobacco and B&W in which asbestos
companies and/or asbestos-related trust funds allege that they overpaid claims brought against
them to the extent that tobacco use, not asbestos exposure, was the cause of the alleged personal
injuries, Fibreboard Corp. v. R. J. Reynolds Tobacco Co., pending in state court in California.
Motions to dismiss those claims have been stayed indefinitely.
Antitrust Cases
A number of tobacco wholesalers and consumers have sued U.S. cigarette manufacturers,
including RJR Tobacco and B&W, in federal and state courts, alleging that cigarette manufacturers
combined and conspired to set the price of cigarettes in violation of antitrust statutes and
various state unfair business practices statutes. In these cases, the plaintiffs asked the court
to certify the lawsuits as class actions on behalf of other persons who purchased cigarettes
directly or indirectly from one or more of the defendants. The federal cases against RJR Tobacco
and B&W were consolidated and sent by the Judicial Panel on Multi-District Litigation for pretrial
proceedings in the United States District Court for the Northern District of Georgia. The court
certified a nation-wide class of direct purchasers on January 27, 2001. The court granted the
defendants motion for summary judgment in the consolidated federal cases on July 11, 2002, and the
United States Court of Appeals for the Eleventh Circuit affirmed that decision on September 22,
2003. As of April 15, 2005, all state court cases on behalf of indirect purchasers have been
dismissed, except for two cases pending in Kansas and New Mexico. The Kansas court granted class
certification on November 15, 2001, while the New Mexico court granted class certification on May
14, 2003. On February 8, 2005, the New Mexico Court of Appeals affirmed the trial courts
certification order. The defendants have moved for summary judgment in New Mexico.
On July 30, 1999, Cigarettes Cheaper!, a retailer, filed an antitrust counterclaim against RJR
Tobacco in a gray market trademark suit originally brought by RJR Tobacco in the United States
District Court for the Northern District of Illinois. Cigarettes Cheaper! alleged that it was
denied promotional resources in violation of the Robinson-Patman Act. On January 23, 2001, the
court granted Cigarettes Cheaper!s motion to amend its counterclaim to include a violation of
Section 1 of the Sherman Antitrust Act. On March 21, 2001, RJR Tobaccos motion to add a trademark
dilution claim against Cigarettes Cheaper! was granted.
On June 25, 2003, the court granted RJR Tobaccos motion for summary judgment on Cigarettes
Cheaper!s counterclaim alleging an illegal conspiracy under the Sherman Antitrust Act, but denied
the motion with respect to the counterclaims alleging price discrimination under the
Robinson-Patman Act. Trial on RJR Tobaccos trademark claims and the remaining antitrust
counterclaims began on January 12, 2004. The court declared a mistrial on January 13, 2004,
because of an inappropriate opening statement by Cigarettes Cheaper!s counsel. The court severed
the trademark claims from the antitrust claims and held the trial on the trademark claims on April
25, 2004. On May 5, 2004, the jury returned a verdict in favor of RJR Tobacco on all counts in the
trademark claim in the amount of $3.5 million. Trial began on the Robinson-Patman claim on
September 14, 2004, and on October 15, 2004, the jury returned a unanimous verdict in favor of RJR
Tobacco. On December 8, 2004, the plaintiff appealed to the United States Court of Appeals for the
Seventh Circuit. Oral argument occurred on September 12, 2005
and RJR Tobacco is awaiting the ruling.
On February 16, 2000, a class-action complaint, DeLoach v. Philip Morris Cos., Inc., was
brought against RJR Tobacco, B&W and other cigarette manufacturers and others, in the United States
District Court for the District of Columbia on behalf of a class of all tobacco growers and tobacco
allotment holders. The plaintiffs assert that the defendants, including Philip Morris, RJR
Tobacco, B&W and Lorillard, engaged in bid-rigging of American burley and flue-cured tobacco
auctions beginning at least by 1996 and continuing. The defendants actions are alleged to have
held the auction prices of tobacco at artificially low prices. In addition, the plaintiffs alleged
that the defendants have engaged in a conspiracy to force the elimination or destruction of the
federal governments tobacco quota and price support program through an alleged illegal group
boycott. On November 30, 2000, the court granted a motion to transfer venue to the United States
District Court for the Middle District of North Carolina. In May 2003, the plaintiffs reached a
settlement with all the defendants, including B&W, except RJR Tobacco. The settlement was approved
by the trial court on October 1, 2003. The settling defendants agreed to pay $210 million to the
plaintiffs, of which B&Ws share was $23 million, to pay the plaintiffs attorneys fees as set by
the court, of which B&Ws share was 13%, and to purchase a minimum amount of U.S. leaf for ten
years, expressed as both a percentage of domestic requirements, with 35% for B&W, and as a minimum
number of pounds per year, with 55 million pounds for B&W. On December 19, 2003, the court set the
plaintiffs attorneys fees at $75.3 million. B&Ws 13% share of this amount is $9.8 million.
The case continued against RJR Tobacco. On April 22, 2004, the parties settled the case.
Under the settlement, RJR Tobacco has paid $33 million into a settlement fund, which after
deductions for attorneys fees and
38
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
administrative costs, will be distributed to the class pending the courts final settlement
approval. This amount was recorded in selling, general and administrative expense in RAIs
consolidated statement of income in the first quarter of 2004. RJR Tobacco also agreed to purchase
annually a minimum of 90 million pounds, including the assumed obligation of B&W, of domestic green
leaf flue-cured and burley tobacco combined for the next 10 years, beginning with the 2004 crop
year. On March 21, 2005, the court approved the RJR Tobacco settlement and dismissed the suit.
On January 31, 2003, in Smith Wholesale Co., Inc. v. R. J. Reynolds Tobacco Co., Smith
Wholesale filed a complaint against RJR Tobacco under the federal antitrust laws in the United
States District Court for the Eastern District of Tennessee in connection with RJR Tobaccos
termination of its distribution agreement with Smith Wholesale. That same day, Smith Wholesale
moved for an order to prevent RJR Tobacco from terminating the agreement. The court granted Smith
Wholesales motion on February 7, 2003, and required RJR Tobacco to reinstate Smith Wholesales
contract. Prior to the courts order that day, RJR Tobacco terminated its distribution agreement
with Rice Wholesale Company, Inc., consistent with the terms of the agreement. On February 18,
2003, Smith Wholesale moved to amend its complaint to add Rice Wholesale as a plaintiff and allege
similar claims on behalf of Rice Wholesale, a motion the court immediately granted, and Rice
Wholesale filed a motion for a preliminary injunction to prevent RJR Tobacco from terminating the
distribution agreement. The court granted Rice Wholesales motion on March 4, 2003. RJR Tobacco
appealed the preliminary injunctions on February 11, 2003, and March 6, 2003, respectively. The
United States Court of Appeals for the Sixth Circuit consolidated the appeals.
On June 10, 2003, nine other wholesalers joined the lawsuit, and ten of the eleven plaintiffs
filed another motion for a preliminary injunction, this time asking the federal district court to
enjoin RJR Tobacco from implementing amendments to its distribution agreements that were scheduled
to become effective on June 30, 2003. After a hearing on July 24, 2003, the district court granted
the motion on August 6, 2003. Prior to issuing its decision, the district court granted the State
of Tennessees motion to intervene as a plaintiff on July 3, 2003, and the State of Mississippis
motion to intervene as a plaintiff on July 14, 2003. RJR Tobacco appealed to the United States
Court of Appeals for the Sixth Circuit on August 8, 2003. On September 24, 2003, the district
court granted RJR Tobaccos emergency motion for a stay of the August 6, 2003 order, pending RJR
Tobaccos appeal.
The
plaintiffs eventually numbered 20. On June 3, 2005, the District Court Judge granted
summary judgment in RJR Tobaccos favor. Each of the preliminary injunctions has extinguished, and
on June 23, 2005, the district court dismissed the entire case. On June 23, 2005, the plaintiffs
filed a notice of appeal of the summary judgment and dismissal. RJR Tobacco reached a non-monetary
settlement in principle with Bates Wholesale and a non-monetary settlement with the states of
Tennessee and Mississippi on July, 22, 2005. Those plaintiffs have dropped their appeal.
On May 24, 2004, RJR Tobacco was served with a class action lawsuit, Genesee Vending, Inc. v.
R. J. Reynolds Tobacco Co., which was filed in the United States District Court for the Eastern
District of Michigan by Genesee Vending, Inc. and other cigarette vending companies. The
plaintiffs, operators of vending machines, allege that they were denied participation in RJR
Tobaccos retail promotions in violation of the Robinson-Patman Act. The suit seeks unspecified
damages and a jury trial. The complaint also requests an injunction against RJR Tobacco
prohibiting it from paying promotional benefits and buy downs to any retailers. On July 2, 2004,
RJR Tobacco filed its motion to dismiss. After the court, in a case filed by these same plaintiffs
against Lorillard Tobacco Company, granted a motion to dismiss for failure to state the elements of
a claim individually on behalf of each of the named plaintiffs, the plaintiffs agreed to
voluntarily amend their complaint against RJR Tobacco and filed an amended complaint in December
2004. RJR Tobaccos motion to dismiss was denied on May 2, 2005. Discovery is not yet underway, and
the parties met with the court on July 27, 2005, concerning the schedule for various pretrial
matters and trial. On September 27, 2005, the plaintiffs filed a motion for class certification,
and RJR Tobacco has responded to that motion by seeking leave to take class discovery before
responding to the motion for class certification. The plaintiffs class certification motion and
RJR Tobaccos motion for class discovery are pending. No discovery, pretrial or trial schedule has
been set in the case.
Other Litigation and Developments
On July 3, 2003, the Securities and Exchange Commission, referred to as the SEC, issued a
subpoena to RJR pursuant to a formal order of investigation of potential violations of the
securities laws. The subpoena, and discussions to date with the SEC staff, focus on whether the
disclosure of specific amounts of certain expenses of RJR should have been quantified separately
rather than aggregated with other expense items. RJR is cooperating with the SEC in a way that
protects its rights. On August 14, 2003, the SEC filed, in the United States District Court for
the District of Columbia, an application for an order to show cause and an order requiring
compliance with the subpoena. On August 29, 2003, RJR filed a motion for a protective order and
its opposition to the SECs application for an order to show
39
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
cause. On June 29, 2004, the court issued an order granting in part and denying in part the
SECs order to show cause and granting in part and denying in part RJRs motion for protective
order. RJR has produced documents to the SEC in compliance with the subpoena and the courts
order. RAI is unable to predict the outcome of this investigation or any effects that the outcome
may have on its disclosures related to its results of operations.
On January 24, 2003, RJR and RJR Tobacco each were served with a subpoena issued by a federal
grand jury sitting in the Southern District of New York. The subpoena seeks the production of
documents relating to the sale and distribution of cigarettes in international markets. RJR and
RJR Tobacco have been responding and will continue to respond appropriately to the subpoena and
otherwise cooperate with this grand jury investigation. Although this investigation has been
dormant, it remains a pending matter.
On December 22, 1998, Northern Brands International, Inc., referred to as Northern Brands,
entered into a plea agreement with the United States Attorney for the Northern District of New
York. Northern Brands was charged with and pled guilty to aiding and abetting certain customers who
brought merchandise into the United States by means of false and fraudulent practices....
Northern Brands is a now inactive RJR subsidiary that was part of the business of R. J. Reynolds
International B.V., a former Netherlands subsidiary of RJR Tobacco, which was managed by a former
affiliate, RJR-Macdonald, Inc., referred to as RJR-MI. By purchase agreement dated May 12, 1999,
referred to as the 1999 Purchase Agreement, RJR and RJR Tobacco sold the international tobacco
business, including RJR-MI, to JTI. RJR-MI subsequently changed its name to JTI-Macdonald Corp.,
referred to as JTI-MC.
Although the international business was sold to JTI pursuant to the 1999 Purchase Agreement,
RJR and RJR Tobacco retained certain liabilities relating to the activities of Northern Brands,
including those related to the above-mentioned guilty plea, as well as an investigation conducted
by Royal Canadian Mounted Police, referred to as RCMP, for possible violations of Canadian law
related to the activities that led to the Northern Brands guilty plea and certain conduct by
Stanley Smith, a former executive of RJR-MI, which led to the termination of his severance
agreement. In addition, under its reading of the indemnification provisions of the 1999 Purchase
Agreement, JTI has requested indemnification for any damages it may incur arising out of the three
matters described below.
|
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|
On or about February 27, 2003, the RCMP filed criminal charges against and purported
to serve summonses on JTI-MC, Northern Brands, R. J. Reynolds Tobacco International,
Inc., referred to as RJR-TI, R. J. Reynolds Tobacco Co. (Puerto Rico), referred to as
RJR-PR, and eight individuals associated with RJR-MI and/or RJR-TI during the period
January 1, 1991 through December 31, 1996. The charges filed are for alleged fraud and
conspiracy to defraud Canada and the Provinces of Ontario and Quebec in connection with
the purchase, sale, export, import and/or re-export of cigarettes and/or fine cut
tobacco. In October 2003, Northern Brands, RJR-TI and RJR-PR filed an application
challenging both the propriety of the service of the summons on each of them as well as
the jurisdiction of the Canadian court over each of them. A hearing on the application
was held in December 2003. On February 9, 2004, the Superior Court of Justice,
Ontario, Canada, ruled in favor of these companies and granted their application. The
Canadian government filed a notice of appeal from that ruling on February 18, 2004, but
has not formally taken any additional action to pursue an appeal. A preliminary
inquiry commenced on April 11, 2005, for the purpose of determining whether the
Canadian prosecutor has sufficient evidence supporting the criminal charges to justify
a trial of the defendants that have been properly served to date. |
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|
|
In August 2004, the Quebec Ministry of Revenue (1) issued a tax assessment covering
the period January 1, 1990 through December 31, 1998, for alleged unpaid duties,
penalties and interest in an amount of about $1.36 billion (Canadian) against JTI-MC;
(2) issued an order for the immediate payment of that amount; and (3) obtained an ex
parte judgment to enforce the payment of that amount. On August 24, 2004, JTI-MC
applied for protection under the Companies Creditor Arrangement Act, referred to as
CCAA Proceedings, in the Ontario Superior Court of Justice, Toronto, Canada and the
court entered orders staying the Quebec Ministry of Revenues proceedings against
JTI-MC. In November 2004, JTI-MC filed a motion in the Superior Court, Province of
Quebec, District of Montreal, seeking a declaratory judgment to set aside, annul and
declare inoperative the tax assessment and all ancillary enforcement measures and to
require the Quebec Minister of Revenue to reimburse JTI-MC for funds unduly
appropriated, along with interest and other relief. On May 3, 2005, the court in the
CCAA Proceedings entered a Crown Claims Bar Order establishing June 27, 2005, as the
deadline for Canada, and any of its Provinces and Territories, to assert any individual
civil or statutory claim, except criminal claims, against JTI-MC for taxes and revenues
owed as a result of Contraband Tobacco Activities, as defined in the Order. As of June
27, 2005, Canada and several Provinces filed Crown claims against JTI-MC in the CCAA
Proceedings in the following amounts: Canada ($4.3 billion Canadian); Ontario ($1.5
billion Canadian); New Brunswick ($1.5 billion Canadian); Quebec ($1.4 billion
Canadian); British Columbia |
40
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
($450 million Canadian); Nova Scotia ($326 million Canadian); Prince Edward Island ($75
million Canadian) and Manitoba ($23 million Canadian). |
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On November 17, 2004, a Statement of Claim was filed against JTI-MC in the Supreme
Court of British Columbia by Stanley Smith, a former executive of RJR-MI, for alleged
breach of contract and other legal theories. Under his claim, Mr. Smith is claiming
$840,000 (Canadian) for salary allegedly owed under his severance agreement with
RJR-MI, as well as other unspecified compensatory and punitive damages. |
Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have
indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree
with JTI as to whether the circumstances relating to any of these three matters give rise to any
indemnification obligation by RJR and RJR Tobacco. RJR and RJR Tobacco conveyed their position to
JTI, and the parties have agreed to resolve their differences at a later time. For further
information on the JTI indemnification claims, see -Other Contingencies and Guarantees.
Furthermore, on September 18, 2003, RJR, RJR Tobacco, RJR-TI, RJR-PR, and Northern Brands were
served with a statement of claim filed by the Attorney General of Canada in the Superior Court of
Justice, Ontario, Canada. Also named as defendants are JTI and a number of its affiliates. The
statement of claim seeks to recover under various legal theories taxes and duties allegedly not
paid as a result of cigarette smuggling and related activities. As filed, the Attorney Generals
statement of claim seeks to recover $1.5 billion (Canadian) in compensatory damages and $50 million
(Canadian) in punitive damages, as well as equitable and other forms of relief. As noted above, in
the CCAA Proceedings, the Attorney General amended and increased Canadas claim to $4.3 billion
Canadian. The parties have agreed to a stay of all proceedings until February 2006. The time
period for the stay may be lengthened or shortened by the occurrence of certain events or agreement
of the parties.
Over the past few years, several lawsuits have been filed against RJR Tobacco and its
affiliates and, in certain cases, against other cigarette manufacturers, including B&W, by the
European Community and ten of its member states, Ecuador, Belize, Honduras and various Departments
of the Republic of Colombia. These suits generally contend that RJR Tobacco and other tobacco
companies, including B&W, may be held responsible under the federal RICO statute, the common law
and other legal theories for taxes and duties allegedly unpaid as a result of cigarette smuggling.
Some of these actions have been dismissed completely. In each of the remaining actions, which are
discussed below, the plaintiffs seek compensatory, punitive and treble damages.
The European Community and ten of its member states have filed three RICO lawsuits against RJR
Tobacco, certain of its affiliates, and others in the United States District Court for the Eastern
District of New York. The first complaint was filed on November 3, 2000, and dismissed by the court
on July 16, 2001. No appeal was taken.
On August 6, 2001, the European Community and ten of its member states filed a second civil
RICO action. A similar complaint was filed against B&W and other defendants by various Departments
of the Republic of Colombia. RJR Tobacco and B&W and the other defendants filed motions to dismiss
the complaints filed against each of them. On February 25, 2002, the court granted the defendants
motions to dismiss the complaints and, on March 25, 2002, the plaintiffs appealed to United States
Court of Appeals for the Second Circuit. The Second Circuit affirmed the dismissals on January 14,
2004. On April 13, 2004, the European Community and its member states, together with the Colombian
Departments, petitioned the United States Supreme Court for a writ of certiorari. On May 2, 2005,
the Supreme Court vacated each decision and, without commenting on the merits of the cases,
instructed the Second Circuit to review the cases in light of the Supreme Courts decision in
Pasquantino v. United States. On September 13, 2005, the Second Circuit reinstated its prior
decision upholding the dismissal of the complaint. The European Community and member states are
considering whether they will pursue additional appellate court action.
On October 30, 2002, the European Community and ten of its member states filed a third
complaint against RJR, RJR Tobacco and several currently and formerly related companies. The
complaint contains many of the same or similar allegations found in the earlier complaints and also
alleges that the defendants, together with certain identified and unidentified persons, engaged in
money laundering and other conduct violating civil RICO and a variety of common laws. The
complaint also alleges that the defendants manufactured cigarettes which were eventually sold in
Iraq in violation of U.S. sanctions. Plaintiffs seek compensatory, punitive and treble damages
among other types of relief. This matter remains pending, but all proceedings were stayed while
the Second Circuit reconsidered its decision affirming the dismissal of the second European
Community complaint. On September 13, 2005, the Second Circuit reinstated its prior decision
upholding the dismissal of the complaint. The proceedings in this case remain stayed while the
European Community and the member states consider whether they will pursue additional appellate
court action regarding that decision by the Second Circuit.
On December 20, 2000, October 15, 2001, and January 9, 2003, RJR Tobacco and the other
defendants named in each of the European Community cases filed cases in the Court of First Instance
in Luxembourg challenging the
41
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
competency of the European Community to bring each of the actions and seeking an annulment of
the decision to bring each of the actions. On January 15, 2003, the Court of First Instance entered
a judgment denying the first two applications, principally on the grounds that the filing of the
first two complaints did not impose binding legal effects on RJR Tobacco and the other defendants.
On March 21, 2003, RJR and its affiliates appealed that judgment to the Court of Justice of the
European Communities. The application for annulment filed in connection with the third European
Community complaint is still pending before the Court of First Instance. On September 18, 2003,
however, the Court of First Instance stayed the proceedings in the third action, pending resolution
of the appeals from the January 15, 2003, judgment denying the admissibility of the first two
applications.
RJR Tobacco has been served in two reparations actions brought by descendants of slaves,
claiming that the defendants, including RJR Tobacco, profited from the use of slave labor. These
two actions have been transferred to Judge Norgle in the Northern District of Illinois by the
Judicial Panel on Multi-District Litigation for coordinated or consolidated pretrial proceedings
with other reparation actions. Seven additional cases were originally filed in California,
Illinois and New York. RJR Tobacco is a named defendant in only one of these additional cases, but
it has not been served. The action in which RJR Tobacco is named, but has not been served, was
conditionally transferred to the Northern District of Illinois on January 7, 2003, but the
plaintiffs contested that transfer, and the Judicial Panel on Multi-District Litigation has not yet
issued a final ruling on the transfer. The plaintiffs filed a consolidated complaint on June 17,
2003. On July 18, 2003, the defendants moved to dismiss the plaintiffs complaint. That motion
was granted on January 26, 2004, although the court allowed the plaintiffs to file an amended
complaint, which they did on April 5, 2004. In addition, several plaintiffs attempted to appeal
the trial courts January 26, 2004 dismissal. Because the dismissal was not a final order, that
appeal was dismissed by the United States Court of Appeals for the Seventh Circuit. On July 6,
2005, the trial court granted the defendants motion to dismiss the amended complaint with
prejudice. On August 3, 2005, the plaintiffs filed a notice of appeal to the Seventh Circuit. A
separate notice was filed by an individual plaintiff, Deadria Farmer-Paellman, on the same date.
The plaintiffs initial brief was filed on October 12, 2005. Briefing is not yet complete.
On June 8, 2001, the Attorney General of the State of California filed a lawsuit against RJR
Tobacco in California state court alleging that RJR Tobacco violated California state law by
distributing free cigarettes and free coupons for discounts on cigarettes on public grounds, even
though the promotions occurred within an adult-only facility at a race track and certain
festivals. RJR Tobacco answered the complaint on July 19, 2001, asserting that its promotions
complied with all laws, including California state law and that this California state law is
preempted by the Federal Cigarette Labeling and Advertising Act. On March 29, 2002, the court
ruled that RJR Tobaccos distribution of free cigarettes violated the law, but the distribution of
free coupons for discounts on cigarettes did not. On April 29, 2002, the judge assessed a civil
fine against RJR Tobacco of $14.8 million. On October 30, 2003, the California Court of Appeal,
Second Appellate District, affirmed the trial courts decision. On December 8, 2003, RJR Tobacco
filed its petition for review with the California Supreme Court. On January 28, 2004, the
California Supreme Court agreed to review the case. Oral argument occurred on October 5, 2005.
On May 23, 2001, Star Scientific, Inc., referred to as Star, filed a patent infringement
action against RJR Tobacco in the United States District Court for the District of Maryland. The
suit alleges infringement of United States Patent No. 6,202,649 entitled Method of Treating
Tobacco to Reduce Nitrosamine Content, and Products Produced Thereby. On July 30, 2002, Star
filed another infringement action against RJR Tobacco in the United States District Court for the
District of Maryland alleging infringement of a related patent, United States Patent No. 6,425,401,
also entitled Method of Treating Tobacco to Reduce Nitrosamine Content, and Products Produced
Thereby. RJR Tobacco has filed counterclaims seeking a declaration that the claims of the two
Star patents in dispute are invalid, unenforceable and not infringed by RJR Tobacco. The Maryland
court consolidated the two cases. Between January 31 and February 8, 2005, the court held a first
bench trial on RJR Tobaccos affirmative defense and counterclaim based upon inequitable conduct.
The court has not yet issued a ruling on the issue of inequitable conduct. Additionally, in
response to the courts invitation, RJR Tobacco filed two summary judgment motions on January 20,
2005, which have been fully briefed by the parties. Furthermore, the court has requested
additional briefing on certain claim construction issues. The court has indicated that it will rule
on RJR Tobaccos two pending summary judgment motions and the issue of inequitable conduct at the
same time. The court has not set a trial date for the remaining issues in the case.
Finally, in the first quarter of 2005, Commonwealth Brands, Inc., referred to as Commonwealth,
was served with two individual smoking and health cases, Croft v. Akron Gasket in Cuyahoga County,
Ohio, and Ryan v. Philip Morris, U.S.A., Inc. in Jay County, Indiana. Commonwealth requested
indemnity from RJR Tobacco pursuant to the Asset Purchase Agreement dated July 24, 1996, between
Commonwealth and B&W, referred to as the 1996 Purchase Agreement, in which B&W agreed to indemnify
Commonwealth for certain claims. As a result of the business combination of RJR Tobacco and the
U.S. cigarette and tobacco business of B&W, RJR Tobacco agreed to indemnify Commonwealth for these
claims to the extent (if any) required by the 1996 Purchase Agreement.
42
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Cautionary Statement Concerning Tobacco-Related Litigation
Even though RAIs management continues to conclude that the loss of any particular pending
smoking and health tobacco litigation claim against RJR Tobacco or its affiliates or indemnitees
when viewed on an individual basis, is not probable, the possibility of material losses related to
such litigation is more than remote. Litigation is subject to many uncertainties, and generally it
is not possible to predict the outcome of the litigation pending against RJR Tobacco or its
affiliates, including RAI, or indemnitees, including B&W, or to reasonably estimate the amount or
range of any possible loss.
Unfavorable judgments awarding compensatory damages, punitive damages or fines have been
returned against RJR Tobacco and B&W in the Engle class-action case, which was reversed by the
intermediate appellate court on May 21, 2003, but is now on appeal to the Florida Supreme Court,
the Scott class-action case, a small number of individual smoking and health cases, a Broin II
flight attendant ETS case and a California state law enforcement action. In addition, unfavorable
judgments have been returned against RJR Tobacco in two MSA enforcement actions, and RJR has
recorded liabilities in connection with certain indemnification claims asserted by JTI against RJR
and RJR Tobacco concerning certain activities of Northern Brands and related litigation. Although
RJR Tobacco believes that it has numerous bases for successful appeals in its pending cases, and
RJR Tobacco and RAI believe they have a number of valid defenses to all actions, and intend to
defend all actions vigorously, it is possible that there could be further adverse developments in
pending cases, and that additional cases could be decided unfavorably against RAI, RJR Tobacco or
their affiliates or indemnitees, including B&W.
Determinations of liability or adverse rulings in such cases or in similar cases involving
other cigarette manufacturers as defendants, even if such judgments are not final, could materially
adversely affect the litigation against RJR Tobacco or its affiliates or indemnitees and they could
encourage the commencement of additional tobacco-related litigation. In addition, a number of
political, legislative, regulatory and other developments relating to the tobacco industry and
cigarette smoking have received wide media attention. These developments may negatively affect the
outcomes of tobacco-related legal actions and encourage the commencement of additional similar
litigation.
Although it is impossible to predict the outcome of such events on pending litigation and the
rate new lawsuits are filed against RJR Tobacco and B&W, a significant increase in litigation or in
adverse outcomes for tobacco defendants could have a material adverse effect on any or all of these
entities. Moreover, notwithstanding the quality of defenses available to it and its affiliates and
indemnitees in litigation matters, it is possible that RAIs results of operations, cash flows or
financial condition could be materially adversely affected by the ultimate outcome of certain
pending litigation matters.
Tobacco Buyout Legislation
On October 22, 2004, the President signed the Fair and Equitable Tobacco Reform Act of 2004,
eliminating the U.S. government tobacco production controls and price support program. The buyout
of tobacco quota holders provided for in FETRA is funded by a direct quarterly assessment on every
tobacco product manufacturer and importer, on a market-share basis measured on volume to which
federal excise tax is applied. The aggregate cost of the buyout to the industry is approximately
$10.1 billion, payable over ten years, including approximately $9.6 billion of fixed obligation and
approximately $540 million resulting from the liquidation of quota tobacco stock. As a result of
the tobacco buyout legislation, the MSA Phase II obligations established in 1999 and scheduled to
expire by the end of 2010 will be continued, but will be offset against the tobacco quota buyout
obligations. RAIs operating subsidiaries annual expense under FETRA, excluding the tobacco stock
liquidation assessment, is estimated to be approximately $265 million for 2005, $255 million for
2006 and $250 million per year thereafter. RAIs operating subsidiaries have incurred $74 million
and $81 million of expense for the three months and nine months ended September 30, 2005, respectively,
related to assessments from quota tobacco stock liquidation. Of these amounts, approximately $20
million has been paid through the third quarter of 2005, and the remaining amount is scheduled to
be paid over the next five quarters. Remaining contingent liabilities for liquidation of quota
tobacco stock, if any, will be recorded when an assessment is made.
RAIs operating subsidiaries will record the FETRA assessment on a quarterly basis upon
required notification of assessments. RAIs operating
subsidiaries estimate that their overall share
of the buyout will approximate $2.4 billion to $2.9 billion prior to the deduction of permitted
offsets under the MSA and expected cost savings on domestic leaf purchases as a result of the
elimination of the tobacco quota program. In addition, future market pricing could impact the
carrying value of inventory, and adversely affect RJR Tobaccos financial condition and results of
operations. Of the accrued but unpaid MSA Phase II obligations, $69 million was reversed in the
fourth quarter of 2004, and $79 million was reversed in the first six months of 2005.
43
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On December 23, 2004, the North Carolina Business Court held that RJR Tobacco was entitled to
a refund of its first three quarterly MSA Phase II payments made for 2004 of approximately $111
million, and was not obligated to make its fourth quarter payment of approximately $37 million. On
August 19, 2005, the North Carolina Supreme Court reversed the lower courts decision, and remanded
the case back to the North Carolina Business Court, where the MSA Phase II payments of
approximately $111 million previously made for 2004 were
released to the beneficiaries of the growers trust. On October 19, 2005, the North
Carolina Business Court denied RJR Tobaccos motion for additional proceedings on the issue of the
payment of the fourth quarter MSA Phase II payment of approximately $37 million, ordered RJR
Tobacco to make this payment within ten business days and ordered RJR Tobacco to pay pre-judgment
interest at 8% per annum from December 15, 2004, until the payment is made. In the third quarter
of 2005, RJR Tobacco recognized $39 million of expense relating to the court ruling.
For information concerning indemnifications between RJR Tobacco and B&W related to pre-closing
MSA liabilities, see Other Contingencies and Guarantees below.
ERISA Litigation
On May 13, 2002, in Tatum v. The R.J.R. Pension Investment Committee of the R. J. Reynolds
Tobacco Company Capital Investment Plan, an employee of RJR Tobacco filed a class-action suit in
the United States District Court for the Middle District of North Carolina, alleging that the
defendants, RJR, RJR Tobacco, the RJR Employee Benefits Committee and the RJR Pension Investment
Committee, violated the Employee Retirement Income Security Act of 1974, referred to as ERISA. The
actions about which the plaintiff complains stem from a decision made in 1999 by RJR Nabisco
Holdings Corp., subsequently renamed Nabisco Group Holdings Corp., referred to as NGH, to spin off
RJR, thereby separating NGHs tobacco business and food business. As part of the spin-off, the
401(k) plan for the previously related entities had to be divided into two separate plans for the
now separate tobacco and food businesses. The plaintiff contends that the defendants violated
ERISA by not overriding an amendment to RJRs 401(k) plan requiring that, prior to February 1,
2000, the stock funds of the companies involved in the food business, NGH and Nabisco Holdings
Corp., referred to as Nabisco, be eliminated as investment options from RJRs 401(k) plan. In his
complaint, the plaintiff requests, among other things, that the court issue an order requiring the
defendants to pay as damages to the RJR 401(k) plan an amount equal to the subsequent appreciation
that was purportedly lost as a result of the liquidation of the NGH and Nabisco funds. On July 29,
2002, the defendants filed a motion to dismiss, which the court granted on December 10, 2003. On
January 7, 2004, the plaintiff appealed to the United States Court of Appeals for the Fourth
Circuit, which, on December 14, 2004, reversed the dismissal of the complaint and remanded the case
for further proceedings. On January 20, 2005, the defendants filed a second motion to dismiss on
other grounds, which remains pending.
Environmental Matters
RAI and its subsidiaries are subject to federal, state and local environmental laws and
regulations concerning the discharge, storage, handling and disposal of hazardous or toxic
substances. Such laws and regulations provide for significant fines, penalties and liabilities,
sometimes without regard to whether the owner or operator of the property knew of, or was
responsible for, the release or presence of hazardous or toxic substances. In addition, third
parties may make claims against owners or operators of properties for personal injuries and
property damage associated with releases of hazardous or toxic substances. In the past, RJR
Tobacco has been named a potentially responsible party, referred to as a PRP, with third parties
under the Comprehensive Environmental Response, Compensation and Liability Act, referred to as
CERCLA, with respect to several superfund sites. RAI and its subsidiaries are not aware of any
current environmental matters that are expected to have a material adverse effect on the business,
results of operations or financial condition of RAI or its subsidiaries.
Regulations promulgated by the United States Environmental Protection Agency, referred to as
EPA, and other governmental agencies under various statutes have resulted in, and likely will
continue to result in, substantial expenditures for pollution control, waste treatment, plant
modification and similar activities. RAI and its subsidiaries are engaged in a continuing program
to comply with federal, state and local environmental laws and regulations, and dependent upon the
probability of occurrence and reasonable estimation of cost, accrue or disclose any material
liability. Although it is difficult to reasonably estimate the portion of capital expenditures or
other costs attributable to compliance with environmental laws and regulations, RAI does not expect
such expenditures or other costs to have a material adverse effect on the business, results of
operations or financial condition of RAI or its subsidiaries.
44
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Other Contingencies and Guarantees
In connection with the business combination of RJR Tobacco and the U.S. cigarette and tobacco
business of B&W on July 30, 2004, RJR Tobacco has agreed to indemnify B&W and its
affiliates against any liabilities, costs and expenses incurred by B&W or its affiliates arising
out of the U.S. cigarette and tobacco business of B&W. Although it is impossible to predict the
possibility or amount of any such liabilities, costs and expenses, a significant indemnification
claim by B&W against RJR Tobacco could have an adverse effect on either
or both of RAI and RJR Tobacco.
Also, as part of the business combination, B&W transferred to RJR Tobacco, along with its U.S.
operations, cash of $604 million, an amount equal to its estimated pre-closing accrued liabilities
under the MSA and related agreements, referred to as the MSA Liability Amount. B&W will indemnify
RAI and its subsidiaries to the extent the actual pre-closing MSA
liabilities paid by RJR Tobacco exceed,
and RJR Tobacco will indemnify B&W to the extent the actual pre-closing
MSA liabilities paid by RJR Tobacco are
less than, the MSA Liability Amount. On February 14, 2005, RJR Tobacco received a formal notice
from B&W claiming that B&W was entitled to a return of approximately $52.8 million of the MSA
Liability Amount resulting from the offset of B&Ws pre-closing MSA Phase II obligations against
certain of RJR Tobaccos tobacco quota obligations as a result of FETRA. In the third quarter of
2005, RJR Tobacco agreed to pay B&W approximately $14 million in
settlement of this claim.
In the first quarter of 2005, Commonwealth Brands, Inc. was served with two individual smoking
and health cases, Croft v. Akron Gasket in Cuyahoga County, Ohio, and Ryan v. Philip Morris,
U.S.A., Inc. in Jay County, Indiana. Commonwealth requested indemnity from RJR Tobacco pursuant to
the 1996 Purchase Agreement, in which B&W agreed to indemnify Commonwealth for certain claims. As a
result of the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of
B&W, RJR Tobacco agreed to indemnify Commonwealth for these
claims to the extent, if any, required
by the 1996 Purchase Agreement.
Until the acquisition by merger by Philip Morris Companies, Inc. of Nabisco from NGH on
December 11, 2000, NGH and Nabisco were members of the consolidated group of NGH for U.S. federal
income tax purposes. Each member of a consolidated group is jointly and severally liable for the
U.S. federal income tax liability of other members of the group as well as for pension and funding
liabilities of the other group members. NGH, now known as RJR Acquisition Corp., continues to be
jointly and severally liable for these Nabisco liabilities prior to December 11, 2000.
In connection with Philip Morriss acquisition by merger of Nabisco and RJRs subsequent
acquisition by merger of NGH, Philip Morris, Nabisco and NGH entered into a voting and indemnity
agreement and tax sharing agreement that generally seeks to allocate tax liabilities ratably based
upon NGHs taxable income and that of Nabisco, had the parties been separate taxpayers. If Philip
Morris and Nabisco are unable to satisfy their obligations under this agreement, NGH would be
responsible for satisfying them.
In connection with the sale of the international tobacco business to Japan Tobacco Inc., on
May 12, 1999, pursuant to the 1999 Purchase Agreement, RJR and RJR Tobacco agreed to indemnify JTI
against:
|
|
|
any liabilities, costs and expenses arising out of the imposition or assessment
of any tax with respect to the international tobacco business arising prior to the
sale, other than as reflected on the closing balance sheet; |
|
|
|
|
any liabilities, costs and expenses that JTI or any of its affiliates, including
the acquired entities, may incur after the sale with respect to any of RJRs or RJR
Tobaccos employee benefit and welfare plans; and |
|
|
|
|
any liabilities, costs and expenses incurred by JTI or any of its affiliates
arising out of certain activities of Northern Brands. |
As described above under Other Litigation and Developments, RJR Tobacco has received
several claims for indemnification from JTI under these indemnification provisions in connection
with the activities of Northern Brands and its affiliates. Although RJR and RJR Tobacco recognize
that, under certain circumstances, they may have indemnification obligations to JTI under the 1999
Purchase Agreement, RJR and RJR Tobacco disagree whether the circumstances described in such claims
give rise to any indemnification obligations by RJR and RJR Tobacco. RJR and
45
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
RJR Tobacco have conveyed their position to JTI, and the parties have agreed to resolve their
differences at a later date. RJR has liabilities totaling $96 million that were recorded in 1999 in
connection with these indemnification claims.
RJR Tobacco, Santa Fe and Lane have entered into agreements to indemnify certain distributors
and retailers from liability and related defense costs arising out of the sale or distribution of
their products. Additionally, Santa Fe has entered into an agreement to indemnify a supplier from
liability and related defense costs arising out of the sale or use of Santa Fes products. The cost
of such defense indemnification has been, and is expected to be, insignificant. RJR Tobacco, Santa
Fe and Lane believe that the indemnified claims are substantially similar in nature and extent to
the claims that they are already exposed to by virtue of their having manufactured those products.
Under certain circumstances, including RJRs guaranteed, secured debt rating remaining either
one level below BBB- by S&P or Baa3 by Moodys, or lower, any fair value that results in a
liability position of the interest rate swaps will require full collateralization with cash or
securities.
RAI is not able to estimate the maximum potential amount of future payments, if any, related
to these guarantees and indemnification obligations.
Of the approximately 8,200 full-time employees of RAI and its subsidiaries at September 30,
2005, approximately 1,100 were located at the former B&W facilities. The Macon facility production
and maintenance employees are covered by collective bargaining agreements that extended their
employment through the anticipated facility closure. On March 3, 2005, a majority of RJR Tobaccos
production and maintenance employees employed in North Carolina voted not to be represented by the
International Association of Machinists and Aerospace Workers.
Note 8Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Total |
|
|
|
|
|
|
Common |
|
|
Paid-In |
|
|
Accumulated |
|
|
Comprehensive |
|
|
Shareholders |
|
|
Comprehensive |
|
|
|
Stock |
|
|
Capital |
|
|
Deficit |
|
|
Loss |
|
|
Equity |
|
|
Income |
|
Balance at December 31, 2004 |
|
$ |
|
|
|
$ |
8,682 |
|
|
$ |
(2,061 |
) |
|
$ |
(445 |
) |
|
$ |
6,176 |
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
745 |
|
|
|
|
|
|
|
745 |
|
|
$ |
745 |
|
Minimum pension liability,
net of $127 tax benefit |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(235 |
) |
|
|
(235 |
) |
|
|
(235 |
) |
Cumulative translation
adjustment and other, net of
tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3 |
) |
|
|
(3 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends |
|
|
|
|
|
|
|
|
|
|
(435 |
) |
|
|
|
|
|
|
(435 |
) |
|
|
|
|
Stock options exercised |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
Tax benefit on stock-based
compensation plans |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
Common stock repurchased |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2005 |
|
$ |
|
|
|
$ |
8,683 |
|
|
$ |
(1,751 |
) |
|
$ |
(683 |
) |
|
$ |
6,249 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 9Segment Information
RAI has one reportable operating segment, RJR Tobacco, which is the second largest cigarette
manufacturer in the United States. RJR Tobaccos largest selling cigarette brands, CAMEL, KOOL,
DORAL, WINSTON and SALEM, are currently five of the ten best-selling brands of cigarettes in the
United States. Those brands, and its other brands, including PALL MALL, ECLIPSE, MISTY, CAPRI,
CARLTON, VANTAGE, MORE and NOW, are manufactured in a variety of styles and marketed in the United
States to meet a range of adult smoker preferences.
The disclosures classified as All Other include the total assets and results of operations of
Santa Fe, Lane and GPI. The financial condition and results of operations of these operating
segments do not meet the materiality criteria to be reportable. Concurrent with the July 2004
business combination transactions, certain immaterial subsidiaries were reorganized, and as a
result, are reported as All Other rather than RJR Tobacco.
Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL
AMERICAN SPIRIT brand. Santa Fe markets its products primarily in the United States, and has a
small, but growing, international tobacco business. Lane manufactures or distributes cigars,
roll-your-own, cigarette and pipe tobacco brands, including
46
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
DUNHILL and CAPTAIN BLACK tobacco products. GPI manufactures and exports cigarettes to U.S.
territories, U.S. Duty Free and overseas military and manages a contract manufacturing business.
Amounts presented in prior periods have been reclassified accordingly.
On July 16, 2002, RJR, through its wholly owned subsidiary R. J. Reynolds Tobacco C.V.,
acquired a 50% interest in R. J. Reynolds-Gallaher International Sarl, a joint venture created with
Gallaher Group Plc, to manufacture and market a limited portfolio of American-blend cigarette
brands. The joint venture, headquartered in Switzerland, which initially marketed its products in
France, Spain, the Canary Islands and Italy, expanded into Andorra and Belgium in 2003 and into
Luxembourg, Sweden and Norway in 2004. Its products are manufactured in Austria. RJR Tobacco is
licensing REYNOLDS and AUSTIN, two American-blend brands, to the joint venture, and accounts for
the investment using the equity method. Segment disclosures related to the joint venture are
included in the classification All Other.
Segment Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Net sales: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
1,892 |
|
|
$ |
1,630 |
|
|
$ |
5,461 |
|
|
$ |
4,025 |
|
All Other |
|
|
257 |
|
|
|
236 |
|
|
|
748 |
|
|
|
411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net sales |
|
$ |
2,149 |
|
|
$ |
1,866 |
|
|
$ |
6,209 |
|
|
$ |
4,436 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
322 |
|
|
$ |
354 |
|
|
$ |
1,180 |
|
|
$ |
865 |
|
All Other |
|
|
51 |
|
|
|
37 |
|
|
|
105 |
|
|
|
62 |
|
Corporate expense |
|
|
(16 |
) |
|
|
(45 |
) |
|
|
(44 |
) |
|
|
(94 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income |
|
$ |
357 |
|
|
$ |
346 |
|
|
$ |
1,241 |
|
|
$ |
833 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation to income before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
357 |
|
|
$ |
346 |
|
|
$ |
1,241 |
|
|
$ |
833 |
|
Interest and debt expense |
|
|
31 |
|
|
|
21 |
|
|
|
81 |
|
|
|
62 |
|
Interest income |
|
|
(23 |
) |
|
|
(7 |
) |
|
|
(53 |
) |
|
|
(16 |
) |
Other (income) expense |
|
|
7 |
|
|
|
(1 |
) |
|
|
14 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before
income taxes |
|
$ |
342 |
|
|
$ |
333 |
|
|
$ |
1,199 |
|
|
$ |
783 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Assets: |
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
11,743 |
|
|
$ |
11,580 |
|
All Other |
|
|
1,330 |
|
|
|
1,352 |
|
Corporate |
|
|
1,443 |
|
|
|
1,496 |
|
|
|
|
|
|
|
|
Consolidated assets |
|
$ |
14,516 |
|
|
$ |
14,428 |
|
|
|
|
|
|
|
|
Note 10Related Party Transactions
RAIs operating subsidiaries have entered into various transactions with affiliates of BAT,
the indirect parent of B&W. RAIs operating subsidiaries sell contract-manufactured cigarettes,
processed strip leaf, manufacturing materials, pipe tobacco and little cigars to BAT affiliates.
For 2005, pricing is calculated using B&Ws forecasted 2004 manufacturing costs multiplied by the
Producer Price Index reported by the U.S. Bureau of Labor Statistics. During the nine-month period
ended September 30, 2005, net sales to BAT affiliates were $378 million, primarily cigarettes,
representing 6.1% of RAIs total net sales. RJR Tobacco also had $4 million of sales of raw
materials to the R. J. Reynolds-Gallaher International Sarl joint venture during the nine-month
period ended September 30, 2005.
RJR Tobacco performs certain research and development for BAT affiliates pursuant to a joint
technology sharing agreement as a part of the business combination. During the nine-month period
ended September 30, 2005, $4
47
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
million has been billed to BAT affiliates for these services recorded in selling, general and
administrative expenses, net of associated costs.
RAIs operating subsidiaries also purchase unprocessed leaf at market prices, and import
cigarettes at prices not to exceed manufacturing costs plus 10%, from BAT affiliates. Royalty
expense is paid to BAT affiliates that own the trademarks to imported brands of cigarettes and pipe
tobacco. The royalty rates vary, although none is in excess of 10% of the local sales price.
During the nine-month period ended September 30, 2005, the aggregate purchases for leaf and
cigarettes were $4 million and royalty expenses were less than $1 million. At September 30, 2005,
the accounts payable due to BAT affiliates was insignificant.
In
the third quarter of 2005, an agreement was reached with B&W related to the MSA
indemnification agreement and the MSA Phase II obligations. As a result, RJR Tobacco recorded an
expense of approximately $14 million included in selling, general and administrative expense for
the quarter ended September 30, 2005. For additional information, see Other Contingencies and
Guarantees in note 7.
Note
11Lease Commitments
RAI has operating lease agreements that are primarily for office space, automobiles, warehouse
space and computer equipment. The majority of these leases expire within the next five years, and
some contain renewal or purchase options and escalation clauses or restrictions relating to
subleases. Total rent expense was $10 million for each of the three-month periods ended September
30, 2005 and 2004, respectively, and $29 million and $26 million for the nine months ended
September 30, 2005 and 2004, respectively.
|
|
|
|
|
|
|
Noncancellable Operating Leases |
|
Remainder of 2005 |
|
$ |
8 |
|
2006 |
|
|
28 |
|
2007 |
|
|
17 |
|
2008 |
|
|
12 |
|
2009 |
|
|
7 |
|
2010 |
|
|
6 |
|
Thereafter |
|
|
16 |
|
|
|
|
|
|
|
$ |
94 |
|
|
|
|
|
The 2004 acquisition restructuring accrual includes $47 million related to the lease obligations of
the former B&W facilities included in the table above.
Note
12Condensed Consolidating Financial Statements
Separate financial statements and other disclosures have not been presented concerning the
guarantors, because such information is not believed to be material to holders of RJRs $1.45
billion guaranteed, secured notes and $190 million guaranteed, unsecured notes. RAI and the other
guarantors, which are direct or indirect, wholly owned subsidiaries of RAI, have fully and
unconditionally guaranteed these notes. Because the guarantees are full and unconditional and
joint and several, the following condensed consolidating financial statements include: the
accounts and activities of RAI, the parent guarantor; RJR, the issuer of the debt securities; RJR
Tobacco, RJR Acquisition Corp., and certain of RJRs other subsidiaries, the other guarantors; other
subsidiaries of RAI and RJR, including Santa Fe, Lane and GPI, which are not guarantors; and elimination
adjustments. All periods below are presented pursuant to the guarantor classification as described
above. Certain reclassifications were made to conform prior years financial statements to the
current presentation.
48
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Three Months Ended September 30,
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,055 |
|
|
$ |
125 |
|
|
$ |
(31 |
) |
|
$ |
2,149 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
1,354 |
|
|
|
62 |
|
|
|
(32 |
) |
|
|
1,384 |
|
Selling, general and administrative expenses |
|
|
8 |
|
|
|
|
|
|
|
369 |
|
|
|
22 |
|
|
|
|
|
|
|
399 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
9 |
|
Interest and debt expense |
|
|
|
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31 |
|
Interest income |
|
|
|
|
|
|
(3 |
) |
|
|
(19 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(23 |
) |
Intercompany interest (income) expense |
|
|
6 |
|
|
|
(1 |
) |
|
|
(9 |
) |
|
|
4 |
|
|
|
|
|
|
|
|
|
Intercompany
dividend income |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Other (income) expense, net |
|
|
|
|
|
|
11 |
|
|
|
(1 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss)
before income taxes |
|
|
(14 |
) |
|
|
(27 |
) |
|
|
352 |
|
|
|
41 |
|
|
|
(10 |
) |
|
|
342 |
|
Provision for (benefit from) income taxes |
|
|
(7 |
) |
|
|
4 |
|
|
|
120 |
|
|
|
12 |
|
|
|
|
|
|
|
129 |
|
Equity income from subsidiaries |
|
|
220 |
|
|
|
245 |
|
|
|
8 |
|
|
|
|
|
|
|
(473 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
213 |
|
|
$ |
214 |
|
|
$ |
240 |
|
|
$ |
29 |
|
|
$ |
(483 |
) |
|
$ |
213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30,
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,793 |
|
|
$ |
98 |
|
|
$ |
(25 |
) |
|
$ |
1,866 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
1,119 |
|
|
|
43 |
|
|
|
(23 |
) |
|
|
1,139 |
|
Selling, general and administrative expenses |
|
|
9 |
|
|
|
21 |
|
|
|
324 |
|
|
|
23 |
|
|
|
|
|
|
|
377 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
11 |
|
Restructuring and asset impairment charges |
|
|
|
|
|
|
|
|
|
|
(7 |
) |
|
|
|
|
|
|
|
|
|
|
(7 |
) |
Interest and debt expense |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21 |
|
Interest income |
|
|
|
|
|
|
(1 |
) |
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
(7 |
) |
Intercompany interest (income) expense |
|
|
3 |
|
|
|
(2 |
) |
|
|
(5 |
) |
|
|
4 |
|
|
|
|
|
|
|
|
|
Other (income) expense, net |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
(2 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before
income taxes |
|
|
(12 |
) |
|
|
(40 |
) |
|
|
357 |
|
|
|
30 |
|
|
|
(2 |
) |
|
|
333 |
|
Provision for (benefit from) income taxes |
|
|
27 |
|
|
|
(81 |
) |
|
|
88 |
|
|
|
9 |
|
|
|
|
|
|
|
43 |
|
Equity income from subsidiaries |
|
|
378 |
|
|
|
323 |
|
|
|
7 |
|
|
|
|
|
|
|
(708 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
339 |
|
|
|
364 |
|
|
|
276 |
|
|
|
21 |
|
|
|
(710 |
) |
|
|
290 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
339 |
|
|
$ |
364 |
|
|
$ |
325 |
|
|
$ |
21 |
|
|
$ |
(710 |
) |
|
$ |
339 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Nine Months Ended September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
5,952 |
|
|
$ |
344 |
|
|
$ |
(87 |
) |
|
$ |
6,209 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
3,654 |
|
|
|
171 |
|
|
|
(89 |
) |
|
|
3,736 |
|
Selling, general and administrative expenses |
|
|
22 |
|
|
|
2 |
|
|
|
1,086 |
|
|
|
65 |
|
|
|
|
|
|
|
1,175 |
|
Loss on sale of assets |
|
|
|
|
|
|
|
|
|
|
25 |
|
|
|
|
|
|
|
|
|
|
|
25 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
33 |
|
Restructuring and asset impairment charges |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
Interest and debt expense |
|
|
|
|
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
81 |
|
Interest income |
|
|
|
|
|
|
(6 |
) |
|
|
(45 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
(53 |
) |
Intercompany interest (income) expense |
|
|
17 |
|
|
|
(4 |
) |
|
|
(25 |
) |
|
|
12 |
|
|
|
|
|
|
|
|
|
Intercompany
dividend income |
|
|
|
|
|
|
(50 |
) |
|
|
|
|
|
|
|
|
|
|
50 |
|
|
|
|
|
Other (income) expense, net |
|
|
|
|
|
|
22 |
|
|
|
1 |
|
|
|
(9 |
) |
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) before income taxes |
|
|
(39 |
) |
|
|
(45 |
) |
|
|
1,224 |
|
|
|
107 |
|
|
|
(48 |
) |
|
|
1,199 |
|
Provision for (benefit from) income taxes |
|
|
(29 |
) |
|
|
(16 |
) |
|
|
466 |
|
|
|
33 |
|
|
|
|
|
|
|
454 |
|
Equity income from subsidiaries |
|
|
755 |
|
|
|
788 |
|
|
|
22 |
|
|
|
|
|
|
|
(1,565 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
745 |
|
|
$ |
759 |
|
|
$ |
780 |
|
|
$ |
74 |
|
|
$ |
(1,613 |
) |
|
$ |
745 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
4,286 |
|
|
$ |
205 |
|
|
$ |
(55 |
) |
|
$ |
4,436 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
2,622 |
|
|
|
78 |
|
|
|
(53 |
) |
|
|
2,647 |
|
Selling, general and administrative expenses |
|
|
9 |
|
|
|
37 |
|
|
|
861 |
|
|
|
63 |
|
|
|
|
|
|
|
970 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
11 |
|
Restructuring and asset impairment charges |
|
|
|
|
|
|
(1 |
) |
|
|
(24 |
) |
|
|
|
|
|
|
|
|
|
|
(25 |
) |
Interest and debt expense |
|
|
|
|
|
|
62 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62 |
|
Interest income |
|
|
|
|
|
|
(3 |
) |
|
|
(12 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(16 |
) |
Intercompany interest (income) expense |
|
|
3 |
|
|
|
(6 |
) |
|
|
(7 |
) |
|
|
10 |
|
|
|
|
|
|
|
|
|
Other (income) expense, net |
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations before income
taxes |
|
|
(12 |
) |
|
|
(96 |
) |
|
|
835 |
|
|
|
58 |
|
|
|
(2 |
) |
|
|
783 |
|
Provision for (benefit from) income taxes |
|
|
27 |
|
|
|
(99 |
) |
|
|
276 |
|
|
|
17 |
|
|
|
|
|
|
|
221 |
|
Equity income from subsidiaries |
|
|
651 |
|
|
|
621 |
|
|
|
19 |
|
|
|
|
|
|
|
(1,291 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
|
612 |
|
|
|
624 |
|
|
|
578 |
|
|
|
41 |
|
|
|
(1,293 |
) |
|
|
562 |
|
Gain on sale of discontinued businesses, net of tax |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
612 |
|
|
|
624 |
|
|
|
579 |
|
|
|
41 |
|
|
|
(1,293 |
) |
|
|
563 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
612 |
|
|
$ |
624 |
|
|
$ |
628 |
|
|
$ |
41 |
|
|
$ |
(1,293 |
) |
|
$ |
612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Cash Flows
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Nine Months Ended September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
513 |
|
|
$ |
328 |
|
|
$ |
914 |
|
|
$ |
33 |
|
|
$ |
(937 |
) |
|
$ |
851 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
|
|
|
|
|
|
|
|
(68 |
) |
|
|
(8 |
) |
|
|
2 |
|
|
|
(74 |
) |
Distribution from equity investees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
3 |
|
Investment (to subsidiaries) from parent |
|
|
|
|
|
|
|
|
|
|
(6 |
) |
|
|
6 |
|
|
|
|
|
|
|
|
|
Purchases of short-term investments |
|
|
|
|
|
|
(2 |
) |
|
|
(7,789 |
) |
|
|
|
|
|
|
|
|
|
|
(7,791 |
) |
Proceeds from short-term investments |
|
|
|
|
|
|
|
|
|
|
7,148 |
|
|
|
|
|
|
|
|
|
|
|
7,148 |
|
Intercompany notes receivable |
|
|
|
|
|
|
18 |
|
|
|
12 |
|
|
|
|
|
|
|
(30 |
) |
|
|
|
|
Proceeds from sale of business |
|
|
|
|
|
|
|
|
|
|
48 |
|
|
|
|
|
|
|
|
|
|
|
48 |
|
Other, net |
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
(2 |
) |
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
|
|
|
|
16 |
|
|
|
(650 |
) |
|
|
1 |
|
|
|
(30 |
) |
|
|
(663 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3 |
) |
Dividends paid on common stock |
|
|
(420 |
) |
|
|
(463 |
) |
|
|
(435 |
) |
|
|
|
|
|
|
898 |
|
|
|
(420 |
) |
Dividends paid on preferred stock |
|
|
(39 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
39 |
|
|
|
|
|
Repayment of
long-term debt |
|
|
|
|
|
|
(360 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(360 |
) |
Issuance of
long-term debt |
|
|
|
|
|
|
499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
499 |
|
Deferred debt issuance costs |
|
|
|
|
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6 |
) |
Debt retirement costs |
|
|
|
|
|
|
(7 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7 |
) |
Proceeds from exercise of stock options |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Intercompany notes payable |
|
|
(16 |
) |
|
|
4 |
|
|
|
(2 |
) |
|
|
(16 |
) |
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing activities |
|
|
(476 |
) |
|
|
(333 |
) |
|
|
(437 |
) |
|
|
(16 |
) |
|
|
967 |
|
|
|
(295 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
37 |
|
|
|
11 |
|
|
|
(173 |
) |
|
|
18 |
|
|
|
|
|
|
|
(107 |
) |
Cash and cash equivalents at beginning of period |
|
|
141 |
|
|
|
31 |
|
|
|
1,256 |
|
|
|
71 |
|
|
|
|
|
|
|
1,499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
178 |
|
|
$ |
42 |
|
|
$ |
1,083 |
|
|
$ |
89 |
|
|
$ |
|
|
|
$ |
1,392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
135 |
|
|
$ |
162 |
|
|
$ |
492 |
|
|
$ |
54 |
|
|
$ |
(354 |
) |
|
$ |
489 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
|
|
|
|
|
|
|
|
(39 |
) |
|
|
(11 |
) |
|
|
|
|
|
|
(50 |
) |
Purchases of short-term investments |
|
|
|
|
|
|
(1 |
) |
|
|
(3,317 |
) |
|
|
|
|
|
|
|
|
|
|
(3,318 |
) |
Proceeds from short-term investments |
|
|
|
|
|
|
|
|
|
|
3,551 |
|
|
|
|
|
|
|
|
|
|
|
3,551 |
|
Purchase of long-term investments |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10 |
) |
Acquisition, net of cash acquired |
|
|
(400 |
) |
|
|
|
|
|
|
604 |
|
|
|
|
|
|
|
|
|
|
|
204 |
|
Distribution from equity investees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
5 |
|
Other, net |
|
|
(3 |
) |
|
|
(35 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(38 |
) |
Intercompany notes receivable |
|
|
|
|
|
|
18 |
|
|
|
(125 |
) |
|
|
2 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
(403 |
) |
|
|
(28 |
) |
|
|
674 |
|
|
|
(4 |
) |
|
|
105 |
|
|
|
344 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock |
|
|
(10 |
) |
|
|
(28 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(38 |
) |
Repayment of long-term debt |
|
|
|
|
|
|
(56 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(56 |
) |
Dividends paid on common stock |
|
|
|
|
|
|
(403 |
) |
|
|
(194 |
) |
|
|
|
|
|
|
354 |
|
|
|
(243 |
) |
Proceeds from exercise of stock options |
|
|
22 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33 |
|
Intercompany notes payable |
|
|
400 |
|
|
|
7 |
|
|
|
(287 |
) |
|
|
(15 |
) |
|
|
(105 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) financing
activities |
|
|
412 |
|
|
|
(469 |
) |
|
|
(481 |
) |
|
|
(15 |
) |
|
|
249 |
|
|
|
(304 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
144 |
|
|
|
(335 |
) |
|
|
685 |
|
|
|
35 |
|
|
|
|
|
|
|
529 |
|
Cash and cash equivalents at beginning of period |
|
|
|
|
|
|
386 |
|
|
|
551 |
|
|
|
33 |
|
|
|
|
|
|
|
970 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
144 |
|
|
$ |
51 |
|
|
$ |
1,236 |
|
|
$ |
68 |
|
|
$ |
|
|
|
$ |
1,499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
178 |
|
|
$ |
42 |
|
|
$ |
1,083 |
|
|
$ |
89 |
|
|
$ |
|
|
|
$ |
1,392 |
|
Short-term investments |
|
|
|
|
|
|
113 |
|
|
|
1,005 |
|
|
|
|
|
|
|
|
|
|
|
1,118 |
|
Assets held for sale |
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
3 |
|
Short-term intercompany notes and interest
receivable |
|
|
|
|
|
|
88 |
|
|
|
422 |
|
|
|
3 |
|
|
|
(513 |
) |
|
|
|
|
Other current assets |
|
|
285 |
|
|
|
29 |
|
|
|
2,139 |
|
|
|
211 |
|
|
|
(343 |
) |
|
|
2,321 |
|
Trademarks, net |
|
|
|
|
|
|
|
|
|
|
2,210 |
|
|
|
180 |
|
|
|
|
|
|
|
2,390 |
|
Goodwill |
|
|
|
|
|
|
|
|
|
|
5,320 |
|
|
|
365 |
|
|
|
|
|
|
|
5,685 |
|
Other intangibles, net |
|
|
|
|
|
|
|
|
|
|
151 |
|
|
|
35 |
|
|
|
|
|
|
|
186 |
|
Long-term intercompany notes |
|
|
|
|
|
|
262 |
|
|
|
367 |
|
|
|
7 |
|
|
|
(636 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
6,367 |
|
|
|
8,092 |
|
|
|
90 |
|
|
|
|
|
|
|
(14,549 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
16 |
|
|
|
69 |
|
|
|
1,230 |
|
|
|
116 |
|
|
|
(10 |
) |
|
|
1,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
6,846 |
|
|
$ |
8,695 |
|
|
$ |
14,020 |
|
|
$ |
1,006 |
|
|
$ |
(16,051 |
) |
|
$ |
14,516 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related accruals |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,161 |
|
|
$ |
13 |
|
|
$ |
|
|
|
$ |
2,174 |
|
Short-term intercompany notes and interest
payable |
|
|
23 |
|
|
|
399 |
|
|
|
6 |
|
|
|
85 |
|
|
|
(513 |
) |
|
|
|
|
Other current liabilities |
|
|
172 |
|
|
|
550 |
|
|
|
1,495 |
|
|
|
105 |
|
|
|
(343 |
) |
|
|
1,979 |
|
Long-term intercompany notes |
|
|
367 |
|
|
|
|
|
|
|
13 |
|
|
|
256 |
|
|
|
(636 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
|
|
|
|
1,564 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,564 |
|
Other noncurrent liabilities |
|
|
35 |
|
|
|
171 |
|
|
|
2,250 |
|
|
|
104 |
|
|
|
(10 |
) |
|
|
2,550 |
|
Shareholders equity |
|
|
6,249 |
|
|
|
6,011 |
|
|
|
8,095 |
|
|
|
443 |
|
|
|
(14,549 |
) |
|
|
6,249 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
6,846 |
|
|
$ |
8,695 |
|
|
$ |
14,020 |
|
|
$ |
1,006 |
|
|
$ |
(16,051 |
) |
|
$ |
14,516 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
141 |
|
|
$ |
31 |
|
|
$ |
1,256 |
|
|
$ |
71 |
|
|
$ |
|
|
|
$ |
1,499 |
|
Short-term investments |
|
|
|
|
|
|
109 |
|
|
|
364 |
|
|
|
|
|
|
|
|
|
|
|
473 |
|
Assets held for sale |
|
|
|
|
|
|
|
|
|
|
52 |
|
|
|
|
|
|
|
|
|
|
|
52 |
|
Short-term intercompany notes and interest
receivable |
|
|
|
|
|
|
93 |
|
|
|
415 |
|
|
|
3 |
|
|
|
(511 |
) |
|
|
|
|
Other current assets |
|
|
352 |
|
|
|
14 |
|
|
|
2,456 |
|
|
|
170 |
|
|
|
(392 |
) |
|
|
2,600 |
|
Trademarks, net |
|
|
|
|
|
|
|
|
|
|
2,223 |
|
|
|
180 |
|
|
|
|
|
|
|
2,403 |
|
Goodwill |
|
|
|
|
|
|
|
|
|
|
5,321 |
|
|
|
364 |
|
|
|
|
|
|
|
5,685 |
|
Other intangibles, net |
|
|
|
|
|
|
|
|
|
|
170 |
|
|
|
36 |
|
|
|
|
|
|
|
206 |
|
Long-term intercompany notes |
|
|
|
|
|
|
281 |
|
|
|
384 |
|
|
|
10 |
|
|
|
(675 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
6,260 |
|
|
|
7,970 |
|
|
|
65 |
|
|
|
|
|
|
|
(14,295 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
15 |
|
|
|
105 |
|
|
|
1,293 |
|
|
|
106 |
|
|
|
(9 |
) |
|
|
1,510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
6,768 |
|
|
$ |
8,603 |
|
|
$ |
13,999 |
|
|
$ |
940 |
|
|
$ |
(15,882 |
) |
|
$ |
14,428 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities related to assets held for sale |
|
$ |
|
|
|
$ |
|
|
|
$ |
11 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
11 |
|
Tobacco settlement and related accruals |
|
|
|
|
|
|
|
|
|
|
2,367 |
|
|
|
14 |
|
|
|
|
|
|
|
2,381 |
|
Short-term intercompany notes and interest
payable |
|
|
21 |
|
|
|
394 |
|
|
|
6 |
|
|
|
90 |
|
|
|
(511 |
) |
|
|
|
|
Other current liabilities |
|
|
158 |
|
|
|
470 |
|
|
|
1,328 |
|
|
|
96 |
|
|
|
(389 |
) |
|
|
1,663 |
|
Long-term intercompany notes |
|
|
384 |
|
|
|
|
|
|
|
18 |
|
|
|
273 |
|
|
|
(675 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
|
|
|
|
1,595 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,595 |
|
Other noncurrent liabilities |
|
|
29 |
|
|
|
194 |
|
|
|
2,288 |
|
|
|
100 |
|
|
|
(9 |
) |
|
|
2,602 |
|
Shareholders equity |
|
|
6,176 |
|
|
|
5,950 |
|
|
|
7,981 |
|
|
|
367 |
|
|
|
(14,298 |
) |
|
|
6,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
6,768 |
|
|
$ |
8,603 |
|
|
$ |
13,999 |
|
|
$ |
940 |
|
|
$ |
(15,882 |
) |
|
$ |
14,428 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
The following is a discussion and analysis of RAIs business, initiatives, critical accounting
policies and its consolidated financial condition and results of operations. Following the
overview and discussion of initiatives, the critical accounting policies disclose certain
accounting policies that are material to RAIs results of operations and financial condition for
the periods presented in this report. The discussion and analysis of RAIs results of operations
compares the third quarter of 2005 with the third quarter of 2004 and the first nine months of 2005
with the first nine months of 2004. Disclosures related to liquidity and financial condition
complete managements discussion and analysis. You should read this discussion and analysis of
RAIs consolidated financial condition and results of operations in conjunction with the financial
information included in the condensed consolidated financial statements (unaudited).
Overview and Initiatives
RAIs wholly owned subsidiaries include its operating subsidiaries, RJR Tobacco, Santa Fe,
Lane and GPI. RAIs single reportable operating segment, RJR Tobacco, is the second largest
cigarette manufacturer in the United States. Santa Fe manufactures and markets cigarettes and
other tobacco products primarily in the United States. Lane manufactures or distributes cigars,
roll-your-own, cigarette and pipe tobacco brands primarily in the United States. GPI manufactures
and exports cigarettes to U.S. territories, U.S. Duty Free and overseas military and manages a
contract manufacturing business.
RAIs operating subsidiaries primarily conduct business in the highly competitive U.S.
cigarette market with a few large manufacturers and many smaller participants. The U.S. cigarette
market is believed to be a mature market, and overall consumer demand is expected to continue to
decline over time. Trade inventory adjustments may result in short-term changes in demand for its
operating subsidiaries products if, and when, wholesale and retail tobacco distributors adjust the
timing of their purchases of product to manage their inventory levels. However, RAI believes it is
not appropriate for it to speculate on external factors that may impact the purchasing decision of
the wholesale and retail tobacco distributors.
Competition is based primarily on brand positioning and price, as well as product attributes
and packaging, consumer loyalty, promotions, advertising and retail presence. Cigarette brands
produced by the major manufacturers generally require competitive pricing, substantial marketing
support, retail programs and other incentives to maintain or improve a brands market position or
to introduce a new brand.
RAIs operating subsidiaries are committed to building and maintaining a portfolio of strong
brands. RJR Tobaccos marketing programs are designed to strengthen brand image, build brand
awareness and loyalty, and switch adult smokers of competing brands. In addition to building
strong brand equity, RJR Tobaccos marketing approach utilizes a retail pricing strategy,
including discounting at retail, to defend certain brands shares of market against competitive
pricing pressure. Competitive discounting has increased significantly over time as a result of
higher state excise taxes and the growth of deep-discount brands. Deep-discount brands are brands
marketed by manufacturers that are not original participants in the MSA, and accordingly, do not
have cost structures burdened with MSA payments to the same extent as the original participating
manufacturers.
RJR Tobaccos new brand portfolio strategy, which took effect at the beginning of 2005,
established three categories of brands: investment, selective support and non-support. The
investment brands are CAMEL and KOOL, which receive significant resources focused on accelerating
their share-of-market growth. The selective support brands include two full-price brands, WINSTON
and SALEM, and two savings brands, DORAL and PALL MALL, all of which receive limited support in an
effort to optimize profitability over time. ECLIPSE, a full-price brand of cigarettes that
primarily heats rather than burns tobacco, is also a selective support brand. The remaining
non-support brands are managed to maximize short-term profitability. RJR Tobacco expects that,
over time, this focused portfolio strategy will result in growth in total RJR Tobacco share, as
gains on investment brands offset declines among other brands.
Critical Accounting Policies
U.S. GAAP requires estimates and assumptions to be made that affect the reported amounts in
RAIs condensed consolidated financial statements and accompanying notes. Some of these estimates
require difficult, subjective and/or complex judgments about matters that are inherently uncertain,
and as a result, actual results could differ from those estimates. Due to the estimation processes
involved, the following summarized accounting policies
53
and their application are considered to be critical to understanding the business operations,
financial condition and results of operations of RAI and its subsidiaries.
Purchase Accounting
RAI accounts for business combination transactions in accordance with SFAS No. 141, Business
Combinations. SFAS No. 141 requires that RAI allocate the cost of the acquisition to assets
acquired and liabilities assumed, based on their fair values as of the acquisition date. The
determination of fair values involves considerable estimation and judgment. The value of goodwill
and trademarks and other intangibles with indefinite lives are subjected to annual impairment
testing that could result in future impairment charges. Changes in the useful lives of property,
plant and equipment, finite-lived trademarks or other intangibles could impact depreciation,
amortization or, in certain situations, impairment charges.
Tobacco-Related Litigation
RAI and RJR Tobacco disclose information concerning tobacco-related litigation for which an
unfavorable outcome is more than remote. RJR Tobacco and its affiliates record their legal
expenses and other litigation costs and related administrative costs as selling, general and
administrative expenses as those costs are incurred. RAI and RJR Tobacco will record any loss
related to tobacco litigation at such time as an unfavorable outcome becomes probable and the
amount can be reasonably estimated. When the reasonable estimate is a range, the recorded loss
will be the best estimate within the range. If no amount in the range is a better estimate than
any other amount, the minimum amount of the range will be recorded.
As discussed in note 7 to condensed consolidated financial statements (unaudited), RJR Tobacco
and its affiliates, including RAI, and indemnitees, including B&W, have been named in a number of
tobacco-related legal actions, proceedings or claims seeking damages in amounts ranging into the
hundreds of millions or even billions of dollars. Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned against RJR Tobacco in the Engle
class-action case, reversed by the intermediate appellate court on May 21, 2003, the Scott
class-action case, a small number of individual smoking and health cases, a Broin II flight
attendant ETS case and a California state law enforcement action. RJR Tobacco has paid
approximately $11 million since 2003 related to unfavorable judgments, primarily for
pre-acquisition contingencies related to the business combination.
RJR Tobacco believes, however, that it has numerous bases for successful appeals in its
pending cases, and both RJR Tobacco and RAI believe they have a number of valid defenses to all
actions and intend to defend all actions vigorously. As a result, RAIs management continues to
conclude that the loss of any particular smoking and health tobacco litigation claim against RJR
Tobacco or its affiliates, when viewed on an individual basis, is not probable. Accordingly, no
liability for smoking and health tobacco litigation currently is recorded in RAIs condensed
consolidated financial statements (unaudited) as of September 30, 2005. As discussed in more
detail in note 7 to condensed consolidated financial statements (unaudited), RJR has liabilities
totaling $96 million that were recorded in 1999 in connection with certain indemnification claims
asserted by JTI against RJR and RJR Tobacco, relating to the activities of Northern Brands and
related litigation.
Litigation is subject to many uncertainties, and it is possible that some of the
tobacco-related legal actions, proceedings or claims could ultimately be decided against RJR
Tobacco or its affiliates, including RAI, and its indemnitees, including B&W. Any unfavorable
outcome of such actions could have a material adverse effect on the financial condition, results of
operations or cash flows of RAI or its subsidiaries.
Settlement Agreements
As discussed in note 7 to condensed consolidated financial statements (unaudited), RJR
Tobacco, Santa Fe and Lane are participants in the MSA, and RJR Tobacco is a participant in other
state settlement agreements related to governmental health care cost recovery actions. Their
obligations and the related expense charges under the MSA and other settlement agreements are
subject to adjustments based upon, among other things, the volume of cigarettes sold by the
operating subsidiaries, their relative market share and inflation. Since relative market share is
based on cigarette shipments, the best estimate of the allocation of charges under these agreements
is recorded in costs of products sold as the products are shipped. Adjustments to these estimates,
which historically have not been significant, are recorded in the period that the change becomes
probable and the amount can be reasonably estimated. For more information related to historical
and expected settlement expenses and payments under the MSA and other settlement agreements, see
54
Governmental Health-Care Cost Recovery Cases MSA and Other State Settlement Agreements in
note 7 to condensed consolidated financial statements (unaudited).
Intangible Assets
Intangible assets include goodwill, trademarks and other intangibles and are accounted for
under SFAS No. 142, Goodwill and Other Intangible Assets. The determination of fair value
involves considerable estimates and judgment. Although RAI believes
it bases its impairment
testing, generally performed on an annual basis in the fourth
quarter, and any resulting impairment charges on reasonable estimates and assumptions, the use of different
estimates and assumptions could result in materially different results. If the competitive
environment worsens, or RAIs operating companies strategic initiatives or the business
combination transactions adversely affect RAIs financial performance, the fair value of RJR
Tobaccos goodwill and trademarks could be impaired in future periods.
Revenue Recognition
Revenue from product sales is recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the sellers price to the buyer is fixed or determinable, and collectibility
is reasonably assured. For RAIs operating subsidiaries, these criteria generally are met when
title and risk of loss pass to the customer. Shipping and handling costs are classified as cost of
products sold.
Given the nature of the business of RAIs operating subsidiaries, revenue recognition
practices contain no significant estimates that could materially affect their results of
operations.
Income taxes
Tax law requires certain items to be included in taxable income at different times than are
required for book reporting purposes under SFAS No. 109, Accounting for Income Taxes. These
differences may be permanent or temporary in nature.
To the extent a book and tax difference is permanent in nature, that is, the financial
treatment differs permanently from the tax treatment under SFAS No. 109, the tax effect of this
item is reflected in RAIs effective income tax rate.
RAI determines its annual effective income tax rate based on forecasted pre-tax book income
and forecasted permanent book and tax differences. The rate is established at the beginning of the
year, and it is evaluated on a quarterly basis. Any changes to the forecasted information or any
resolution of an audit with taxing authorities may cause the effective rate to be adjusted. Any
required adjustments are made on a prospective basis for the remaining quarters in the year.
To the extent that any book and tax differences are temporary in nature, that is, the book
realization will occur in a different period than the tax realization, a deferred tax asset or
liability is established as required under SFAS No. 109. To the extent that a deferred tax asset
is created, management evaluates RAIs ability to realize this asset. Management currently
believes it is more likely than not that the deferred tax assets will be realized. To the extent a
deferred tax liability is established under SFAS No. 109, it is recorded, tracked and, once it
becomes currently due and payable, paid to the taxing authorities.
The financial statements currently reflect managements best estimate of RAIs current and
deferred tax liabilities and assets. Future events, including but not limited to, additional
resolutions with taxing authorities could have an impact on RAIs current estimate of tax
liabilities, realization of tax assets and upon RAIs effective income tax rate.
Recently Issued Accounting Pronouncements
In September 2005, the FASBs EITF reached a consensus on Issue No. 04-13, Inventory
Exchanges. EITF No. 04-13 requires two or more inventory transactions with the same party to be
considered a single nonmonetary transaction subject to APB No. 29, Accounting for Nonmonetary
Transactions, if the transactions were entered into in contemplation of one another. EITF No.
04-13 is effective for RAI for new arrangements entered into after April 1, 2006. RAI does not expect
the adoption of EITF No. 04-13 to have a material impact on its financial position, results of
operations or cash flows.
55
In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which
replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim
Financial Statements. SFAS No. 154 requires retrospective application to prior periods financial
statements of voluntary changes in accounting principle and changes required by new accounting
standards when the standard does not include specific transition provisions, unless it is
impracticable to do so. SFAS No. 154 defines retrospective application as the application of a
different accounting principle to prior accounting periods as if that principle had always been
used and redefines restatement as the revising of previously issued financial statements to reflect
the correction of an error. SFAS No. 154 is effective for RAI as of January 1, 2006. RAI does not
expect the adoption of SFAS No. 154 to have a material impact on its financial position, results of
operations or cash flows.
In March 2005, the FASB issued FIN No. 47, Accounting for Conditional Asset Retirement
Obligations. FIN No. 47 clarifies SFAS No. 143, Accounting for Asset Retirement Obligations,
relating to obligations to perform an asset retirement activity in which the timing and the method
of settlement is conditional upon a future event. FIN No. 47 requires a liability for the fair
value of a conditional asset retirement obligation to be recognized when incurred if the fair value
of the liability can be reasonably estimated. FIN No. 47 is effective for RAI no later than
December 31, 2005. RAI has not yet determined the impact of the adoption of FIN No. 47 on its
financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs an amendment of ARB No. 43,
Chapter 4. This statement clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted materials. Accounting Research Bulletin No. 43 allowed some of
these costs to be carried as inventory, whereas SFAS No. 151 requires these costs to be recognized
as expenses when incurred. Additionally, SFAS No. 151 requires that the allocation of fixed
production overheads to the costs of conversion be based on the normal capacity of the production
facilities. SFAS No. 151 is effective for RAI as of January 1, 2006. RAI does not expect the
adoption of SFAS No. 151 to have a material impact on its financial position, results of operations
or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-an amendment
to APB Opinion No. 29. This statement requires exchanges of similar productive assets to now be
accounted for at fair value, the basic principle for nonmonetary transactions, unless the exchange
lacks commercial substance. SFAS No. 153 is effective for RAI as of January 1, 2006. RAI does not
expect the adoption of SFAS No. 153 to have a material impact on its financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment. This statement is a
revision of SFAS No. 123 and supersedes APB No. 25, Accounting for Stock Issued to Employees, and
its related implementation guidance. SFAS No. 123(R) addresses all forms of share-based payment
awards, including shares issued under employee stock purchase plans, stock options, restricted
stock and stock appreciation rights. SFAS No. 123(R) is effective for RAI as of January 1, 2006.
RAI does not expect the adoption of SFAS No. 123(R) to have a material impact on its financial
position, results of operations or cash flows primarily because all
of RAIs outstanding stock options are fully vested.
Results of Operations
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Three Months Ended |
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|
Nine Months Ended |
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|
|
September 30, |
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|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
% Change |
|
|
2005 |
|
|
2004 |
|
|
% Change |
|
Net sales1 |
|
$ |
2,149 |
|
|
$ |
1,866 |
|
|
|
15.2 |
% |
|
$ |
6,209 |
|
|
$ |
4,436 |
|
|
|
40.0 |
% |
Cost of products sold1, 2 |
|
|
1,384 |
|
|
|
1,139 |
|
|
|
21.5 |
% |
|
|
3,736 |
|
|
|
2,647 |
|
|
|
41.1 |
% |
Selling, general and administrative
expenses |
|
|
399 |
|
|
|
377 |
|
|
|
5.8 |
% |
|
|
1,175 |
|
|
|
970 |
|
|
|
21.1 |
% |
Loss on sale of assets |
|
|
|
|
|
|
|
|
|
NM3 |
|
|
25 |
|
|
|
|
|
|
NM3 |
Amortization expense |
|
|
9 |
|
|
|
11 |
|
|
|
(18.2 |
)% |
|
|
33 |
|
|
|
11 |
|
|
NM3 |
Restructuring and asset impairment
charges |
|
|
|
|
|
|
(7 |
) |
|
NM3 |
|
|
(1 |
) |
|
|
(25 |
) |
|
NM3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
357 |
|
|
$ |
346 |
|
|
|
3.2 |
% |
|
$ |
1,241 |
|
|
$ |
833 |
|
|
|
49.0 |
% |
|
|
|
|
|
|
|
|
|
|
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|
|
1 |
|
Excludes excise taxes of $573 million and $525 million for the three months
ended September 30, 2005 and 2004, respectively, and $1.6 billion and $1.3 billion for the
nine months ended September 30, 2005 and 2004, respectively. |
|
2 |
|
See Cost of products sold below for further information related to
settlement and federal tobacco buyout expense. |
|
3 |
|
Percent change is not meaningful. |
56
Net sales for the third quarter of 2005 increased $283 million from the comparable
prior-year quarter, primarily due to increased volume of $159 million, driven by the business
combination, and higher pricing net of higher discounting. Net sales increased $1.8 billion during
the first nine months of 2005 from the comparable prior-year period, primarily due to increased
volume of $1.6 billion, driven by the business combination and higher pricing net of higher
discounting. RAIs net sales are dependent upon its shipment volume in a declining market,
full-price versus savings brand mix, and list pricing, offset by promotional spending, trade
incentives and federal excise taxes.
Domestic shipment volume, in billions of units for RAIs operating subsidiaries and the
industry, were as follows1:
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Three Months Ended |
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|
Nine Months Ended |
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|
|
September 30, |
|
|
September 30, |
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|
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% |
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% |
|
|
|
2005 |
|
|
2004 |
|
|
Change |
|
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2005 |
|
|
2004 |
|
|
Change |
|
RJR Tobacco investment brands: |
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|
CAMEL excluding Regular |
|
|
6.0 |
|
|
|
5.6 |
|
|
|
5.9 |
% |
|
|
16.3 |
|
|
|
16.2 |
|
|
|
0.6 |
% |
KOOL |
|
|
3.0 |
|
|
|
2.1 |
|
|
NM3 |
|
|
8.7 |
|
|
|
2.1 |
|
|
NM3 |
|
|
|
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|
|
|
|
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|
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|
RJR Tobacco selective support
brands: |
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DORAL |
|
|
4.5 |
|
|
|
4.7 |
|
|
|
(2.6 |
)% |
|
|
12.9 |
|
|
|
13.8 |
|
|
|
(6.5 |
)% |
WINSTON |
|
|
3.7 |
|
|
|
3.9 |
|
|
|
(4.1 |
)% |
|
|
10.8 |
|
|
|
11.2 |
|
|
|
(3.6 |
)% |
SALEM |
|
|
2.0 |
|
|
|
2.2 |
|
|
|
(11.1 |
)% |
|
|
5.8 |
|
|
|
6.7 |
|
|
|
(13.4 |
)% |
PALL MALL Savings |
|
|
1.5 |
|
|
|
1.0 |
|
|
NM3 |
|
|
4.3 |
|
|
|
1.0 |
|
|
NM3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco non-support brands |
|
|
7.5 |
|
|
|
6.6 |
|
|
|
13.9 |
% |
|
|
21.8 |
|
|
|
12.6 |
|
|
|
73.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco total full-price |
|
|
17.0 |
|
|
|
15.9 |
|
|
|
7.1 |
% |
|
|
48.6 |
|
|
|
40.4 |
|
|
|
20.4 |
% |
RJR Tobacco total savings |
|
|
11.2 |
|
|
|
10.1 |
|
|
|
10.4 |
% |
|
|
32.1 |
|
|
|
23.2 |
|
|
|
38.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
RJR Tobacco total domestic |
|
|
28.2 |
|
|
|
26.0 |
|
|
|
8.4 |
% |
|
|
80.7 |
|
|
|
63.6 |
|
|
|
26.9 |
% |
Other |
|
|
0.6 |
|
|
|
0.6 |
|
|
|
0.0 |
% |
|
|
1.8 |
|
|
|
1.7 |
|
|
|
10.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAI total domestic |
|
|
28.8 |
|
|
|
26.6 |
|
|
|
8.2 |
% |
|
|
82.6 |
|
|
|
65.3 |
|
|
|
26.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
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|
|
Industry2: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Full-price |
|
|
70.4 |
|
|
|
70.8 |
|
|
|
(0.6 |
)% |
|
|
204.6 |
|
|
|
205.8 |
|
|
|
(0.6 |
)% |
Savings |
|
|
28.7 |
|
|
|
30.3 |
|
|
|
(5.1 |
)% |
|
|
82.5 |
|
|
|
89.7 |
|
|
|
(8.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry total domestic |
|
|
99.1 |
|
|
|
101.1 |
|
|
|
(1.9 |
)% |
|
|
287.1 |
|
|
|
295.5 |
|
|
|
(2.8 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Amounts presented in this table are rounded on an individual basis and,
accordingly, may not sum on an aggregate basis. |
|
2 |
|
Based on information from MSAi. These amounts, including the restatement
of prior periods, reflect revised methodology adopted to better estimate industry volume. |
|
3 |
|
Percent change is not meaningful due to only two months of sales in 2004 for KOOL
and PALL MALL. |
RJR Tobaccos total domestic shipment volume increased 8.4% in the third quarter of 2005
from the third quarter of 2004 and 26.9% in the first nine months of 2005 from the first nine
months of 2004. These increases reflect the impact of the business combination offset in part by
the underlying declines in consumption, or retail sales to consumers.
Shipments in the full-priced tier decreased to 60.4% of RJR Tobaccos total domestic shipments
during the third quarter of 2005 as compared with 61.2% in the prior-year quarter. RJR Tobaccos
full-price shipments were 60.2% and 63.5% of total shipments for the nine months ended September
30, 2005 and 2004, respectively. These decreases are primarily due to the combination of the
former B&W brands, which were more heavily weighted in the savings category. Industry full-price
shipments as a percentage of total domestic shipments increased to 71.0% from 70.0% in the three
months ended September 30, 2005 and 2004, respectively; and to 71.3% from 69.7% in the nine months
ended September 30, 2005 and 2004, respectively.
The shares of U.S. retail cigarette sales of RJR Tobacco are presented as if the portfolio
resulting from the business combination had been combined as of July 1, 2004. The shares of RJR
Tobacco as a percentage of total share of U.S. retail cigarette sales according to data1
from Information Resources, Inc./Capstone Research Inc., collectively referred to as IRI, were:
57
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended2 |
|
|
|
September 30, |
|
|
June 30, |
|
|
Share Point |
|
|
September 30, |
|
|
Share Point |
|
|
|
2005 |
|
|
2005 |
|
|
Change |
|
|
2004 |
|
|
Change |
|
RJR Tobacco investment brands: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding Regular |
|
|
6.55 |
% |
|
|
6.53 |
% |
|
|
0.01 |
|
|
|
6.36 |
% |
|
|
0.18 |
|
KOOL |
|
|
3.00 |
% |
|
|
2.97 |
% |
|
|
0.03 |
|
|
|
2.76 |
% |
|
|
0.24 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco selective support
brands: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DORAL |
|
|
4.61 |
% |
|
|
4.69 |
% |
|
|
(0.08 |
) |
|
|
4.89 |
% |
|
|
(0.28 |
) |
WINSTON |
|
|
3.98 |
% |
|
|
4.04 |
% |
|
|
(0.07 |
) |
|
|
4.12 |
% |
|
|
(0.14 |
) |
SALEM |
|
|
2.15 |
% |
|
|
2.20 |
% |
|
|
(0.05 |
) |
|
|
2.63 |
% |
|
|
(0.48 |
) |
PALL MALL Savings |
|
|
1.54 |
% |
|
|
1.50 |
% |
|
|
0.04 |
|
|
|
1.57 |
% |
|
|
(0.03 |
) |
ECLIPSE |
|
|
0.01 |
% |
|
|
0.01 |
% |
|
|
|
|
|
|
0.02 |
% |
|
|
(0.00 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco non-support brands |
|
|
7.82 |
% |
|
|
7.92 |
% |
|
|
(0.10 |
) |
|
|
8.40 |
% |
|
|
(0.57 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco total domestic |
|
|
29.66 |
% |
|
|
29.88 |
% |
|
|
(0.21 |
) |
|
|
30.75 |
% |
|
|
(1.08 |
) |
|
|
|
1 |
|
Retail share of U.S. cigarette sales data is included in this document because
it is used by RJR Tobacco primarily as an indicator of the relative performance of industry
participants and brands and market trends. You should not rely on the market share data reported
by IRI as being a precise measurement of actual market share because IRI is not able to effectively
track all volume. Moreover, you should be aware that in a product market experiencing overall
declining consumption, a particular product can experience increasing market share relative to
competing products, yet still be subject to declining consumption volumes. |
|
2 |
|
Amounts presented in this table are rounded on an individual basis and,
accordingly, may not sum on an aggregate basis. |
The retail share of market of CAMELs filtered styles continued to grow compared with the
prior-year period based on the strength of the brands equity, driven by its Pleasure to Burn
positioning. In addition, the brand launched Turkish Silver in April 2005. KOOL continues to
maintain its appeal among adult menthol smokers and increased its share in the third quarter of
2005 over the prior-year quarter. At the end of the second quarter, RJR Tobacco introduced KOOLs
Be True advertising campaign to support KOOLs future growth potential.
The combined share of market of RJR Tobaccos investment brands during the third quarter of
2005 showed improvement over the preceding quarter and prior-year quarter. However, the decline in
share of selective support and non-support brands more than offset the gains on the investment
brands. The results for the first nine months of 2005 were in line with the brand portfolio
strategy announced in early 2005.
RJR Tobaccos full-price share position of 18.16% of the market in the third quarter of 2005
declined 0.13 share points from the second quarter of 2005 and 0.42 share points from the third
quarter of 2004. RJR Tobaccos savings share position of 11.51% of the market in the third quarter
of 2005 declined 0.08 share points from the second quarter of 2005 and 0.67 share points compared
with the third quarter 2004.
Santa Fes NATURAL AMERICAN SPIRIT brand continued to deliver higher volume and share for the
first nine months of 2005 compared with the comparable 2004 period.
Cost of products sold increased $245 million in the third quarter of 2005 from the third
quarter of 2004, and increased $1.1 billion for the first nine months of 2005 compared with the
first nine months of 2004, primarily due to increased MSA settlement and federal tobacco buyout
expenses, as detailed in the schedule below. The increase in cost of products sold for the first
nine months of 2005 compared with the first nine months of 2004 also was driven by integration
costs of $14 million and $376 million higher variable product costs related to volume of acquired
operations, including BAT contract manufacturing.
58
Cost of products sold includes the following components for MSA settlement and federal tobacco
buyout expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months Ended |
|
|
For The Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Ongoing settlement |
|
$ |
717 |
|
|
$ |
652 |
|
|
$ |
2,014 |
|
|
$ |
1,592 |
|
Phase II growers liability offset |
|
|
|
|
|
|
|
|
|
|
(79 |
) |
|
|
|
|
Phase II growers expense |
|
|
39 |
|
|
|
|
|
|
|
39 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total settlement expense |
|
$ |
756 |
|
|
$ |
652 |
|
|
$ |
1,974 |
|
|
$ |
1,592 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout |
|
$ |
67 |
|
|
$ |
|
|
|
$ |
202 |
|
|
$ |
|
|
Federal
quota tobacco stock liquidation assessment |
|
|
74 |
|
|
|
|
|
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense |
|
$ |
141 |
|
|
$ |
|
|
|
$ |
283 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MSA expenses are expected to be approximately $2.6 billion in 2005, subject to adjustment for
changes in volume and other factors and the federal tobacco quota buyout is expected to be
approximately $345 million in 2005. For additional information, see -Governmental Health-Care
Cost Recovery Cases MSA and Other State Settlement Agreements in note 7 to condensed
consolidated financial statements (unaudited) and -Governmental Activity below.
Selling, general and administrative expenses increased $22 million from the prior-year
quarter, primarily due to increased marketing and other increased costs related to operations
acquired in the business combination, partially offset by integration costs of $36 million in the
third quarter of 2005 compared with $62 million for the prior-year quarter. Selling, general and
administrative expenses increased $205 million during the first nine months of 2005 compared with
the prior-year period, primarily due to increased legal expenses and other increased costs related
to acquired operations, partially offset by $33 million growers settlement recorded in the first
quarter of 2004. Integration costs were $74 million for the first nine months of 2005 compared
with $87 million for the prior-year period.
Selling, general and administrative expenses include the costs of litigating and administering
product liability claims, as well as other legal expenses. For the quarters ended September 30,
2005 and 2004, RJR Tobaccos product liability defense costs were $32 million and $34 million,
respectively. For the nine-month periods ended September 30, 2005 and 2004, RJR Tobaccos product
liability defense costs were $111 million and $79 million, respectively. The increase in product
liability defense costs for the first nine months of 2005 compared with the prior-year period was
primarily related to the assumption of certain B&W litigation as a result of the business
combination and the Department of Justice case.
Product liability cases generally include smoking and health related cases. In particular,
these cases include the following categories of cases listed in the table of cases set forth in
"-Litigation Affecting the Cigarette Industry-Overview in note 7 to condensed consolidated
financial statements (unaudited):
|
|
|
Individual Smoking and Health; |
|
|
|
|
Flight Attendant ETS (Broin II); |
|
|
|
|
Class Actions; |
|
|
|
|
Governmental Health-Care Cost Recovery; |
|
|
|
|
Other Health-Care Cost Recovery and Aggregated Claims; and |
|
|
|
|
Asbestos Contribution. |
Product liability defense costs include the following items:
59
|
|
|
direct and indirect compensation, fees and related costs and expenses for
internal legal and related administrative staff administering product liability
claims; |
|
|
|
|
fees and cost reimbursements paid to outside attorneys; |
|
|
|
|
direct and indirect payments to third party vendors for litigation support activities; |
|
|
|
|
expert witness costs and fees; and |
|
|
|
|
payments to fund legal defense costs for the now dissolved Council for Tobacco Research -U.S.A. |
Numerous factors affect the amount of product liability defense costs. The most important
factors are the number of cases pending and the number of cases in trial or in preparation for
trial (i.e., with active discovery and motions practice). See -Litigation Affecting the Cigarette
Industry-Overview in note 7 to condensed consolidated financial statements (unaudited) for
detailed information regarding the number and type of cases pending, and -Litigation Affecting the
Cigarette Industry-Scheduled Trials in note 7 to condensed consolidated financial statements
(unaudited) for detailed information regarding the number and nature of cases in trial and
scheduled for trial through the end of September 2006.
RJR Tobacco expects that the factors described above will continue to have the primary impact
on its product liability defense costs in the future. Given the level of activity in cases in
preparation for trial, in trial and on appeal and the amount of product liability defense costs
incurred by RJR Tobacco over the past three years, RJR Tobaccos recent experiences in defending
its product liability cases and the reasonably anticipated level of activity in RJR Tobaccos
pending cases and possible new cases, RJR Tobacco does not expect that the variances in its product
liability defense costs will be significantly different than they have been historically. However,
it is possible that adverse developments in the factors discussed above, as well as other
circumstances beyond the control of RJR Tobacco, could have a material adverse effect on the
financial condition, results of operations or cash flows of RAI or its subsidiaries. Those other
circumstances beyond the control of RJR Tobacco include the results of present and future trials
and appeals, and the development of possible new theories of liability by plaintiffs and their
counsel.
Loss on sale of assets of $25 million relates to RJR Tobaccos sale of its packaging
operations on May 2, 2005, to a consortium of five packaging companies for $48 million.
RJR Tobacco agreed to provide severance and related benefits to employees who would not
receive offers for ongoing employment from the consortium of buyers. Accordingly, the loss
includes approximately $28 million for severance and related benefits to be paid by RJR Tobacco to
approximately 185 employees out of approximately 740 employees who served the packaging operations
at the time of disposition. RJR Tobacco also agreed to provide a transition bonus to eligible
employees who continue to work during the transition period, which is expected to be up to 24
months from the date of closing. The termination of the packaging employees triggered a
remeasurement of the plan assets and benefit obligations of certain of RAIs pension and
postretirement plans. The remeasurement resulted in an additional minimum liability of $362
million and a one-time net curtailment gain of $10 million, reflecting $3 million of pension
expense and $13 million of postretirement income.
Pursuant to various supply contracts entered into between the buyers and RJR Tobacco, RJR
Tobacco will continue to obtain its packaging materials from certain of the buyers. As a result of
certain transitional supply pricing, which is above current market prices, $14 million was accrued
as part of the loss. Accordingly, anticipated purchases over the transition period will be
recorded at approximate current market prices.
Amortization expense of $9 million and $33 million were recorded during the three- and
nine-month periods ended on September 30, 2005, respectively, relating to intangibles acquired in
the business combination and finite-lived trademarks. During the three-month period ended on
September 30, 2004, $11 million was recorded relating to intangibles acquired in the business
combination based on preliminary valuations.
Restructuring and asset impairment charge adjustment of $1 million was recorded during the
nine-month period ended on September 30, 2005, and $7 million and $25 million were recorded during
the three- and nine-month periods ended on September 30, 2004, respectively.
60
2003 Restructuring and Asset Impairment Charges
The components of the 2003 restructuring and asset impairment charges recorded and utilized
were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance |
|
|
|
|
|
|
Contract |
|
|
|
|
|
|
and |
|
|
Asset |
|
|
Termination/ |
|
|
|
|
|
|
Benefits |
|
|
Impairment |
|
|
Exit Costs |
|
|
Total |
|
Original charge |
|
$ |
292 |
|
|
$ |
28 |
|
|
$ |
53 |
|
|
$ |
373 |
|
Utilized in 2003 |
|
|
(92 |
) |
|
|
(28 |
) |
|
|
(52 |
) |
|
|
(172 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2003 |
|
|
200 |
|
|
|
|
|
|
|
1 |
|
|
|
201 |
|
Incurred in 2004 |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
1 |
|
Utilized in 2004 |
|
|
(91 |
) |
|
|
|
|
|
|
(2 |
) |
|
|
(93 |
) |
Adjusted in 2004 |
|
|
(34 |
) |
|
|
|
|
|
|
|
|
|
|
(34 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004 |
|
|
75 |
|
|
|
|
|
|
|
|
|
|
|
75 |
|
Utilized in 2005 |
|
|
(49 |
) |
|
|
|
|
|
|
|
|
|
|
(49 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
26 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During 2003, in response to continuing challenges of an intensely competitive environment, RJR
and RJR Tobacco incurred restructuring and asset impairment charges of $373 million, or $225
million after tax. Of these charges, RJR Tobacco incurred $287 million related to severance and
benefits, $28 million related to asset impairments, primarily reflecting abandonment of certain
merchandising fixtures not yet shipped to retailers, and $34 million related to professional fees
for valuation and consulting services, as well as the discontinuation of certain event-marketing
programs and other associated exit costs. The remaining $24 million was incurred by RJR.
During 2004, RJR Tobacco decided that approximately 750 sales positions that were expected to
be outsourced would not be eliminated and had approximately 100 other less-than-expected workforce
reductions, primarily in manufacturing. Accordingly, associated severance and related benefits of
$34 million, or $20 million after tax, was reversed from the restructuring charge during 2004.
After the adjustments during 2004, the workforce reduction was approximately 22%, or
approximately 1,680 full-time employees, in operations and corporate functions. The workforce
reduction was substantially completed during the fourth quarter of 2004. The remaining accrual
represents severance that will be paid through 2007.
The cash portion of the restructuring and asset impairment charges to date is approximately
$225 million, of which $171 million relates to employee severance costs and $54 million relates to
exit costs. As of September 30, 2005, $199 million of this amount had been paid. Of the $115
million non-cash portion of the charges, $87 million related to benefit charges and $28 million
related to asset impairments. In the condensed consolidated balance sheet (unaudited) as of
September 30, 2005, $21 million is included in other current liabilities and $5 million is included
in other noncurrent liabilities. No significant additional charges are expected to be incurred in
connection with the 2003 restructuring plan. Cost savings related to the 2003 restructuring
charges were $188 million during the first nine months of 2005, and are expected to be $252 million
for the full year 2005 and $258 million on an annualized basis thereafter.
61
2002 Restructuring and Asset Impairment Charges
The components of the 2002 restructuring and asset impairment charges recorded and utilized
were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance |
|
|
|
|
|
|
Contract |
|
|
|
|
|
|
and |
|
|
Asset |
|
|
Termination/ |
|
|
|
|
|
|
Benefits |
|
|
Impairment |
|
|
Exit Costs |
|
|
Total |
|
Original charge |
|
$ |
102 |
|
|
$ |
115 |
|
|
$ |
7 |
|
|
$ |
224 |
|
Utilized in 2002 |
|
|
(44 |
) |
|
|
(115 |
) |
|
|
(2 |
) |
|
|
(161 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2002 |
|
|
58 |
|
|
|
|
|
|
|
5 |
|
|
|
63 |
|
Utilized in 2003 |
|
|
(27 |
) |
|
|
|
|
|
|
|
|
|
|
(27 |
) |
Adjusted in 2003 |
|
|
(2 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2003 |
|
|
29 |
|
|
|
|
|
|
|
2 |
|
|
|
31 |
|
Incurred in 2004 |
|
|
|
|
|
|
40 |
|
|
|
|
|
|
|
40 |
|
Utilized in 2004 |
|
|
(23 |
) |
|
|
(40 |
) |
|
|
|
|
|
|
(63 |
) |
Adjusted in 2004 |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004 |
|
|
4 |
|
|
|
|
|
|
|
2 |
|
|
|
6 |
|
Utilized in 2005 |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
(2 |
) |
Adjusted in 2005 |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
2 |
|
|
$ |
|
|
|
$ |
1 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2002, RJR Tobacco recorded a pre-tax restructuring charge of $224 million, $135 million
after tax, in response to changing competitive practices within the tobacco industry.
During 2004, RJR Tobacco reversed $2 million for employee severance and benefits, due to
less-than-expected workforce reductions. As adjusted, the employee severance and benefits relate
to the elimination of approximately 500 full-time positions in operations support and corporate
functions, which were substantially completed as of December 31, 2004.
The asset impairment resulted from the remeasurement of the non-tobacco businesses at the
lower of their carrying value or fair value less cost to sell. Based on the results of
negotiations, a revaluation of the fair value of RJR Tobaccos packaging business resulted in
additional impairment of $40 million in the fourth quarter of 2004.
Assets held for sale and liabilities related to assets held for sale in the condensed
consolidated balance sheets are classified in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. As of September 30, 2005, the carrying amounts of
the major classes of assets and liabilities in the disposal group included $3 million of property,
plant and equipment and other. As of December 31, 2004, the carrying amounts of the major classes
of assets and liabilities in the disposal group included $14 million of accounts receivable, $31
million of inventories, $7 million of property, plant and equipment and other, and $11 million of
accounts payable and accrued liabilities. RJR Tobacco completed the sale of one of the non-tobacco
businesses in the second quarter of 2003 and the sale of its packaging operations during the second
quarter of 2005.
Contract termination and exit costs included certain contract terminations and lease
terminations of 15 sales offices. Exit costs also included the separation of the non-tobacco
businesses held for sale. During 2003, $5 million of the charge was reversed, reflecting
less-than-expected workforce reductions and exit costs of field sales offices. During 2005, $1
million of the charge was reversed relating to the sale of the packaging operations.
The cash portion of the 2002 restructuring and asset impairment charges is expected to be $55
million and primarily relates to employee severance costs. As of September 30, 2005, $52 million
of this amount had been paid. The $201 million non-cash portion included $44 million related to
employee benefits, $155 million related to asset impairments and $2 million related to the
write-off of prepaid promotional rights that were terminated. In the condensed consolidated
balance sheet (unaudited) as of September 30, 2005, $3 million is included in other current
liabilities. Cost savings related to the 2002 restructuring charges were $45 million during the
first nine months of 2005, and are expected to be $60 million on an annualized basis thereafter.
62
Interest and debt expense was $31 million and $81 million during the three- and nine-month
periods ended September 30, 2005, respectively, an increase of $10 million and $19 million from the
respective comparable prior-year periods. The increases from the prior-year periods are primarily
due to higher interest rates and higher debt.
Interest income was $23 million and $53 million during the three- and nine-month periods ended
September 30, 2005, respectively, an increase of $16 million and $37 million from the respective
comparable prior-year periods. The increases from the prior-year periods are primarily due to
higher interest rates and to a lesser extent higher average cash balances.
Other expense was $7 million and $14 million during the three- and nine-month periods ended
September 30, 2005, respectively, an increase of $8 million and $10 million from the respective
comparable prior-year periods. The increases are primarily due to $7 million net costs related to
the extinguishment of the 2006 Notes.
Provision for income taxes was $129 million, or an effective rate of 37.9%, in the third
quarter of 2005 compared with $43 million, or an effective rate of 12.9%, in the third quarter of
2004. The provision for income taxes during the first nine months of 2005 was $454 million, or an
effective rate of 37.9%, compared with $221 million, or an effective rate of 28.2%, in the
prior-year period. The 2005 periods were impacted by the estimated impact of the domestic
production credit of the American Jobs Creation Act, enacted on October 22, 2004, and the favorable
resolution of certain state tax matters during 2005. The effective tax rates exceeded the federal
statutory rate of 35% primarily due to the impact of state taxes and certain non-deductible items.
The 2004 periods were impacted mainly by the resolution of certain prior years tax matters that
resulted in a reduction of income tax expense of $96 million, offset in part by state tax and
certain non-deductible items.
Gain on sale of discontinued businesses was $1 million during nine-month period ended
September 30, 2004, reflecting net settlements associated with the 1999 sale of the international
business to Japan Tobacco Inc.
Extraordinary item was $49 million income during the three- and nine-month period ended
September 30, 2004, related to the 2000 acquisition of RJRs former parent, NGH, primarily from
settlement of tax matters.
Liquidity and Financial Condition
Liquidity
At present, the principal sources of liquidity for RAIs operating subsidiaries businesses
and operating needs are internally generated funds from their operations and borrowings through
RJR. Cash flows from operating activities are believed to be sufficient for the foreseeable future
to enable the operating subsidiaries to meet their obligations under the MSA, to fund their capital
expenditures and to make payments to RJR that, when combined with RJRs cash balance, will enable
RJR to make its required debt-service payments, and to fund RAI to enable it to pay dividends to
its shareholders. The negative impact, if any, on the sources of liquidity that could result from
a decrease in demand for products due to short-term inventory adjustments by wholesale and retail
distributors, changes in competitive pricing or accelerated declines in consumption, cannot be
predicted. RAI cannot predict its cash requirements or those of its subsidiaries related to any
future settlements or judgments, including cash required to be held in escrow or to bond any
appeals, if necessary, and RAI makes no assurance that it or its subsidiaries will be able to meet
all of those requirements.
63
The second quarter debt issuance and the third quarter tender offer of the 2006 Notes resulted
in the following material changes in RAIs contractual obligations:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
Less than 1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year |
|
|
1-3 Years |
|
|
4-5 Years |
|
|
Thereafter |
|
|
|
Total |
|
|
(2005) |
|
|
(2006-2007) |
|
|
(2008-2009) |
|
|
(2010 +) |
|
Long-term debt issued in
June 2005, exclusive of
interest1 |
|
$ |
499 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
499 |
|
Long-term debt reduction related
to the tender offer of the 2006
Notes exclusive of
interest1 |
|
|
(310 |
) |
|
|
|
|
|
|
(310 |
) |
|
|
|
|
|
|
|
|
Interest payments related to
long-term debt issued in June
2005 net of the 2006 Notes
reduction1 |
|
|
229 |
|
|
|
9 |
|
|
|
62 |
|
|
|
68 |
|
|
|
90 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total change in cash obligations |
|
$ |
418 |
|
|
$ |
9 |
|
|
$ |
(248 |
) |
|
$ |
68 |
|
|
$ |
589 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
For more information about RJRs long-term debt, see
Debt below and
note 6 to condensed consolidated financial statements (unaudited). |
Cash Flows
Net cash flows from operating activities were $851 million in the first nine months of 2005,
compared with $489 million in the first nine months of 2004. This change is primarily due to
higher net income and favorable working capital movements, including inventory and accounts
receivable. These increases were offset in part by higher 2005 MSA payments and higher pension
funding in 2005.
Net cash flows used in investing activities were $663 million in the first nine months of
2005, compared with $344 million net cash flows from investing activities in the prior-year period.
This change is primarily due to higher net purchases of short-term investments offset in part by
proceeds from the sale of the packaging business in 2005. Cash flows from investing for the 2004
period was also impacted by $204 million net cash received related to the business combination
transactions.
Net cash flows used in financing activities were $295 million in the first nine months of
2005, compared with $304 million in the prior-year period. This change is primarily due to the
$500 million debt issuance proceeds in June 2005 less the tender offer for the 2006 Notes, offset
in part by higher dividends paid reflecting the outstanding shares of common stock issued in
consideration of the business combination.
Stock Repurchases
RAI repurchases and cancels shares forfeited with respect to the tax liability associated with
certain option exercises under the RAI Long-Term Incentive Plan. Additionally, to maintain B&Ws
ownership level of 42%, RAI was required to repurchase shares, dependent upon certain stock
issuances, through September 2005. Due to RAIs incorporation in North Carolina, which does not
recognize treasury shares, the shares repurchased under these plans are cancelled at the time of
repurchase. During the first nine months of 2005, RAI repurchased 41,777 shares of its common
stock at an aggregate cost of $3 million.
Dividends
On July 13, 2005, RAIs board of directors declared a quarterly cash dividend of $1.05 per
common share, which equals $4.20 per common share on an annualized basis. The dividend was payable
on October 3, 2005, to shareholders of record as of September 9, 2005. This 11% increase in
dividends is an initial step toward meeting the stated policy of paying dividends to the holders of
RAIs common stock in an aggregate amount that is approximately 75% of RAIs annual consolidated
net income.
Capital Expenditures
RAIs operating subsidiaries capital expenditures were $74 million for the first nine months
of 2005 compared with $50 million for the first nine months of 2004. The increase in 2005 reflects
$38 million of capital expenditures that
64
were incurred to continue the operations integration resulting from the business combination.
RAIs operating subsidiaries plan to spend an additional $50 million to $60 million for capital
expenditures during the remainder of 2005, funded primarily by cash flows from operations. The
estimated remaining 2005 amount includes $17 million capital expenditures that are expected to be
incurred relating to the operations integration. RAIs operating subsidiaries capital expenditure
programs are expected to continue at a level sufficient to support their strategic and operating
needs. There were no material long-term commitments for capital expenditures as of September 30,
2005.
Debt
RJRs revolving credit facility with a syndicate of banks has a committed amount of $486
million through January 2007. RJR can use the full credit facility to obtain loans or letters of
credit, at its option.
Under the terms of the credit facility, RJR is not required to maintain compensating balances;
however, RJR pays commitment fees of 1.5% per annum of the credit facility committed amount.
Borrowings under the credit facility bear interest at rates based upon the prime rate, the federal
funds rate or LIBOR plus, in each case, an applicable interest margin based upon the credit rating
assigned to RJRs long-term guaranteed, secured debt. The credit facility has restrictive
covenants that limit RAIs ability to pay dividends and repurchase stock, and limits RAI and its
subsidiaries ability to incur indebtedness, engage in transactions with affiliates, create liens,
acquire, sell or dispose of specific assets and engage in specified mergers or consolidations.
Under the credit facility, RAIs cumulative dividends and share repurchases generally may not
exceed the sum of $500 million plus 75% of cumulative adjusted cash net income. RJRs credit
facility is secured by substantially all of RJRs assets, including RJRs stock in RJR Tobacco.
Also, certain of RJRs subsidiaries, including RJR Tobacco, and RJRs parent, RAI, have guaranteed
RJRs obligations under the credit facility and have pledged substantially all of their assets to
secure such guarantees. As described below, the collateral securing RJRs credit facility, and the
related guarantees, will be released automatically in certain circumstances. At September 30,
2005, RJR had $26 million in letters of credit outstanding under the facility. No borrowings were
outstanding, and the remaining $460 million of the facility was available for borrowing.
RJR has a $30 million uncommitted, unsecured line of credit with one bank. No borrowings were
outstanding on this line of credit at September 30, 2005.
In June 2005, RJR completed the Private Offering of $300 million of 6.5% secured notes due
July 15, 2010, and $200 million of 7.3% secured notes due July 15, 2015. The Private Offering
requires RJR to pay additional interest on the foregoing notes at an annual rate of 0.5% if it
fails to comply with certain of its obligations under a registration rights agreement covering such
notes, including completion of an exchange offer for publicly registered notes no later than
February 24, 2006.
In conjunction with the Private Offering, RJR commenced in June 2005, the Offer for any and
all of its then outstanding $500 million of 7.75% secured notes due May 15, 2006, and a consent
solicitation to amend the related indenture. The consents were solicited to approve the
Amendments, which eliminated substantially all of the restrictive covenants and one of the events
of default with respect to the 2006 Notes. After RJR received the requisite consents to the
Amendments, RJR, the guarantors of the 2006 Notes and the indenture trustee entered into a
supplemental indenture effecting the Amendments, which affect only the 2006 Notes. In July 2005,
RJR used a portion of the proceeds from the Private Offering to extinguish approximately $310
million of the 2006 Notes that were tendered pursuant to the Offer. The remainder of the Private
Offering proceeds will be maintained and used to pay at maturity the 2006 Notes that were not
tendered in the Offer, or at RJRs discretion, to redeem the 2006 Notes. In accordance with the
terms of the Amendments, the outstanding 2006 Notes that were not tendered in the Offer are no
longer secured, but remain guaranteed by RAI and certain of RJRs subsidiaries, as described below.
In the third quarter of 2005, RJR recorded $7 million of net costs related to the extinguishment
of the 2006 Notes.
Unlike RJRs other non-bank debt, RJRs secured notes, as well as the 2006 Notes that were not
extinguished pursuant to the Offer and are unsecured, are guaranteed by certain of RJRs
subsidiaries, including RJR Tobacco, and its parent, RAI, which entities also guarantee RJRs
obligations under RJRs credit facility.
Any guarantor that is released from its guarantee under RJRs credit facility also will be
released automatically from its guarantee of RJRs notes. RJRs secured notes and the related
guarantees are secured by the stock of RJR and the subsidiary guarantors and certain of their
subsidiaries, indebtedness of subsidiaries of RJR and the guarantors, to the extent owed to RJR or
a guarantor, and principal property of RJR and the subsidiary guarantors. These assets constitute
a portion of the security for the obligations of RJR and the guarantors under RJRs credit
facility. If these assets are no longer pledged as security for the obligations of RJR and the
guarantors under RJRs credit facility, or any other
65
indebtedness of RJR, they will be released automatically as security for RJRs secured notes
and the related guarantees. Under the terms of RJRs credit facility, the security therefor will
be released automatically at such time that certain debt of RJR is rated investment grade by each
of Moodys and S&P. RAIs stock in Santa Fe and CMSI, the parent company of Lane, is excluded from
the collateral securing RAIs guarantee of RJRs secured notes and credit facility. Generally, the
terms of RJRs guaranteed secured notes restrict the pledge of collateral, sale/leaseback
transactions and the transfer of all or substantially all of the assets of RJR and its
subsidiaries.
Moodys rating of RJRs guaranteed, secured notes is Ba2, negative outlook, and S&Ps rating
is BB+, negative outlook. Concerns about, or further lowering of, the ratings of RJRs guaranteed,
secured notes by S&P or Moodys could have an adverse impact on RJRs ability to access the debt
markets. However, given the cash balances of RAI and its subsidiaries, RAIs management believes
that such concerns about, or further lowering of, such ratings would not have a material adverse
impact on RAIs cash flows.
As of September 30, 2005, RJR had $1.45 billion of guaranteed, secured notes outstanding, with
fixed annual interest rates of 6.5% to 7.875%, due in 2007 through 2015 and $190 million
guaranteed, unsecured notes outstanding, at a fixed annual interest rate of 7.75% due in 2006. In
addition, as of September 30, 2005, RJR had $89 million of notes outstanding which were neither
secured nor guaranteed, at fixed annual interest rates of 8.5% to 9.25%, due in 2007 through 2013.
At its option, RJR may redeem any or all of its outstanding notes, in whole or in part at any time,
subject to the payment of a make-whole premium.
RJR uses interest rate swaps to manage interest rate risk on a portion of its debt
obligations. Under certain conditions, including RJRs guaranteed, secured debt remaining either
one level below BBB- by S&P or Baa3 by Moodys, or lower, any fair value that results in a
liability position of the interest rate swaps will require full collateralization with cash or
securities. In addition, because RJR and the guarantors, including RAI and RJR Tobacco, have
pledged substantially all of their assets, including the stock of
certain of their subsidiaries, to secure their obligations under RJRs credit facility,
such pledge also has secured their obligations under these interest rate swap agreements.
RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed
by their indebtedness at September 30, 2005.
Litigation and Settlements
Various legal proceedings, including actions claiming that lung cancer and other diseases, as
well as addiction, have resulted from the use of, or exposure to, RAIs operating subsidiaries
products, are pending or may be instituted against RJR Tobacco or its affiliates, including RAI, or
indemnitees, including B&W. In July 2000, a jury in the Florida state court case Engle v. R.J.
Reynolds Tobacco Co. rendered a punitive damages verdict in favor of the Florida class of
plaintiffs of approximately $145 billion, with approximately $36.3 billion and $17.6 billion being
assigned to RJR Tobacco and B&W, respectively. RJR Tobacco, B&W and the other defendants appealed
this verdict. On May 21, 2003, Floridas Third District Court of Appeal reversed the trial courts
final judgment and remanded the case to the Miami-Dade County Circuit Court with instructions to
decertify the class. On October 23, 2003, the plaintiffs filed a notice seeking review by the
Florida Supreme Court. On May 12, 2004, the Florida Supreme Court agreed to review the case. Oral
argument occurred on November 3, 2004. Although RJR Tobacco remains confident in the bases for
appeal in this case, it cannot predict the final outcome of the appellate process. For further
discussion of the Engle case and other litigation and legal proceedings pending against RAI or its
affiliates or indemnitees, see note 7 to condensed consolidated financial statements (unaudited).
Even though RAIs management continues to conclude that the loss of any particular smoking and
health tobacco litigation claim against RJR Tobacco or its affiliates, when viewed on an individual
basis, is not probable, the possibility of material losses related to smoking and health tobacco
litigation is more than remote. However, RAIs management is unable to predict the outcome of such
litigation or to reasonably estimate the amount or range of any possible loss. Moreover,
notwithstanding the quality of defenses available to it and its affiliates in tobacco-related
litigation matters, it is possible that RAIs financial condition, results of operations or cash
flows could be materially adversely affected by the ultimate outcome of certain pending or future
litigation matters.
In November 1998, RJR Tobacco, B&W and the other major U.S. cigarette manufacturers entered
into the MSA with attorneys general representing most U.S. states, territories and possessions.
The MSA imposes a stream of future payment obligations on RJR Tobacco and the other major U.S.
cigarette manufacturers and places significant restrictions on their ability to market and sell
cigarettes in the future. For more information related to historical and expected settlement
expenses and payments under the MSA and other settlement agreements,
see Governmental
66
Health-Care Cost Recovery Cases MSA and Other State Settlement Agreements in note 7 to
condensed consolidated financial statements (unaudited). The MSA and other state settlement
agreements have materially adversely affected RJR Tobaccos shipment volumes. RAI believes that
these settlement obligations may materially adversely affect the results of operations, cash flows
or financial position of RAI and RJR Tobacco in future periods. The degree of the adverse impact
will depend, among other things, on the rate of decline in U.S. cigarette sales in the premium and
discount categories, RJR Tobaccos share of the domestic premium and discount cigarette categories,
and the effect of any resulting cost advantage of manufacturers not subject to the MSA and other
state settlement agreements.
Governmental Activity
The marketing, sale, taxation and use of cigarettes have been subject to substantial
regulation by government and health officials for many years. Various state governments have
adopted or are considering, among other things, legislation and regulations that would:
|
|
|
increase their excise taxes on cigarettes; |
|
|
|
|
restrict displays and advertising of tobacco products; |
|
|
|
|
establish ignition propensity standards for cigarettes; |
|
|
|
|
raise the minimum age to possess or purchase tobacco products; |
|
|
|
|
ban the sale of flavored cigarette brands; |
|
|
|
|
require the disclosure of ingredients used in the manufacture of tobacco products; |
|
|
|
|
impose restrictions on smoking in public and private areas; and |
|
|
|
|
restrict the sale of tobacco products directly to consumers or other unlicensed
recipients, including over the Internet. |
In addition, during the remainder of 2005, the U.S. Congress is considering or may consider
legislation regarding:
|
|
|
further increases in the federal excise tax; |
|
|
|
|
regulation of cigarette manufacturing and sale by the U.S. Food and Drug Administration; |
|
|
|
|
amendments to the Federal Cigarette Labeling and Advertising Act to require additional warnings; |
|
|
|
|
reduction or elimination of the tax deductibility of advertising expenses; |
|
|
|
|
implementation of a national standard for fire-safe cigarettes; |
|
|
|
|
regulation of the retail sale of cigarettes over the Internet and in other
non-face-to-face retail transactions, such as by mail order and telephone; and |
|
|
|
|
banning of the delivery of cigarettes by the U.S. Postal Service. |
Together with manufacturers price increases in recent years and substantial increases in state and
federal excise taxes on cigarettes, these developments have had and will likely continue to have an
adverse effect on cigarette sales.
Cigarettes are subject to substantial excise taxes in the United States. The federal excise
tax per pack of 20 cigarettes is $0.39. All states and the District of Columbia currently impose
excise taxes at levels ranging from $0.07 per pack in South Carolina to $2.46 per pack in Rhode
Island. In 2005, seven state legislatures have increased their cigarette excise tax per pack:
Kentucky (from $0.03 to $0.30), Maine (from $1 to $2), New Hampshire (from $0.52 to $0.80), North
Carolina (from $0.05 to $0.30 with an additional $0.05 effective in 2006), Ohio (from $0.55 to
$1.25), Washington (from $1.425 to $2.025) and Virginia, whose graduated increase of $0.10 per pack
(from $0.20 to $0.30) passed in 2004, went into effect. Although not a tax increase, Idaho voted
to make permanent $0.29 of the states
67
cigarette excise tax that was scheduled to sunset on June 30, 2005; the tax remains at $0.57
per pack. After consideration of these actions, the weighted average state cigarette excise tax
per pack, calculated on a 12-month rolling average, is $0.774. Several states still have pending
legislation proposing excise tax increases.
In addition, Minnesota enacted a health impact fee, effective August 1, 2005, that among
other things imposes a $0.75 per pack fee on cigarettes, which is in addition to its current
cigarette excise tax of $0.48 per pack. The legislation imposing the health impact fee expressly
states that its purpose is to recover for the state health care costs related to or caused by
tobacco use. RJR Tobacco and certain other tobacco manufacturers and distributors have filed a
motion in Minnesota state court to enforce provisions of the Minnesota settlement agreement, which
in the view of RJR Tobacco and the other moving parties released any right the state might have to
claim additional compensation for such costs, beyond that provided by the ongoing payments made to
the state annually pursuant to the terms of the settlement agreement. A hearing on this motion was
held on September 29, 2005. Additional briefing was requested by the court and was completed in
October 2005.
In December 2003, the California Environmental Protection Agency Air Resources Board issued a
Proposed Identification of Environmental Tobacco Smoke as a Toxic Air Contaminant for public
review. If environmental tobacco smoke is identified as a toxic air contaminant, the Air
Resources Board is required to prepare a report assessing the need and appropriate degree of
control of environmental tobacco smoke. RJR Tobacco cannot predict the form any future California
regulation may take.
Several states have enacted or have proposed legislation or regulations that would require
cigarette manufacturers to disclose the ingredients used in the manufacture of cigarettes. In
September 2003, the Massachusetts Department of Public Health, referred to as the MDPH, announced
its intention to hold public hearings on amendments to its tobacco regulations. The proposed
regulations would delete any ingredients-reporting requirement. (The United States Court of
Appeals for the First Circuit previously affirmed a ruling that the Massachusetts
ingredient-reporting law was unconstitutional.) MDPH also has proposed to inaugurate extensive
changes to its regulations requiring tobacco companies to report nicotine yield ratings for
cigarettes according to methods prescribed by MDPH. Because MDPH withdrew its notice for a public
hearing in November 2003, it is impossible to predict the final form any new regulations will take
or the effect they will have on the business or results of operations of RJR Tobacco.
In June 2000, the New York state legislature passed legislation charging the states Office of
Fire Prevention and Control with developing standards for fire-safe or self-extinguishing
cigarettes. On December 31, 2003, OFPC issued a final standard with accompanying regulations that
requires all cigarettes offered for sale in New York state after June 28, 2004, to achieve
specified test results when placed on ten layers of filter paper in controlled laboratory
conditions. The cigarettes that RAIs operating companies sell in New York state comply with this
standard. In 2005, each of California and Vermont enacted fire-safe legislation of its own,
adopting the same testing standard set forth in the OFPC regulations described above. This
requirement will take effect in Vermont on May 1, 2006, and in California on January 1, 2007.
Similar legislation is being considered in a number of other states. Varying standards from state
to state could have an adverse effect on the business or results of operations of RJR Tobacco.
RJR Tobacco expects to benefit from certain state legislative activity aimed at leveling the
playing field between original participating manufacturers under the MSA and nonparticipating
manufacturers under the MSA, referred to as NPMs. Forty-six states have passed legislation to
ensure NPMs are making required escrow payments. Under this legislation, a state would only permit
distribution of brands by manufacturers who are deemed by the states to be MSA-compliant. Failure
to make escrow payments could result in the loss of an NPMs ability to sell tobacco products in a
respective state. Early efforts to enact legislation, from 2001 to early 2002, resulted in a range
of NPM laws, some containing only minimal requirements. However, once the National Association of
Attorneys General, referred to as NAAG, became involved in the legislative initiative, model
complementary NPM language was developed and introduced in the states where either no NPM laws
existed or where existing laws needed to be amended to bring them in line with the model language.
Additionally, 44 states have enacted legislation that closes a loophole in the MSA. The
loophole allows NPMs that concentrate their sales in a single state, or a limited number of states,
to recover most of the funds from their escrow accounts. To obtain the refunds, the manufacturers
must establish that their escrow deposit was greater than the amount the state would have received
had the manufacturer been a subsequent participating manufacturer under the MSA (i.e., the
states allocable share). NAAG has endorsed adoption of the allocable share legislation needed
to eliminate this loophole. Following a challenge by NPMs, the United States District Court for
the Southern District of New York
68
has issued an order enjoining New York from enforcing allocable share legislation. It is
possible that NPMs will challenge allocable share legislation passed in other states.
Finally, four states, Alaska, Michigan, Minnesota and Utah, have enacted equity assessments
on NPMs products. This legislative initiative has not been endorsed by NAAG, and one NPM has
filed a challenge to the equity assessment in Michigan.
Thirty-three states have passed and several additional states are considering statutes
limiting the amount of the bonds required to file an appeal of an adverse judgment in state court.
The limitation on the amount of such bonds generally ranges from $25 million to $150 million. Such
bonding statutes allow defendants that are subject to large adverse judgments, such as cigarette
manufacturers, to reasonably bond such judgments and pursue the appellate process. In six other
jurisdictions, the filing of a notice of appeal automatically stays the judgment of the trial
court.
On October 22, 2004, the President signed the Fair and Equitable Tobacco Reform Act of 2004,
eliminating the U.S. government tobacco production controls and price support program. The buyout
of tobacco quota holders provided for in FETRA is funded by a direct quarterly assessment on every
tobacco product manufacturer and importer, on a market-share basis measured on volume to which
federal excise tax is applied. The aggregate cost of the buyout to the industry is approximately
$10.1 billion, payable over ten years, including approximately $9.6 billion of fixed obligation and
approximately $540 million resulting from the liquidation of quota tobacco stock. As a result of
the tobacco buyout legislation, the MSA Phase II obligations established in 1999 and scheduled to
expire by the end of 2010 will be continued, but will be offset against the tobacco quota buyout
obligations. RAIs operating subsidiaries annual expense under FETRA, excluding the tobacco stock
liquidation assessment, is estimated to be approximately $265 million for 2005, $255 million for
2006 and $250 million per year thereafter. RAIs operating subsidiaries have incurred $74 million
and $81 million of expense for the three months and nine months ended September 30, 2005, respectively,
related to assessments from quota tobacco stock liquidation. Of these amounts, approximately $20
million has been paid through the third quarter of 2005, and the remaining amount is scheduled to
be paid over the next five quarters. Remaining contingent liabilities for liquidation of quota
tobacco stock, if any, will be recorded when an assessment is made.
RAIs operating subsidiaries will record the FETRA assessment on a quarterly basis upon
required notification of assessments. RAIs operating
subsidiaries estimate that their overall share
of the buyout will approximate $2.4 billion to $2.9 billion prior to the deduction of permitted
offsets under the MSA and expected cost savings on domestic leaf purchases as a result of the
elimination of the tobacco quota program. In addition, future market pricing could impact the
carrying value of inventory, and adversely affect RJR Tobaccos financial condition and results of
operations. Of the accrued but unpaid MSA Phase II obligations, $69 million was reversed in the
fourth quarter of 2004, and $79 million was reversed in the first six months of 2005.
On December 23, 2004, the North Carolina Business Court held that RJR Tobacco was entitled to
a refund of its first three quarterly MSA Phase II payments made for 2004 of approximately $111
million, and was not obligated to make its fourth quarter payment of approximately $37 million. On
August 19, 2005, the North Carolina Supreme Court reversed the lower courts decision, and remanded
the case back to the North Carolina Business Court, where the MSA Phase II payments of
approximately $111 million previously made for 2004 were
released to the beneficiaries of the growers trust. On October 19, 2005, the North
Carolina Business Court denied RJR Tobaccos motion for additional proceedings on the issue of the
payment of the fourth quarter MSA Phase II payment of approximately $37 million, ordered RJR
Tobacco to make this payment within ten business days and ordered RJR Tobacco to pay pre-judgment
interest at 8% per annum from December 15, 2004, until the payment is made. In the third quarter
of 2005, RJR Tobacco recognized $39 million of expense relating to the court ruling.
For information concerning indemnifications between RJR Tobacco and B&W related to pre-closing
MSA liabilities, see note 7 to condensed consolidated financial statements (unaudited).
On May 21, 2003, the World Health Organization adopted a broad tobacco-control treaty. The
treaty recommends and requires enactment of legislation establishing specific actions to prevent
youth smoking, restrict and gradually eliminate tobacco products marketing, provide greater
regulation and disclosure of ingredients, increase the size and scope of package warning labels to
cover at least 30% of each package and include graphic pictures on packages. The treaty entered
into force on February 27, 2005 90 days after ratification by the 40th country. Within a year of
entering into force, a subsidiary body, the Conference of the Parties, will begin meeting to review
national reports, provide further guidance on proper implementation of the treaty, initiate
protocol negotiations and promote the mobilization of financial resources. Although the U.S.
delegate to the World Health Organization voted for the treaty in
69
May 2003, and the Secretary for Health and Human Services signed the document in May 2004, it
is not known whether the treaty will be sent to the U.S. Senate for ratification. Ratification of
the treaty by the United States could lead to broader regulation of the industry.
It is not possible to determine what additional federal, state or local legislation or
regulations relating to smoking or cigarettes will be enacted or to predict the effect of new
legislation or regulations on RJR Tobacco or the cigarette industry in general, but any new
legislation or regulations could have an adverse effect on RJR Tobacco or the cigarette industry in
general.
For further discussion of litigation and legal proceedings pending against RJR, its
affiliates, including RJR Tobacco, or indemnitees, including B&W, see note 7 to condensed
consolidated financial statements (unaudited).
Environmental Matters
RAI and its subsidiaries are subject to federal, state and local environmental laws and
regulations concerning the discharge, storage, handling and disposal of hazardous or toxic
substances. RAI and its subsidiaries have been engaged in a continuing program to assure compliance
with these environmental laws and regulations. Although it is difficult to identify precisely the
portion of capital expenditures or other costs attributable to compliance with environmental laws
and regulations, RAI does not expect such expenditures or other costs to have a material adverse
effect on the business or financial condition of RAI or its subsidiaries.
For further discussion of environmental matters, see -Environmental Matters in note 7 to
condensed consolidated financial statements (unaudited).
Other Contingencies and Guarantees
In connection with the business combination of RJR Tobacco and the U.S. cigarette and tobacco
business of B&W on July 30, 2004, RJR Tobacco has agreed to indemnify B&W and its
affiliates against any liabilities, costs and expenses incurred by B&W or its affiliates arising
out of the U.S. cigarette and tobacco business of B&W. Although it is impossible to predict the
possibility or amount of any such liabilities, costs and expenses, a significant indemnification
claim by B&W against RJR Tobacco could have an adverse effect on either
or both of RAI and RJR Tobacco.
Also, as part of the business combination, B&W transferred to RJR Tobacco, along with its U.S.
operations, cash of $604 million, an amount equal to its estimated pre-closing accrued liabilities
under the MSA and related agreements, referred to as the MSA Liability Amount. B&W will indemnify
RAI and its subsidiaries to the extent the actual pre-closing MSA
liabilities paid by RJR Tobacco exceed,
and RJR Tobacco will indemnify B&W to the extent the actual pre-closing
MSA liabilities paid by RJR Tobacco are
less than, the MSA Liability Amount. On February 14, 2005, RJR Tobacco received a formal notice
from B&W claiming that B&W was entitled to a return of approximately $52.8 million of the MSA
Liability Amount resulting from the offset of B&Ws pre-closing MSA Phase II obligations against
certain of RJR Tobaccos tobacco quota obligations as a result of FETRA. In the third quarter of
2005, RJR Tobacco agreed to pay B&W $14 million in settlement of this
claim.
In the first quarter of 2005, Commonwealth Brands, Inc. was served with two individual smoking
and health cases, Croft v. Akron Gasket in Cuyahoga County, Ohio, and Ryan v. Philip Morris,
U.S.A., Inc. in Jay County, Indiana. Commonwealth requested indemnity from RJR Tobacco pursuant to
the 1996 Purchase Agreement, in which B&W agreed to indemnify Commonwealth for certain claims. As a
result of the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of
B&W, RJR Tobacco agreed to indemnify Commonwealth for these
claims to the extent, if any, required
by the 1996 Purchase Agreement.
Until the acquisition by merger by Philip Morris Companies, Inc. of Nabisco from NGH on
December 11, 2000, NGH and Nabisco were members of the consolidated group of NGH for U.S. federal
income tax purposes. Each member of a consolidated group is jointly and severally liable for the
U.S. federal income tax liability of other members of the group as well as for pension and funding
liabilities of the other group members. NGH, now known as RJR Acquisition Corp., continues to be
jointly and severally liable for these Nabisco liabilities prior to December 11, 2000.
In connection with Philip Morriss acquisition by merger of Nabisco and RJRs subsequent
acquisition by merger of NGH, Philip Morris, Nabisco and NGH entered into a voting and indemnity
agreement and tax sharing agreement that generally seeks to allocate tax liabilities ratably based
upon NGHs taxable income and that of Nabisco,
70
had the parties been separate taxpayers. If Philip Morris and Nabisco are unable to satisfy
their obligations under this agreement, NGH would be responsible for satisfying them.
In connection with the sale of the international tobacco business to Japan Tobacco Inc., on
May 12, 1999, pursuant to the 1999 Purchase Agreement, RJR and RJR Tobacco agreed to indemnify JTI
against:
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any liabilities, costs and expenses arising out of the imposition or assessment
of any tax with respect to the international tobacco business arising prior to the
sale, other than as reflected on the closing balance sheet; |
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any liabilities, costs and expenses that JTI or any of its affiliates, including
the acquired entities, may incur after the sale with respect to any of RJRs or RJR
Tobaccos employee benefit and welfare plans; and |
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any liabilities, costs and expenses incurred by JTI or any of its affiliates
arising out of certain activities of Northern Brands. |
As
described above under Commitments and Contingencies Litigation Affecting the Cigarette
Industry in note 7, RJR Tobacco has received several claims for indemnification from JTI under
these indemnification provisions in connection with the activities of Northern Brands and its
affiliates. Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have
indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree
whether the circumstances described in such claims give rise to any indemnification obligations by
RJR and RJR Tobacco. RJR and RJR Tobacco have conveyed their position to JTI, and the parties have
agreed to resolve their differences at a later date. RJR has liabilities totaling $96 million that
were recorded in 1999 in connection with these indemnification claims.
RJR Tobacco, Santa Fe and Lane have entered into agreements to indemnify certain distributors
and retailers from liability and related defense costs arising out of the sale or distribution of
their products. Additionally, Santa Fe has entered into an agreement to indemnify a supplier from
liability and related defense costs arising out of the sale or use of Santa Fes products. The cost
of such defense indemnification has been, and is expected to be, insignificant. RJR Tobacco, Santa
Fe and Lane believe that the indemnified claims are substantially similar in nature and extent to
the claims that they are already exposed to by virtue of their having manufactured those products.
Under certain circumstances, including RJRs guaranteed, secured debt rating remaining either
one level below BBB- by S&P or Baa3 by Moodys, or lower, any fair value that results in a
liability position of the interest rate swaps will require full collateralization with cash or
securities.
RAI is not able to estimate the maximum potential amount of future payments, if any, related
to these guarantees and indemnification obligations.
Cautionary Information Regarding Forward-Looking Statements
Statements included in this report that are not historical in nature are forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. These statements regarding RAIs future performance and financial results inherently
are subject to a variety of risks and uncertainties, described in the forward-looking statements.
These risks and uncertainties include:
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the substantial and increasing regulation and taxation of the cigarette
industry; |
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various legal actions, proceedings and claims relating to the sale,
distribution, manufacture, development, advertising, marketing and claimed health
effects of cigarettes that are pending or may be instituted against RAI or its
subsidiaries; |
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the substantial payment obligations and limitations on the advertising and
marketing of cigarettes under various litigation settlement agreements; |
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the continuing decline in volume in the domestic cigarette industry; |
71
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competition from other cigarette manufacturers, including increased promotional
activities and continued pressure from deep-discount brands; |
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the success or failure of new product innovations and acquisitions; |
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the responsiveness of both the trade and consumers to new products and marketing
and promotional programs; |
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any potential costs or savings associated with realigning the cost structure of
RAI and its subsidiaries; |
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the ability to realize the anticipated benefits and synergies arising from the
combination of RJR Tobacco and the U.S. cigarette and tobacco business of B&W; |
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the ability to achieve efficiencies in manufacturing and distribution operations
without negatively affecting sales; |
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the cost and availability of tobacco leaf and other raw materials and other
commodities used in products, including future market pricing of tobacco leaf which
could adversely impact inventory valuations; |
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the effect of market conditions on foreign currency exchange rate risk, interest
rate risk and the return on corporate cash; |
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the effect of market conditions on the performance of pension assets or any
adverse effects of any new legislation or regulations changing pension expense
accounting or required pension funding levels; |
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the rating of RJRs securities; |
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any adverse effects from the transition of the packaging operations formerly
conducted by RJR Packaging, LLC, a wholly owned subsidiary of RJR Tobacco, to the
buyers of RJR Packaging, LLCs businesses; and |
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the potential existence of significant deficiencies or material weaknesses in
internal controls over financial reporting that may be identified during the
performance of testing required under Section 404 of the Sarbanes-Oxley Act of
2002. |
Due to these uncertainties and risks, you are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this report. Except as provided by
federal securities laws, RAI is not required to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise.
72
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact the consolidated financial position,
results of operations and cash flows due to adverse changes in financial market prices and rates.
RAI and its subsidiaries are exposed to interest rate risk directly related to their normal
investing and funding activities. In addition, RAI and its subsidiaries have exposure to foreign
currency exchange rate risk concerning obligations for, and service agreements related to, foreign
operations denominated in euros and British pounds. RAI and its subsidiaries have established
policies and procedures to manage their exposure to market risks and use major institutions that
are creditworthy to minimize their investment and credit risk. Derivative financial instruments are
not used for trading or speculative purposes.
The value-at-risk model is used to statistically measure the maximum fair value, cash flows
and earnings loss over one year from adverse changes in interest rates and foreign currency rates.
The computation assumes a 95% confidence level under normal market conditions. The actual observed
correlation method is used for aggregating value at risk amounts across market risk exposure
categories. This model indicates that near-term changes in interest rates and foreign currency
rates will not have a material impact on the future earnings, fair values or cash flows, based on
the historical movements in interest rates, foreign currency rates and the fair value of
market-rate sensitive instruments at September 30, 2005.
Item 4. Controls and Procedures
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(a) |
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RAIs chief executive officer and chief financial officer have concluded that RAIs
disclosure controls and procedures were effective as of the end of the period covered by
this report, based on their evaluation of these controls and procedures. |
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(b) |
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There have been no changes in RAIs internal controls over financial reporting that
occurred during the third quarter of 2005 that have materially affected, or are reasonably
likely to materially affect, RAIs internal controls over financial reporting. |
73
PART II Other Information
Item 1. Legal Proceedings
For a discussion of the litigation and legal proceedings pending against RAI and its
subsidiaries, including RJR Tobacco, and its indemnitees, including B&W, see note 7 to condensed
consolidated financial statements (unaudited) and Managements Discussion and Analysis of
Financial Condition and Results of Operations Liquidity and Financial Condition Litigation and
Settlements and - Governmental Activity included in Part I-Financial Information.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
RAI repurchases shares forfeited with respect to the tax liability associated with certain
option exercises under the RAI Long-Term Incentive Plan. Additionally, to maintain B&Ws ownership
level of 42%, RAI was required to repurchase shares, dependent upon certain stock issuances,
through September 2005. Due to RAIs incorporation in North Carolina, which does not recognize
treasury shares, any shares repurchased are cancelled at the time of repurchase.
The following table summarizes RAIs share purchases of common stock during the third quarter
of 2005:
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Total Number of |
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Approximate Dollar |
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Shares Purchased |
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Value that May Yet |
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Total Number |
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Average Price |
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as Part of Publicly |
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Be Purchased Under |
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of Shares |
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Paid per |
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Announced Plans or |
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the Plans or |
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Purchased |
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Share |
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Programs |
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Programs |
July 1, 2005 to
July 31, 2005 |
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N/A |
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August 1, 2005 to
August 31, 2005 |
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4,752 |
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$ |
85.45 |
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N/A |
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September 1, 2005
to September 30,
2005 |
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4,135 |
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81.27 |
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N/A |
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Third Quarter Total |
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8,887 |
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$ |
83.51 |
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N/A |
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RAI conducts its business through its subsidiaries and is dependent on the earnings and cash
flows of its subsidiaries to satisfy its obligations and other cash needs. RJRs revolving credit
facility limits the payment of dividends by RAI, a guarantor of the credit facility, on its common
stock in excess of specific amounts. For more information, see Managements Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Financial Condition in
Part I, Item 2 and note 6 to condensed consolidated financial statements (unaudited). RJR believes
that the provisions of its credit facility and the guarantees of its credit facility, interest rate
swaps and guaranteed, secured notes will not impair RAIs payment of quarterly dividends.
Item 4. Submission of Matters to a Vote of Security Holders
On June 21, 2005, RJR commenced the Offer to purchase any and all of its then outstanding $500
million of 7.75% secured notes due May 15, 2006, and a consent solicitation to amend the related
indenture. The Amendments required the consent of at least a majority of the noteholders to become
effective. The Offer expired on July 19, 2005, with holders of approximately $310 million of the
2006 Notes having tendered their notes and having consented to the Amendments. The Amendments
substantially eliminated all of the restrictive covenants and one of the events of default with
respect to the 2006 Notes.
74
Item 6. Exhibits
(a) Exhibits
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Exhibit |
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Number |
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Description |
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4.1
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Fourth Supplemental Indenture, dated
July 6, 2005, by and among R.J.
Reynolds Tobacco Holdings, Inc.,
Reynolds American Inc. and various
subsidiaries of Reynolds American
Inc. as guarantors, and The Bank of
New York, as trustee (incorporated
by reference to Exhibit 4.1 to
Registrants Form 8-K dated July 6,
2005). |
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10.1
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First Amendment to Supply Agreement,
dated September 16, 2005, by and
between R. J. Reynolds Tobacco
Company and Alcan Packaging Food and
Tobacco Inc. |
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10.2
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Octobe 2005 Amendments to the
Contract Manufacturing Agreement,
dated as of July 30, 2004, by and
between R. J. Reynolds Tobacco
Company and BATUS Japan, Inc. |
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31.1
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Certification of Chief Executive
Officer relating to RAIs Quarterly
Report on Form 10-Q for the quarter
ended September 30, 2005. |
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31.2
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Certification of Chief Financial
Officer relating to RAIs Quarterly
Report on Form 10-Q for the quarter
ended September 30, 2005. |
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32.1
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Certification of Chief Executive
Officer and Chief Financial Officer
relating to RAIs Quarterly Report
on Form 10-Q for the quarter ended
September 30, 2005, pursuant to
Section 18 U.S.C. §1350, adopted
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. |
75
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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REYNOLDS AMERICAN INC.
(Registrant)
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/s/ Dianne M. Neal
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Dianne M. Neal |
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Executive Vice President and Chief Financial Officer |
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(principal financial officer) |
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Date: November 3, 2005
76