Reynolds American Inc.
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.
20549
FORM 10-K
(Mark
One)
þ ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
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
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer Identification
Number)
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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)
Securities registered pursuant to Section 12(b) of the
Act:
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Name of each
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Name of each
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exchange on which
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exchange on which
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Title of each class
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registered
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Title of each class
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registered
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Common stock, par value $.0001 per
share
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New York
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Rights to Purchase Series A
Junior Participating Preferred Stock
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New York
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Securities registered pursuant to Section 12(g) of the
Act: None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Exchange
Act. Yes þ No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. Yes o No þ
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 if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (check one)
Large accelerated
filer þ
Accelerated
filer o Non-accelerated
filer o
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
The aggregate market value of common stock held by
non-affiliates of Reynolds American Inc. on June 30, 2006,
was approximately $9.8 billion, based on the closing price
of $57.65. Directors, executive officers and a significant
shareholder of Reynolds American Inc. are considered affiliates
for purposes of this calculation but should not necessarily be
deemed affiliates for any other purpose.
Indicate the number of shares outstanding of each of the
registrants classes of common stock, as of the latest
practicable date: February 16, 2007: 295,626,506 shares of
common stock, par value $.0001 per share.
Documents Incorporated by Reference:
Portions of the Definitive Proxy Statement of Reynolds American
Inc. to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A of the Securities Exchange Act
of 1934 on or about March 30, 2007, are incorporated by
reference into Part III of this report.
PART I
Item 1. Business
Reynolds American Inc. was incorporated as a holding company in
the state of North Carolina on January 5, 2004, and its
common stock is listed on the NYSE under the symbol RAI. RAI was
created to facilitate transactions on July 30, 2004, to
combine the U.S. assets, liabilities and operations of
Brown & Williamson Holdings, Inc., formerly known as
Brown & Williamson Tobacco Corporation and 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. RJR is now
a wholly owned subsidiary of RAI. RAIs headquarters are
located in Winston-Salem, North Carolina.
RAIs Internet web site address is
www.reynoldsamerican.com. RAIs annual reports on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
insider trading reports on Forms 3, 4 and 5 and all
amendments to those reports are available free of charge through
RAIs web site, as soon as reasonably practicable after
such material is electronically filed with, or furnished to, the
SEC. RAIs Internet web site and the information contained
therein or connected thereto are not intended to be incorporated
into this Annual Report on
Form 10-K.
Pursuant to requirements of the NYSE, in May 2006, the chief
executive officer of RAI filed a form of Annual CEO
Certification with the NYSE regarding RAIs compliance with
the NYSEs corporate governance listing standards. In
addition, RAIs chief executive officer and chief financial
officer have signed certifications required by the SEC regarding
RAIs public disclosures. These SEC certifications have
been included as Exhibits 31.1 and 31.2 to this
Form 10-K
for the year ended December 31, 2006.
On July 19, 2006, RAI announced that its board of directors
had declared a
two-for-one
stock split, to be effected in the form of a 100% stock dividend
of its common stock, to shareholders of record on July 31,
2006. The stock dividend was distributed to RAIs
shareholders on August 14, 2006. All current and prior
period share and per share amounts have been adjusted to reflect
this stock split.
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.
RAIs wholly owned subsidiaries include its operating
subsidiaries, RJR Tobacco, 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. In addition, RAIs operating
subsidiaries include the companies, collectively referred to as
Conwood, acquired on May 31, 2006, by RAIs newly
formed subsidiary, Conwood Holdings, Inc., described below under
Conwood Acquisition.
RAIs largest operating segment, RJR Tobacco, is the second
largest cigarette manufacturer in the United States. RJR
Tobaccos largest selling cigarette brands, CAMEL, KOOL,
DORAL, WINSTON and SALEM, were five of the ten best-selling
brands of cigarettes in the United States in 2006. Those brands,
and its other brands, including PALL MALL, MISTY and CAPRI, are
manufactured in a variety of styles and marketed in the
United States. RJR Tobacco also manages a contract
manufacturing business through arrangements with BAT affiliates.
RAIs other reportable operating segment, Conwood, is the
second largest smokeless tobacco products manufacturer in the
United States. See Conwood Acquisition
below for information relating to the May 31, 2006,
acquisition. Conwoods primary brands include its largest
selling moist snuff brands, GRIZZLY and KODIAK, two of the six
best-selling brands of moist snuff in the United States, and
LEVI GARRETT, a loose leaf brand. Conwoods other products
include dry snuff, plug and twist tobacco products. All of
Conwoods products held the first or second position in
market share in their respective categories in 2006.
The disclosures classified as All Other include the total assets
and results of operations of Santa Fe, Lane and GPI.
Santa Fe manufactures and markets cigarettes and other
tobacco products under the NATURAL AMERICAN
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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
DUNHILL and CAPTAIN BLACK tobacco products. GPI manufactures and
exports cigarettes to U.S. territories, U.S. duty-free
shops and U.S. overseas military bases, and manages a
contract manufacturing business. Beginning on January 1,
2007, Conwood will distribute certain of Lanes
non-cigarette products, and RJR Tobacco will distribute DUNHILL
cigarettes. Also, beginning on January 1, 2007, GPI will
manage Santa Fes international business.
For net sales, operating income and total assets attributable to
each segment, see note 18 to consolidated financial
statements.
RAI
Strategy
RAI will focus on delivering sustainable earnings growth and
strong cash flow and building long-term shareholder value. To
this end, RAI expects its activities and initiatives to be
driven by the strategic platforms of long-term market share
growth and productivity enhancement for its key tobacco
operating subsidiaries, while maintaining high standards of
corporate governance and business conduct in a high performing
culture.
Conwood
Acquisition
On May 31, 2006, RAI, through its newly formed subsidiary,
Conwood Holdings, Inc., completed its $3.5 billion
acquisition of 100% of the capital stock of a newly formed
holding company owning Conwood Company, L.P., Conwood Sales Co.,
L.P., Rosswil LLC, Scott Tobacco LLC, Conwood LLC, Conwood-1
LLC, and Conwood-2 LLC. Conwood LLC, Conwood-1 LLC and Conwood-2
LLC were merged into Conwood Holdings, Inc. in 2006. Also during
2006, Conwood Company, L.P. and Conwood Sales Co., L.P. were
converted into limited liability companies and renamed Conwood
Company, LLC and Conwood Sales Co., LLC, respectively. The
acquired companies are collectively referred to as Conwood.
Conwood is engaged in the business of developing, manufacturing
and marketing smokeless tobacco products. Conwoods
headquarters and primary manufacturing facility are located in
Memphis, Tennessee. The Conwood acquisition was funded by RAI
borrowings, new debt securities issued by RAI and available
cash. See Liquidity and Financial
Position in Item 7 and notes 11 and 12 to
consolidated financial statements for additional information
relating to borrowing arrangements and long-term debt. The
transaction was treated as a purchase of the Conwood net assets
by RAI for financial accounting purposes. RAI believes the
Conwood acquisition will enhance shareholder value and will
continue to be accretive to operating earnings.
The Conwood acquisition also is expected to enhance RAIs
efforts to offer a range of differentiated tobacco products to
adult consumers. RAI intends to combine certain operations of
Lane with Conwood, to be completed by the end of 2007, in order
to consolidate and strengthen the companies portfolio of
smokeless and other non-cigarette tobacco products.
Other
Acquisitions and B&W Business Combination
Transactions
Prior to June 1999, RJR was a subsidiary of Nabisco Group
Holdings Corp., referred to as NGH. In May 1999, RJR transferred
cash and its 80.5% interest in Nabisco Holdings Corp., referred
to as Nabisco, to NGH through a merger transaction. In June
1999, NGH distributed all of the outstanding shares of RJR
common stock to NGH common stockholders. Shares of RJR common
stock began trading separately on June 15, 1999, on the
NYSE. In 2000, RJR acquired its former parent, NGH, a
non-operating public shell company with no material assets or
liabilities other than $11.8 billion in cash.
On January 16, 2002, RJR acquired all of the voting stock
of privately held Santa Fe for $354 million. Although
Santa Fe is an operating segment of RAI, its financial
condition and results of operations do not meet the materiality
criteria to be reportable as a separate segment. As a result,
information related to Santa Fe is not generally disclosed
separately in this document.
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
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manufacture and market a limited portfolio of American-blend
cigarette brands. GPI manages RJRs interest in the joint
venture. The joint venture, headquartered in Switzerland,
markets its products primarily in Italy, France and Spain. This
investment is accounted for using the equity method.
RAI believes that the acquisitions of NGH and Santa Fe, and
the joint venture with Gallaher Group Plc have provided
meaningful opportunities for RAI to build shareholder value.
Santa Fes approach to building brand equity is
consistent with RJR Tobaccos strategy for its growth
brands, and the acquisition was originated in order to enhance
RAIs consolidated earnings. The joint venture provides RAI
an opportunity to compete in the growing international
American-blend market, and became accretive to earnings in 2004.
RAI facilitated the July 30, 2004, transactions to combine
the U.S. assets, liabilities and operations of B&W with
RJR Tobacco. 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 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 then owned all of the capital stock
of Lane, and RJR became a wholly owned subsidiary of RAI. These
July 30, 2004, transactions generally are referred to as
the B&W business combination. In 2006, CMSI was merged with
and into Lane, and Lane became a direct, wholly owned subsidiary
of RAI.
RAI believes the B&W business combination has provided
significant efficiencies and has enhanced RJR Tobaccos
ability to compete effectively in the U.S. market. The
merger is accretive to earnings and provides value and return to
RAIs shareholders.
In December 2005, GPI acquired from Japan Tobacco Inc., referred
to as JTI, its U.S. duty-free and U.S. overseas
military businesses relating to certain brands. The acquisition
was accounted for as a purchase, with its cost of
$45 million allocated on the basis of the estimated fair
market value of the inventory and intangible assets acquired.
The related rights were previously sold to JTI in 1999 as a part
of the sale of RJRs international tobacco business.
RJR
Tobacco
Cigarette
Industry Overview
RJR Tobacco conducts its business in the highly competitive
U.S. cigarette market, which has a few large manufacturers
and many smaller participants. The U.S. cigarette market is
a mature market in which overall consumer demand has declined
since 1987 and is expected to continue to decline.
U.S. cigarette shipments as tracked by Management Science
Associates, Inc., referred to as MSAi, report that shipments
declined 2.4% in 2006, to 372.5 billion cigarettes, 3.4% in
2005 and 1.8% in 2004.
In addition to decreases in consumption, profitability of the
U.S. cigarette industry and RJR Tobacco continues to be
adversely impacted by increases in state excise taxes and
governmental regulations and restrictions, such as marketing
limitations, product standards and ingredients legislation.
Competition
RJR Tobaccos primary competitors include Philip Morris USA
Inc., a subsidiary of Altria Group, Inc., and Lorillard Tobacco
Company, an indirect subsidiary of the Loews Corporation, as
well as manufacturers of deep-discount brands. Deep-discount
brands are brands manufactured by companies that are not
original participants in the Master Settlement Agreement,
referred to as MSA, and accordingly, do not have cost structures
burdened with MSA-related payments to the same extent as the
original participating manufacturers. For further discussion,
see Litigation Affecting the Cigarette
Industry-Governmental Health-Care Cost Recovery Cases-MSA and
Other State Settlement Agreements in Item 3 and
Critical Accounting Policies and
Estimates in Managements Discussion and
Analysis of Financial Condition and Results of Operations
in Item 7.
Based on data collected by Information Resources Inc./Capstone
Research, Inc., referred to as IRI, during 2006, 2005 and 2004,
Philip Morris USA Inc. had an overall retail share of the
U.S. cigarette market of 50.86%,
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50.59% and 50.00%, respectively. During these same years, the
combined share of RJR Tobacco and B&W brands was 29.78%,
30.28% and 31.12%, respectively.
Domestic shipment volume and retail share of market data that
appear in this document have been obtained from MSAi and IRI.
These two organizations are the primary sources of data relating
to the cigarette and tobacco industry. This information 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. However,
you should not rely on the market share data reported by IRI as
being precise measurements of actual market share because IRI is
not able to effectively track the volume of all deep-discount
brands. RJR Tobacco believes that deep-discount brands made by
small manufacturers have a combined market share of
approximately 13% of U.S. industry unit sales. Accordingly,
the retail share of market of RJR Tobacco and its brands as
reported by IRI may overstate their actual market share. In
addition, in 2006, IRI revised its methodology to better reflect
industry dynamics and restated share data only for 2005. The
revised methodology by IRI did not have a material impact on the
percentages previously reported.
Competition is based primarily on brand positioning, including
price, 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. Most
recently, competition among the major manufacturers has focused
on product innovation and expansion, including into the
smokeless tobacco category, as well as efficient and effective
means of balancing market share and profit growth.
With the exception of the growth of the deep-discount brands
from 1998 through 2003, major manufacturers have had a
competitive advantage in the United States because significant
cigarette marketing restrictions and the scale of investment
required to compete made gaining consumer awareness and trial of
new brands difficult.
Marketing
RJR Tobacco is committed to building and maintaining a portfolio
of profitable 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. RJR Tobaccos
competitive pricing includes list price changes, discounting
programs, such as retail buydowns, free product promotions and
consumer coupons. Retail buydowns refer to payments made to the
retailer to reduce the price that consumers pay at retail.
Consumer coupons are distributed by a variety of methods,
including in, or on, the cigarette pack and by direct mail. Free
product promotions include offers such as Buy 2 packs, Get
1 pack free. The cost of free product promotions is
recorded in cost of goods sold.
RJR Tobacco provides trade incentives through trade terms,
wholesale partner programs and retail incentives. Trade
discounts are provided to wholesalers based on compliance with
certain terms. The wholesale partner programs provide incentives
to RJR Tobaccos direct buying customers based on
performance levels. Retail incentives are paid to the retailer
based on compliance with RJR Tobaccos contract terms.
RJR Tobaccos brand portfolio strategy during 2005 and 2006
included three categories of brands: investment, selective
support and non-support. The investment brands were CAMEL and
KOOL, which received significant resources focused on
accelerating their
share-of-market
growth. The selective support brands included two premium
brands, WINSTON and SALEM, and two value brands, DORAL and PALL
MALL, all of which received limited support in an effort to
optimize profitability. The non-support brands were managed to
maximize near-term profitability.
At the beginning of 2007, RJR Tobacco further refined its brand
portfolio strategy and modified the three categories of brands
to growth, support and non-support. The growth brands include
two premium brands, CAMEL and KOOL, and a value brand, PALL
MALL. Although all of these brands are managed for long-term
accelerated growth and profit, CAMEL and KOOL will continue to
receive significant investment support, consistent with their
previous investment brand status. The support brands include
three premium brands, WINSTON, SALEM and CAPRI, and two value
brands, DORAL and MISTY, all of which receive limited support
for scale and long-term
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profit. The non-support brands include all remaining brands and
are managed to maximize near-term profitability. RJR Tobacco
expects that, within the next four years, this focused portfolio
strategy will result in growth in total RJR Tobacco share, as
gains on growth brands more than offset declines among other
brands.
During 2006, CAMELs filtered styles delivered growth of
0.68 share points based on the strength of the brands
equity, competitive promotions and innovative product and
packaging. CAMEL obtained its highest share point growth since
1947. In 2006, CAMEL introduced new CAMEL Wides packaging and
initiated efforts to enhance the performance of the brands
menthol styles, including new packaging and new CAMEL Wides
Menthol styles. CAMEL Menthol share more than doubled in 2006
driven by these factors and its successful distribution
expansion. In January 2007, CAMEL launched CAMEL No. 9,
offering a light, flavorful tobacco blend with distinctive
packaging intended to appeal to female adult smokers.
In 2006, CAMEL introduced CAMEL SNUS, a smokeless, spitless
tobacco product, in test markets. The SNUS test markets are
providing valuable insights into adult tobacco consumer
preferences.
KOOL continues to maintain its appeal among adult menthol
smokers and had an increase in its retail share for the second
year in a row, with an increase of 0.13 share points in
2006. In the fourth quarter of 2006, KOOL introduced on a
limited distribution, KOOL XL, a wide-gauge cigarette style,
delivering innovation in the highly competitive and growing
menthol category.
PALL MALL increased its share of market by 0.28 share
points in 2006 and continues to demonstrate its strength in the
value category based on its unique product platform of being a
longer lasting cigarette.
The combined share of market of the growth brands of 12.41%
represents a 1.09 share point increase over 2005. However,
the decline in share of support and non-support brands more than
offset the gains of the growth brands. Through 2006, total share
loss has moderated to a 0.50 share loss, from a 0.84 and
1.27 share loss in 2005 and 2004, respectively.
Anti-smoking groups have attempted to restrict cigarette sales,
cigarette advertising, and the testing and introduction of new
cigarette products, as well as encourage smoking bans. The MSA
and other state settlement agreements and other federal, state
and local laws restrict utilization of television, radio or
billboard advertising or certain other marketing and promotional
tools for cigarettes. RJR Tobacco continues to use
advertisements in magazines where the vast majority of readers
are adults 18 years of age or older, direct mailings and
other means to market its brands and enhance their appeal among
age-verified adult smokers. RJR Tobacco continues to advertise
and promote at retail cigarette locations and in adult venues
where permitted. See note 1 to consolidated financial
statements and Managements Discussion and Analysis
of Financial Condition and Results of Operations
Results of Operations for further information, including
advertising expense.
Manufacturing
and Distribution
RJR Tobacco owns its cigarette manufacturing facilities, which
are located in the Winston-Salem, North Carolina area: the
Tobaccoville manufacturing facility; and the Whitaker Park
complex, which includes a manufacturing facility, RJR
Tobaccos Central Distribution Center and a pilot plant for
trial manufacturing of new products. RJR Tobacco has a combined
production capacity of approximately 160 billion cigarettes
per year.
RJR Tobacco sells its cigarettes primarily to distributors,
wholesalers and other direct customers, some of which are retail
chains. RJR Tobacco distributes its cigarettes primarily to
public warehouses located throughout the United States that
serve as local distribution centers for its customers. No
significant backlog of orders existed at December 31, 2006
or 2005.
Sales made by RJR Tobacco to McLane Company, Inc., a
distributor, comprised 29%, 27% and 30% of RJR Tobaccos
revenue in 2006, 2005 and 2004, respectively. No other customer
accounted for 10% or more of RJR Tobaccos revenue during
those years. RJR Tobacco believes that its relationship with
McLane is good. RJR Tobaccos sales to McLane are not
governed by any written supply contract; however, McLane and RJR
Tobacco are parties to an arrangement, whereby RJR Tobacco
observes McLanes inventory to manage the supply and level
of McLanes inventory. McLane and RJR Tobacco are parties
to certain contracts in which consideration is based on
McLanes compliance with specified performance levels and
incentive terms.
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Raw
Materials
In its production of tobacco products, RJR Tobacco uses U.S. and
foreign burley and flue-cured leaf tobaccos, as well as Oriental
tobaccos grown primarily in Turkey and Greece. RJR Tobacco
believes there is a sufficient supply in the worldwide tobacco
market to satisfy its current and anticipated production
requirements.
RJR Tobacco purchases the majority of its U.S. flue-cured
and burley leaf directly through contracts with tobacco growers.
These short-term contracts are frequently renegotiated. RJR
Tobacco believes the relationship with its suppliers is good.
Under the terms of settlement agreements with flue-cured and
burley tobacco growers, and quota holders in connection with the
DeLoach class action litigation, RJR Tobacco is required,
among other things, to purchase minimum amounts of
U.S. flue-cured and burley tobacco, subject to adjustment
based on its annual total requirements for each type of tobacco.
For additional information related to the DeLoach case,
see Litigation Affecting the Cigarette
Industry-Antitrust Cases in Item 3.
On May 2, 2005, RJR Tobacco and RJR Packaging, LLC sold the
assets and business of RJR Packaging, LLC to five packaging
companies. In connection with this sale, RJR Tobacco entered
into agreements with four of the purchasers, pursuant to which
those companies supply RJR Tobacco with certain of its tobacco
packaging materials requirements. As a result, RJR Tobacco is
now dependent upon third parties for its packaging requirements.
Conwood
Smokeless
Tobacco Industry Overview
The smokeless tobacco industry consists of five categories:
moist snuff, loose leaf, dry snuff, plug and twist. The moist
snuff category is further divided into premium brands and
price-value brands. The moist snuff category has become
increasingly sophisticated in recent years and has developed
many of the characteristics of the larger cigarette market,
including multiple pricing tiers with intense competition,
focused marketing programs and significant product innovation.
In contrast to the declining U.S. cigarette market,
U.S. moist snuff volumes have grown at an average rate of
approximately 4% per year over the last four years, with an
accelerated growth rate for price-value brands. Also, the profit
margins on moist snuff are significantly higher than in the
cigarette industry. Moist snuffs growth is partially
attributable to cigarette smokers switching from cigarettes to
smokeless tobacco products or consuming both. Within the moist
snuff category, premium brands have lost market share to
price-value brands in recent years.
Moist snuff has been the key driver to Conwoods overall
growth and profitability within the U.S. smokeless tobacco
market. Moist snuff accounted for 75% of Conwoods revenue
in 2006. Conwood offers KODIAK and HAWKEN in the premium brand
category and GRIZZLY and COUGAR in the price-value brand
category. Conwoods U.S. moist snuff market share was
approximately 25.15% in 2006 based on distributor reported data
processed by MSAi for distributor shipments to retail. Conwood
has more than doubled its total market share of moist snuff in
the past six years. Conwoods continued growth is
attributable to its innovation, product development and brand
building, including the launch of the GRIZZLY moist snuff brand
in 2001. GRIZZLY had a 19.45% market share in 2006.
Loose leaf accounts for 18% of Conwoods revenues in 2006,
led by the LEVI GARRETT brand.
Competition
The competition in the smokeless tobacco market is significant.
Conwood is the second largest smokeless tobacco company in the
United States. Conwoods largest competitor is
U.S. Smokeless Tobacco Company, which had approximately
62.72% of the moist snuff market share in 2006. Conwood also
competes in the U.S. smokeless tobacco market with both
domestic and international companies marketing and selling
price-value and
sub-price-value
smokeless tobacco products. In addition, RJR Tobaccos
largest competitor in the cigarette market,
Phillip Morris USA Inc., has recently begun test
marketing a smokeless tobacco product.
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Conwood is the only company in the industry to manufacture and
sell products in every segment of the smokeless tobacco market.
Conwood holds either the first or second market position in each
of the moist snuff, loose leaf, dry snuff, plug and twist
tobacco categories.
Similar to the cigarette market, competition is based primarily
on brand positioning and price, as well as product attributes
and packaging, consumer loyalty, promotions, advertising and
retail presence.
Marketing
Conwood has made significant contributions in the development of
the smokeless industry. Conwood was responsible for the
innovative packaging of smokeless products, including the
development of a foil pouch for chewing tobacco and a plastic
can for moist snuff. Brands such as LEVI GARRETT, HAWKEN, KODIAK
and GRIZZLY achieved consumer acceptance quickly upon being
introduced.
Conwood is committed to being an innovative industry leader with
high standards in its production operations and in the servicing
of its customers needs.
Manufacturing
and Distribution
Conwoods primary manufacturing facility is located in
Memphis, Tennessee. Other facilities are located in
Winston-Salem, North Carolina; Bowling Green, Kentucky; Sanford,
North Carolina; Springfield, Tennessee; and Clarksville,
Tennessee. Conwood sells its products primarily to distributors,
wholesalers and other direct customers, some of which are retail
chains.
Sales made by Conwood to McLane Company, Inc. comprised 17% of
Conwoods consolidated revenue for the last seven months of
2006. No other customer accounted for 10% or more of
Conwoods revenue during that period. Conwood believes that
its relationship with McLane is good. Conwoods sales to
McLane are not governed by any written supply contract. No
significant backlog of orders existed at December 31, 2006.
Raw
Materials
In its production of moist snuff and chewing tobacco, Conwood
uses U.S. fire-cured and air-cured tobaccos as well as
foreign burley and air-cured leaf tobaccos. Conwood believes
there is a sufficient supply in the worldwide tobacco market to
satisfy its current and anticipated production requirements.
RAI
Operating Subsidiaries Information
Sales to
Foreign Countries
RAIs operating subsidiaries net sales to foreign
countries for the years ended December 31, 2006, 2005 and
2004 were $578 million, $548 million and
$304 million, respectively.
Raw
Materials
On October 22, 2004, the President signed legislation
eliminating the U.S. governments tobacco production
controls and price support program. The buyout 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
$9.9 billion, including approximately $9.6 billion
payable to quota tobacco holders and growers through industry
assessments over ten years and approximately $290 million
for the liquidation of quota tobacco stock. RAIs operating
subsidiaries estimate that their overall share will approximate
$2.4 billion to $2.9 billion prior to the deduction of
permitted offsets under the MSA.
Research
and Development
RAIs operating subsidiaries research and development
expense for the years ended December 31, 2006, 2005 and
2004, was $58 million, $53 million and
$48 million, respectively. RAIs primary research and
development activities are conducted in RJR Tobaccos
Whitaker Park complex. Scientists and engineers at this facility
continue to work to create more efficient methods of preparing
tobacco blends, as well as develop product enhancements,
9
new products and packaging innovations. A focus for research and
development activity is the development of potentially reduced
exposure products, which may ultimately be recognized as
products that present reduced risks to health.
Intellectual
Property
RAIs operating subsidiaries own or have the right to use
numerous trademarks, including the brand names of their tobacco
products and the distinctive elements of their packaging and
displays. RAIs operating subsidiaries material
trademarks are registered with the U.S. Patent and
Trademark Office. Rights in these trademarks in the United
States will last as long as RAIs subsidiaries continue to
use the trademarks. The operating subsidiaries consider the
distinctive blends and recipes used to make each of their brands
to be trade secrets. These trade secrets are not patented, but
RAIs operating subsidiaries take appropriate measures to
protect the unauthorized disclosure of such information.
In 1999, RJR Tobacco sold most of its trademarks and patents
outside the United States in connection with the sale of the
international tobacco business to JTI. The sale agreement
granted JTI the right to use certain of RJR Tobaccos trade
secrets outside the United States, but details of the
ingredients or formulas for flavors and the blends of tobacco
may not be provided to any
sub-licensees
or
sub-contractors.
The agreement also generally prohibits JTI and its licensees and
sub-licensees
from the sale or distribution of tobacco products of any
description employing the purchased trademarks and other
intellectual property rights in the United States. In 2005, GPI
acquired from JTI, its U.S. duty-free and
U.S. overseas military businesses relating to certain
brands. The related rights were previously sold to JTI in 1999
as a part of the sale of the international tobacco business.
In addition to intellectual property rights it directly owns,
RJR Tobacco has certain rights with respect to BAT intellectual
property that were available for use by B&W prior to the
completion of the B&W business combination.
Legislation
and Other Matters Affecting the Tobacco Industry
The tobacco industry is subject to a wide range of laws and
regulations regarding the marketing, sale, taxation and use of
tobacco products imposed by local, state, federal and foreign
governments. Various state governments have adopted or are
considering, among other things, legislation and regulations
that would:
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significantly increase their taxes on tobacco products;
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restrict displays, advertising and sampling of tobacco products;
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establish ignition propensity standards for cigarettes;
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raise the minimum age to possess or purchase tobacco products;
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restrict or ban the use of certain flavorings in tobacco
products;
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require the disclosure of ingredients used in the manufacture of
tobacco products;
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require the disclosure of nicotine yield information for
cigarettes based on a machine test method different from that
required by the U.S. Federal Trade Commission;
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impose restrictions on smoking in public and private
areas; and
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restrict the sale of tobacco products directly to consumers or
other unlicensed recipients, including over the Internet.
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In addition, during 2007, the U.S. Congress will consider
regulation of the manufacture and sale of tobacco products by
the U.S. Food and Drug Administration, and also may
consider legislation regarding:
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further increases in the federal excise tax on cigarettes and
other tobacco products;
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regulation of environmental tobacco smoke;
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additional warnings on tobacco packaging and advertising;
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reduction or elimination of the tax deductibility of advertising
expenses;
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implementation of a national standard for fire-safe
cigarettes;
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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
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banning the delivery of cigarettes by the U.S. Postal
Service.
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Together with manufacturers price increases in recent
years and substantial increases in state and federal taxes on
tobacco products, these developments have had and will likely
continue to have an adverse effect on the sale of tobacco
products. For further discussion of the regulatory and
legislative environment applicable to the tobacco industry, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations Governmental
Activity in Item 7.
Litigation
and Settlements
Various legal claims, 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, Conwood and their affiliates, including
RAI, or indemnitees. For further discussion of the litigation
and legal proceedings pending against RAI or its affiliates or
indemnitees, see Item 3.
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 or indemnitees, or
the loss of any particular claim concerning the use of smokeless
tobacco against Conwood, when viewed on an individual basis, is
not probable, the possibility of material losses related to
tobacco 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,
Conwood or their affiliates or indemnitees, 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. As described under Legal
Proceedings in Item 3, 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 state settlement agreements, see
Governmental Health-Care Cost Recovery
Cases MSA and Other State Settlement
Agreements in Item 3. 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 condition 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 value
categories, RJR Tobaccos share of the domestic premium and
value cigarette categories, and the effect of any resulting cost
advantage of manufacturers not subject to the MSA and other
state settlement agreements. Certain of RAIs other
operating subsidiaries also have payment obligations, to a much
lesser extent than RJR Tobacco, under the MSA as subsequent
participating manufacturers.
Employees
At December 31, 2006, RAI and its subsidiaries had
approximately 7,500 full-time employees and approximately
300 part-time employees. The 7,500 full-time employees
include approximately 6,000 RJR Tobacco employees and 800
Conwood employees. No employees of RAI or its subsidiaries are
unionized.
11
RAI and its subsidiaries operate with certain known risks and
uncertainties that could have a material adverse effect on their
operations, some of which are beyond their control. The
following is a description of the most significant risks and
uncertainties:
RAIs operating subsidiaries could be subject to
substantial liabilities from cases related to cigarette products
as well as to smokeless tobacco products.
RJR Tobacco, Conwood and their affiliates, including RAI, and
indemnitees, 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. As of February 2, 2007, 1,271 cigarette-related
cases were pending against RJR Tobacco or its affiliates,
including RAI, and its indemnitees, including B&W: 1,263 in
the United States; four in Puerto Rico; three in Canada and one
in Israel. Of the 1,263 total cases, 34 cases are pending
against B&W that are not also pending against RJR Tobacco,
and 942 have been consolidated for trial on some common related
issues in West Virginia. As of February 2, 2007, Conwood
was a defendant in eight cases in West Virginia and one in
Florida in which plaintiffs are alleging, among other claims,
that they sustained personal injuries as a result of using
Conwoods smokeless tobacco products.
In addition, as of February 2, 2007, 2,624 cases filed by
individual flight attendants alleging injuries as a result of
exposure to ETS, or secondhand smoke, in aircraft cabins were
pending in Florida against RJR Tobacco or its affiliates or
indemnitees. Punitive damages are not recoverable in these
cases, and the majority of the secondhand smoke cases do not
allege injuries of the same magnitude as alleged in other
tobacco-related litigation.
It is likely that similar legal actions, proceedings and claims
arising out of the sale, distribution, manufacture, development,
advertising, marketing and claimed health effects of cigarettes
will continue to be filed against RJR Tobacco or its affiliates
and indemnitees and other tobacco companies for the foreseeable
future. During the fourth quarter of 2006, process in 21
cigarette-related cases was served against RJR Tobacco or its
affiliates or indemnitees, compared with four such cases in the
fourth quarter of 2005. Victories by plaintiffs in highly
publicized cases against RJR Tobacco and other tobacco companies
regarding the health effects of smoking may stimulate further
claims. A material increase in the number of pending claims
could significantly increase defense costs and have a material
adverse effect on the results of operations, cash flows and
financial condition of RJR Tobacco and, consequently, of RAI. In
addition, adverse outcomes in pending cases could have adverse
effects on the ability of RJR Tobacco and its indemnitees,
including B&W, to prevail in smoking and health litigation.
Punitive damages, often in amounts ranging into the billions of
dollars, are specifically pled in a number of these pending
cases in addition to compensatory and other damages. An
unfavorable resolution of certain of these actions could have a
material adverse effect on the results of operations, cash flows
and financial condition of RJR Tobacco and, consequently, of
RAI. Adverse outcomes in these cases, individually or in the
aggregate, also could have a significant adverse effect on the
ability of RJR Tobacco and RAI to continue to operate.
If plaintiffs in any of the actions to which Conwood is subject
were to prevail, the effect of any judgment or settlement could
have a material adverse effect on RAIs consolidated
financial results in the particular reporting period in which
any such litigation is resolved. In addition, similar litigation
and claims relating to Conwoods smokeless tobacco products
may continue to be filed in the future and, depending on the
size of any resulting judgment or settlement, such judgment or
settlement could have a material adverse effect on RAIs
consolidated financial position. An increase in the number of
pending claims, in addition to the risks posed as to outcome,
could increase Conwoods costs of litigating and
administering claims.
In accordance with generally accepted accounting principles in
the United States of America, referred to as GAAP, RAI, RJR
Tobacco and Conwood, as applicable, record any loss related to
tobacco litigation at such time as an unfavorable outcome
becomes probable and the amount can be reasonably estimated. RJR
Tobacco recorded less than $1 million related to the
judgment in the Thompson v. B&W individual case
in the fourth quarter of 2006, to be paid in 2007.
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, or the loss of any particular
12
claim concerning the use of smokeless tobacco against Conwood,
when viewed on an individual basis, is not probable or
estimable. Other than with respect to the Thompson case,
discussed above, no liability for pending smoking and health
tobacco or smokeless tobacco litigation was recorded in
RAIs consolidated balance sheet as of December 31,
2006. Notwithstanding the foregoing, RAI could be subject to
significant tobacco-related liabilities in the future. In
addition, RJR has liabilities totaling $94 million that
were recorded in 1999 in connection with certain indemnification
claims unrelated to smoking and health asserted by JTI against
RJR and RJR Tobacco, relating to the activities of Northern
Brands International, Inc., an inactive, indirect subsidiary of
RAI involved in the international tobacco business that was sold
to JTI in 1999, and related litigation.
For a more complete description of the litigation involving RAI
and its operating subsidiaries, including RJR Tobacco and
Conwood, see Item 3.
Individual cigarette-related cases may increase as a result
of the Florida Supreme Courts ruling in Engle v. R.
J. Reynolds Tobacco Co.
In July 2000, a jury in the Florida state court case
Engle v. R. J. Reynolds Tobacco Co., referred to as
Engle, rendered a punitive damages verdict in favor of
the Florida class 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.
The Florida Supreme Court issued its decision on July 6,
2006. The court affirmed the appellate courts dismissal of
the punitive damages awards against RJR Tobacco and B&W and
decertified, on a going-forward basis, a Florida-wide class
action on behalf of smokers claiming illnesses caused by
addiction to cigarettes. The court preserved a number of
classwide findings from the Engle trial, including that
cigarettes can cause certain diseases, that nicotine is
addictive and that defendants placed defective and unreasonably
dangerous cigarettes on the market, and authorized class members
to avail themselves of those findings in individual lawsuits,
provided they commence those lawsuits within one year of the
date the courts decision becomes final. The court
specified that the class is confined to those Florida residents
who developed smoking-related illnesses that
manifested themselves on or before November 21,
1996.
RJR Tobacco and the other defendants in Engle filed a
rehearing motion arguing, among other things, that the findings
from the Engle trial are not sufficiently specific to
serve as the basis for further proceedings and that the Florida
Supreme Courts application of the class action rule denies
defendants due process. The plaintiffs also filed a rehearing
motion arguing that some smokers who became sick after
November 21, 1996, and who are therefore not class members
should nevertheless have the statute of limitations tolled since
they may have refrained from filing suit earlier in the mistaken
belief that they were Engle class members. On
December 21, 2006 the Florida Supreme Court issued a
revised opinion, in which it set aside the jurys findings
of a conspiracy to misrepresent and clarified that the future
plaintiffs could rely on the Engle jurys findings
on express warranty. The court issued its mandate on
January 11, 2007, which begins the one-year period for
individual class members to file lawsuits. RAI anticipates that
it is likely that individual case filings in Florida will
increase as a result of the Engle case. In addition to
possible adverse effects of the outcomes in these cases,
individually or in the aggregate, an increase in these cases
will result in increased legal expenses and other litigation and
related costs which could have an adverse effect on the results
of operations and cash flows of RJR Tobacco and, consequently,
of RAI.
RJR Tobacco could be subject to additional, substantial
marketing restrictions, and related compliance costs, as a
result of the order issued in a case brought by the
U.S. Department of Justice.
On September 22, 1999, the U.S. Department of Justice
brought an action against RJR Tobacco, B&W and other tobacco
companies in the U.S. District Court for the District of
Columbia. The government initially sought to recover funds
expended by the federal government in providing health care to
smokers who have developed diseases and injuries alleged to be
smoking-related. In addition, the government sought, pursuant to
the civil provisions of RICO, disgorgement of profits the
government contends were earned as a consequence of a RICO
racketeering enterprise. In September 2000, the
court dismissed the governments claims asserted under the
Medical Care Recovery Act as well as those under the Medicare
Secondary Payer provisions of the Social Security
13
Act, but did not dismiss the RICO claims. In February 2005, the
U.S. Court of Appeals for the District of Columbia ruled
that disgorgement is not an available remedy in this case. The
governments petition for rehearing was denied in April
2005, and its petition for writ of certiorari with the
U.S. Supreme Court was denied in October 2005. The bench
(non-jury) trial began in September 2004, and closing arguments
concluded June 10, 2005.
On August 17, 2006, the court found certain defendants
liable for the RICO claims, but did not impose any direct
financial penalties. The court instead enjoined the defendants
from committing future racketeering acts, participating in
certain trade organizations, making misrepresentations
concerning smoking and health and youth marketing, and using
certain brand descriptors such as low tar,
light, ultra light, mild and
natural. The court also ordered defendants to issue
corrective communications on five subjects,
including smoking and health and addiction, and to comply with
further undertakings, including maintaining web sites of
historical corporate documents and disseminating certain
marketing information on a confidential basis to the government.
In addition, the court placed restrictions on the ability of the
defendants to dispose of certain assets for use in the United
States unless the transferee agrees to abide by the terms of the
courts order. The order also requires the defendants to
reimburse the U.S. Department of Justice its taxable costs
incurred in connection with this case.
Certain defendants, including RJR Tobacco, filed notices of
appeal to the U.S. Court of Appeals for the District of
Columbia on September 11, 2006. The government filed its
notice of appeal on October 16, 2006. In addition, the
defendants, including RJR Tobacco, filed joint motions asking
the district court to clarify and to stay its order pending
defendants appeal. On September 28, 2006, the
district court denied defendants motion to stay. On
September 29, 2006, the defendants, including RJR Tobacco,
filed a motion asking the court of appeals to stay the district
courts order pending defendants appeal. The court
granted the motion on October 31, 2006. On
November 28, 2006, the court of appeals stayed the appeals
pending the trial courts ruling on the defendants
motion for clarification.
The stay of the district courts order suspends the
enforcement of the order pending the outcome of defendants
appeal. RJR Tobacco does not know the timing of an appellate
decision or, if the order is affirmed, the compliance deadlines
that will be imposed. If the order is affirmed without
modification, then RJR Tobacco believes that certain provisions
of the order (such as the ban on certain brand style descriptors
and the corrective advertising requirements) would have adverse
business effects on the marketing of RJR Tobaccos current
product portfolio and that such effects could be material. Also,
if the order is affirmed, then RJR Tobacco would incur costs in
connection with complying with the order (such as the costs of
changing its current packaging to conform to the ban on certain
brand descriptors and the costs of corrective communications).
Given the uncertainty over the timing and substance of an
appellate decision, RJR Tobacco currently is not able to
estimate reasonably the costs of such compliance. Moreover, if
the order were ultimately affirmed and RJR Tobacco were to fail
to comply with the order on a timely basis, then RJR Tobacco
could be subject to substantial monetary fines or penalties.
An adverse outcome in this case could have a material adverse
effect on the results of operations, cash flows and financial
condition of RJR Tobacco and, consequently, of RAI.
RJR Tobacco could be subject to substantial liabilities from
lawsuits based on claims that smokers were misled through its
marketing of light, ultra light and
low-tar cigarettes.
Class-action
suits have been filed in a number of states against individual
cigarette manufacturers and their parent corporations, alleging
that the use of the terms lights and ultra
lights constitutes unfair and deceptive trade practices.
As of February 2, 2007, 12 such suits were pending against
RJR Tobacco or its affiliates, including RAI, and indemnitees,
including B&W, in state or federal courts in Florida,
Illinois, Louisiana, Minnesota, Missouri, New York and
Washington.
A lights
class-action
case is pending in Madison County, Illinois against RJR
Tobaccos competitor, Philip Morris, Inc. Trial of the case
against Philip Morris, Price v. Philip Morris, Inc.,
formerly known as Miles v. Philip Morris, Inc.,
began in January 2003. In March 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. In
April 2003, the trial judge reduced the amount of the bond. The
plaintiffs appealed, and in July
14
2003, the appeals court ordered the trial judge to reinstate the
original bond. In September 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. On December 15, 2005, the Illinois
Supreme Court reversed the lower state courts decision and
sent the case back to the lower court with instructions to
dismiss the case. On May 8, 2006, the plaintiffs filed a
motion to stay mandate until final disposition of their petition
for certiorari to the U.S. Supreme Court. The motion was
granted on May 19, 2006. The plaintiffs petition for
certiorari was denied on November 27, 2006. On
December 15, 2006, the Illinois Supreme Court reversed the
Circuit Courts judgment and remanded the case with
instructions to dismiss. On December 18, 2006, the
defendants filed a motion to dismiss and for entry of final
judgment, which was granted by the trial court. Judgment was
entered dismissing the case with prejudice the same day. The
plaintiffs filed a motion to vacate
and/or
withhold judgment in the Circuit Court on January 17, 2007.
Although RJR Tobacco is not a defendant in the Price
case, it is a defendant in a similar
class-action
case, Turner v. R. J. Reynolds Tobacco Co., also
brought in Madison County, Illinois. The class certified in this
case consists of persons who purchased certain brands of
light cigarettes manufactured and sold by RJR
Tobacco during a specified time period. B&W is a defendant
in a similar
class-action
case, Howard v. Brown & Williamson Tobacco
Corporation, also brought in Madison County, Illinois. The
Turner and Howard cases have been stayed pending a
resolution of the Price case.
Schwab [McLaughlin] v. Philip Morris USA, Inc., a
nation-wide lights
class-action,
was filed on May 11, 2004, in the U.S. District Court
for the Eastern District of New York, against RJR Tobacco and
B&W, as well as other tobacco manufacturers. On
September 25, 2006, the court, among other things, granted
class certification and set a trial date of January 22,
2007. On October 6, 2006, the defendants, including RJR
Tobacco, filed a motion requesting the U.S. Court of
Appeals for the Second Circuit to review the class certification
decision and to stay the case pending that review. On
November 16, 2006, the Second Circuit granted the
defendants motions to stay the district court proceedings
and for review of the class certification ruling. Briefing is
complete. Oral argument has not been scheduled.
In the event RJR Tobacco and its affiliates and indemnitees lose
the Turner, Howard or Schwab cases, or one or more of the
other pending lights
class-action
suits, RJR Tobacco could face bonding difficulties similar to
the difficulties faced by Philip Morris in Price
depending upon the amount of damages ordered, if any. This
result could have a material adverse effect on the results of
operations, cash flows and financial condition of RJR Tobacco
and, consequently, of RAI.
RJR Tobacco could be subject to substantial liabilities from
tobacco-related antitrust lawsuits.
RJR Tobacco and its indemnitees, including B&W, and certain
of their subsidiaries are defendants in multiple actions
alleging violations of federal and state antitrust laws,
including allegations that the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, conspired to
fix cigarette prices. An adverse outcome in any of these cases
could have a material adverse effect on the results of
operations, cash flows and financial condition of RJR Tobacco
and, consequently, of RAI.
RJR Tobaccos retail market share has declined in recent
years and is expected to continue to decline for the medium
term; any continuation in the decline beyond the medium term
could further adversely affect the results of operations, cash
flows and financial condition of RJR Tobacco and, consequently,
of RAI.
According to data from IRI, the combined share of RJR Tobacco
and B&W of the U.S. cigarette retail market declined to
29.78% in 2006 from 30.28% in 2005, continuing a trend in effect
for several years. This data does not reflect revisions made by
IRI to its market share data in April 2006 to better reflect
industry dynamics. The use of revised methodology by IRI would
not have had a material impact on the foregoing percentages. You
should not rely on the foregoing market share data as being a
precise measurement of actual market share because IRI bases its
reporting on sampling and, in addition, is not able to
effectively track the volume of all deep-discount brands, gray
market imports and sales through alternative channels.
Accordingly, the retail share of market of RJR Tobacco as
reported above may overstate its actual market share.
Although RJR Tobacco expects this declining market share trend
to continue for the medium term, at the beginning of 2007, RJR
Tobacco implemented a revised brand portfolio marketing
strategy, discussed in Item 1, which RJR Tobacco expects,
within the next four years, will result in growth in total RJR
Tobacco market share.
15
Lost market share, however, is difficult to regain. If this new
marketing strategy is unsuccessful and the decline in RJR
Tobaccos market share continues beyond the medium term,
this could adversely affect the results of operations, cash
flows and financial condition of RJR Tobacco and, consequently,
of RAI.
RJR Tobacco has substantial payment obligations under the MSA
and other litigation settlement agreements, which materially
adversely affect its ability to compete against manufacturers of
deep-discount cigarettes that are not subject to these
obligations.
In November 1998, the major U.S. cigarette manufacturers,
including RJR Tobacco and B&W, entered into the MSA with
46 states and other U.S. territories to settle the
asserted and unasserted health-care cost recovery claims and
certain other claims of those states and territories. RJR
Tobacco, B&W and the other major U.S. tobacco
manufacturers previously had settled similar claims brought by
four other states.
The aggregate cash payments made by RJR Tobacco under the MSA
and other state settlement agreements were $2.6 billion,
$2.7 billion and $2.0 billion in 2006, 2005 and 2004,
respectively. RJR Tobacco estimates its payments will be
approximately $2.6 billion in 2007, and will be
approximately $2.8 billion thereafter, subject to certain
adjustments. For a more complete description of the MSA and
other state settlement agreements, see Item 3.
The MSA and other state settlement agreements have materially
adversely affected RJR Tobaccos shipment volumes. The
payments under these agreements also make it difficult for RJR
Tobacco to compete with certain manufacturers of deep-discount
cigarettes. RAI believes deep-discount brands made by small
manufacturers have proliferated and have a combined market share
of approximately 13% of U.S. industry unit sales. The
manufacturers of deep-discount brands are either subsequent
participating manufacturers or non-participating manufacturers,
referred to as NPMs, to the MSA. As such, they have lower
payment obligations than do the original participating
manufacturers, allowing them to price their products lower than
the original participating manufacturers. This pricing has
resulted in higher levels of discounting and promotional support
by RJR Tobacco as part of its efforts to defend its existing
brands, attract adult smokers of competitive brands and launch
new brands. RAI believes that these settlement obligations may
materially adversely affect the results of operations, cash
flows and financial condition of RJR Tobacco and, consequently,
of RAI. 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 value categories, RJR Tobaccos
share of the domestic premium and value cigarette categories,
and the effect of any cost advantage of manufacturers not
subject to the MSA and other state settlement agreements.
The MSA includes an adjustment, referred to as an NPM
adjustment, that potentially reduces RJR Tobaccos and
other participating manufacturers annual payment
obligations. As of February 2, 2007, RJR Tobacco was in
litigation with more than 37 of the settling states as to
whether RJR Tobacco is entitled to an NPM adjustment for 2003.
If RJR Tobacco is unsuccessful in disputing that it is entitled
to deduct its share of the 2003, or any subsequent, NPM
adjustment from its MSA payments, RJR Tobacco would be obligated
to continue paying the full amounts of its projected MSA
payments notwithstanding that its market share, and potentially
its revenues, were decreasing as a result of increased
competition from NPMs. Even if RJR Tobacco is successful in
deducting its share of the NPM adjustment from its 2003, and any
subsequent, MSA payments, it could incur substantial litigation
costs to establish its entitlement to the deduction,
particularly if one or more of the settling states that have
filed legal proceedings prevail in their claim that the courts
of the individual states are the proper forum for resolving the
dispute. During 2006, proceedings were initiated and prosecuted
with respect to an NPM adjustment for 2004. The independent
auditors settlement payment calculations pertaining to the
2004 market year determined that the participating manufacturers
again suffered a market share loss sufficient to trigger an NPM
adjustment for that year. For more information on the NPM
adjustment proceedings, see Item 3.
RAIs operating subsidiaries have substantial payment
obligations under the Fair and Equitable Tobacco Reform Act.
On October 22, 2004, the President signed the Fair and
Equitable Tobacco Reform Act of 2004, referred to as FETRA,
eliminating the U.S. governments 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 $9.9 billion, including
approximately $9.6 billion
16
payable to quota tobacco holders and growers through industry
assessments over ten years and approximately $290 million
for the liquidation of quota tobacco stock.
The MSA provided for the establishment of a $5.15 billion
trust fund to be divided among the states that produce cigarette
tobacco to compensate tobacco growers and quota holders for any
negative effects that the MSA might have on them MSA
participants payment obligations with respect to this fund
are referred to as Phase II obligations. As a
result of the tobacco buyout legislation, the MSA Phase II
obligations established in 1999 will be continued as scheduled
through the end of 2010, 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 in the
range of $230 million to $280 million. Since the
inception of FETRA through December 31, 2006, RAIs
operating subsidiaries have incurred $72 million of
cumulative net assessments from quota tobacco stock liquidation.
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.
FETRAs substantial buyout payment obligations could
negatively affect the profits and cash flows of RJR Tobacco and
RAIs other operating subsidiaries and could adversely
affect sales if price increases are required to offset the
obligations.
The assumption of certain of B&Ws historical and
future liabilities has exposed RJR Tobacco and its subsidiaries
to significant additional potential liabilities associated with
the cigarette and tobacco industry.
In connection with the B&W business combination, RJR Tobacco
agreed to indemnify B&W and its affiliates for
B&Ws historic and future liabilities related to the
contributed business, including all tobacco-related litigation
and all post-closing liabilities under the MSA and other state
settlement agreements with respect to B&Ws
U.S. cigarette and tobacco business. These liabilities
could expose RJR Tobacco to material losses, which would
materially adversely affect the results of operations, cash
flows and financial condition of RJR Tobacco and, consequently,
of RAI. As of February 2, 2007, of the 1,263
cigarette-related cases pending against RJR Tobacco or its
affiliates or indemnitees, 34 cases were pending against B&W
that are not also pending against RJR Tobacco.
RJR Tobacco is dependent on the U.S. cigarette business,
which it expects to continue to decline.
The international rights to substantially all of RJR
Tobaccos brands were sold in 1999 to JTI. In connection
with this sale, RJR Tobacco also agreed that, prior to its use
or license outside the United States of any trademarks or other
intellectual property relating to its manufacture or sale of
tobacco products, RJR Tobacco would first negotiate in good
faith with JTI with respect to JTIs acquisition or
licensing of such trademarks or intellectual property. In
addition, in connection with the B&W business combination in
2004, RAI entered into a non-competition agreement with BAT
under which RAIs operating subsidiaries generally are
prohibited, subject to certain exceptions, from manufacturing
and marketing certain tobacco products outside the United States
until July 2009. As a result of the foregoing, RJR Tobacco
is dependent on the U.S. cigarette market. As a result of
price increases, restrictions on advertising and promotions,
funding by U.S. manufacturers, including RJR Tobacco, of
smoking prevention campaigns, increases in regulation and excise
taxes, health concerns, a decline in the social acceptability of
smoking, increased pressure from anti-tobacco groups and other
factors, U.S. cigarette consumption has generally been
declining, and it is expected to continue to decline, which
could adversely affect the results of operations, cash flows and
financial condition of RJR Tobacco and, consequently, of RAI.
U.S. cigarette shipments as tracked by MSAi, report demand
declining since 1987. Shipments declined 2.4% in 2006, 3.4% in
2005 and 1.8% in 2004. Total cigarette industry shipments in
2006 were 372.5 billion cigarettes.
RAIs operating subsidiaries are subject to significant
limitations on advertising and marketing tobacco products that
could harm the value of their existing brands or their ability
to launch new brands.
In the United States, television and radio advertisements of
cigarettes have been prohibited since 1971, and television and
radio advertisements of smokeless tobacco products have been
prohibited since 1986. Under the MSA, certain of RAIs
operating subsidiaries, including RJR Tobacco, cannot use
billboard advertising, cartoon characters, sponsorship of
certain events, non-tobacco merchandise bearing their brand
names and various other advertising and marketing techniques. In
addition, the MSA prohibits targeting of youth in advertising,
promotion or marketing of tobacco products, including the
smokeless tobacco products of RJR Tobacco. Conwood is not a
participant in the MSA. Although these restrictions were
intended to ensure that tobacco advertising was not aimed
17
at young people, some of the restrictions also may limit the
ability of RAIs operating subsidiaries to communicate with
adult smokers. For example, RAIs operating subsidiaries
only advertise their cigarettes in magazines in which the vast
majority of readers are adults 18 years of age or older.
Additional restrictions may be imposed legislatively or agreed
to in the future. Recent proposals have included limiting
tobacco advertising to
black-and-white,
text-only advertisements. These limitations may make it
difficult to maintain the value of existing brands. Moreover,
these limitations could significantly impair the ability of
RAIs operating subsidiaries to launch new premium brands.
Also, as discussed in greater detail above, RJR Tobacco will be
subject to additional marketing restrictions if the recent
decision by the U.S. District Court for the District of
Columbia in the case brought by the U.S. Department of
Justice is not reversed on appeal.
The U.S. cigarette industry is subject to substantial
and increasing regulation and taxation, which has a negative
effect on sales volume and profitability. In addition,
Conwoods tobacco products are subject to excise taxes and
to many restrictions and regulations similar to the ones to
which the tobacco products of RAIs other operating
subsidiaries are subject, which may have a negative effect on
sales volume and profitability of Conwood.
A wide variety of federal, state and local laws limit the
advertising, sale and use of cigarettes, and these laws have
proliferated in recent years. For example, many local laws
prohibit smoking in restaurants and other public places. Private
businesses also have adopted regulations that prohibit or
restrict, or are intended to discourage, smoking. This trend has
had, and is likely to continue to have, a material adverse
effect on the sales, volumes, operating income and cash flows of
RJR Tobacco and, consequently, of RAI.
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 $2.575 per pack in New Jersey. On
December 31, 2006, the weighted average state cigarette
excise tax per pack, calculated on a
12-month
rolling average basis, was approximately $0.799. In 2006, four
states passed excise tax per pack increases, and ballot
initiatives to increase the cigarette excise tax per pack were
approved in two other states. Certain city and county
governments, such as New York and Chicago, also impose
substantial excise taxes on cigarettes sold in those
jurisdictions. In 2007, increased excise taxes are likely to
result in declines in overall sales volume and shifts by
consumers to less expensive brands. Both of these results could
have a material adverse effect on the results of operations,
cash flows and financial condition of RJR Tobacco and,
consequently, of RAI.
A federal excise tax was imposed on smokeless tobacco products
in 1986 and is currently $0.195 per pound for chewing
tobacco, and $0.585 per pound for snuff. The federal tax on
small cigars, defined as those weighing three pounds or less per
thousand, is $1.828 per thousand. Large cigars are taxed at
a rate of 20.719% of the manufacturers price, with a cap
of $48.75 per thousand.
In 1996, the U.S. Food and Drug Administration, referred to
as the FDA, published regulations that would have severely
restricted cigarette advertising and promotion, and limited the
manner in which tobacco products could be sold. On
March 21, 2000, the U.S. Supreme Court held that
Congress did not give the FDA authority to regulate tobacco
products under the Federal Food, Drug, and Cosmetic Act and,
accordingly, the FDAs assertion of jurisdiction over
tobacco products was impermissible under that act. Since the
Supreme Court decision, various proposals have been made for
federal legislation to regulate tobacco products, including
smokeless tobacco products. A presidential commission appointed
by former President Clinton issued a final report on
May 14, 2001, recommending that the FDA be given authority
by Congress to regulate the manufacture, sale, distribution and
labeling of tobacco products to protect public health. Other
proposals for the federal regulation of tobacco products have
related to, among other things, additional warning notices, the
disallowance of advertising and promotion expenses as deductions
under federal tax law, a ban or further restriction of all
advertising and promotion and increased regulation of the
manufacturing and marketing of tobacco products by new or
existing federal agencies.
In February 2007, proposed legislation was introduced in the
U.S. House of Representatives and the U.S. Senate that
would give the FDA broad regulatory authority over tobacco
products. The proposals would grant the FDA authority to impose
product standards (including standards relating to, among other
things, nicotine yields and smoke constituents) and would
reinstate the FDAs 1996 proposed regulations that would
have restricted
18
marketing. The proposed legislation also would govern modified
risk products and would impose new and larger warning labels on
tobacco products.
Over the years, various state and local governments have
continued to regulate tobacco products, including smokeless
tobacco products. These regulations relate to, among other
things, the imposition of significantly higher taxes, increases
in the minimum age to purchase tobacco products, sampling and
advertising bans or restrictions, ingredient and constituent
disclosure requirements and significant tobacco control media
campaigns. Additional state and local legislative and regulatory
actions will likely be considered in the future, including,
among other things, restrictions on the use of flavorings.
Additional federal or state regulation relating to the
manufacture, sale, distribution, advertising, labeling,
mandatory ingredients disclosure and nicotine yield information
disclosure of tobacco products could reduce sales, increase
costs and have a material adverse effect on the business of the
operating subsidiaries of RAI. Extensive and inconsistent
regulation by multiple states could prove to be particularly
disruptive to the business of RJR Tobacco. These factors could
have a material adverse effect on RAIs results of
operations, cash flows and financial condition.
Various state governments have adopted or are considering
adopting legislation establishing fire safety standards for
cigarettes. Compliance with this legislation could be
burdensome. On December 31, 2003, the New York State
Office of Fire Prevention and Control 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, California and Vermont, and
in 2006, Illinois, Massachusetts and New Hampshire, each enacted
fire-safe legislation of its own, adopting the same testing
standard set forth in the OFPC regulations described above. This
requirement took effect in Vermont on May 1, 2006, in
California on January 1, 2007, and will take effect in New
Hampshire on October 1, 2007, and in Illinois and
Massachusetts on January 1, 2008. 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 Tobaccos and Conwoods volumes, market share
and profitability may be adversely affected by competitive
actions and pricing pressures in the marketplace.
The tobacco industry is highly competitive. Among the major
manufacturers, brands primarily compete on such elements as
product quality, price, brand recognition, brand imagery and
packaging. Substantial marketing support, merchandising display,
competitive pricing and other financial incentives generally are
required to maintain or improve a brands market position
or introduce a new brand.
Increased selling prices from higher cigarette taxes and
settlement costs have resulted in increased competitive
discounting and the proliferation of deep-discount brands.
In addition to the competition Conwood faces from its largest
competitor, U.S. Smokeless Tobacco Company, RJR Tobaccos
largest competitor in the cigarette market, Philip Morris USA
Inc., has recently begun test marketing smokeless tobacco
products. Further, other companies may test or enter the
smokeless tobacco marketplace. Increased competition, from new
entrants or existing market participants, could introduce
pricing pressure or decrease Conwoods market share, either
of which could adversely affect Conwoods profitability and
revenues.
Although RAI believes Conwoods business has benefited in
recent years from the increased popularity of price-value brands
compared to premium priced brands, if this trend deprives
Conwoods premium brands of market share, Conwoods
profitability and revenues from those brands could decrease.
Even if consumers shift from Conwoods premium brands to
its own price-value brands, Conwoods revenues and
profitability could be adversely affected due to the higher
sales prices and higher profit margins on Conwoods premium
brands as compared with its price-value brands.
Failure to successfully integrate Conwood into RAIs
corporate organization could prevent RAI from attaining the
anticipated benefits of the Conwood acquisition.
Achieving the anticipated benefits of the Conwood acquisition
will depend in part upon the integration of Conwood into
RAIs corporate organization, expected to be completed by
the end of 2007. Integration of a
19
substantial business is a challenging, time-consuming and costly
process. It is possible that the acquisition itself or the
integration process could result in the loss of the management
of Conwood or other key employees, the disruption of
Conwoods business or inconsistencies in standards,
controls, procedures and policies that adversely affect its
ability to maintain relationships with suppliers, customers and
employees. In addition, successful integration of Conwood will
require the dedication of significant management resources that
may temporarily detract attention from RAIs and
Conwoods
day-to-day
business. If management is not able to integrate the
organizations, operations and systems of Conwood and RAI in a
timely and efficient manner, the anticipated benefits of the
Conwood acquisition may not be realized fully.
If RJR Tobacco is not able to develop, produce or
commercialize new products and technologies required by
regulatory changes or changes in adult consumer preferences,
sales and profitability could be adversely affected.
Consumer health concerns and changes in regulations are likely
to require RJR Tobacco to introduce new products or make
substantial changes to existing products. Similarly, RAI
believes that there may be increasing pressure from public
health authorities and consumers to develop a conventional
cigarette or an alternative cigarette that provides a
demonstrable reduced risk of adverse health effects. RJR Tobacco
may not be able to develop a potentially reduced risk product
that is broadly acceptable to adult consumers in a
cost-effective manner, or at all. Moreover, it may be difficult
for RJR Tobacco to effectively promote such a product in any
event. RJR Tobacco believes that the order in the
U.S. Department of Justice case, described above,
might (unless the order is reversed on appeal) limit RJR
Tobaccos ability to market effectively any potentially
reduced risk product it may develop. Further, additional
marketing restrictions could be imposed legislatively or
judicially in the future that could adversely affect RJR
Tobaccos ability to market effectively any potentially
reduced risk product it may develop. The costs associated with
developing new products and technologies, as well as the
inability to develop and effectively market acceptable products
in response to competitive conditions or regulatory
requirements, may have a material adverse effect on RAIs
results of operations, cash flows and financial condition.
RJR Tobacco now depends on third-party suppliers for its
tobacco packaging materials requirements; if the supply of
tobacco packaging materials from the suppliers is interrupted,
or the quality of the packaging declines, RJR Tobaccos
packaging costs and sales could be negatively affected.
On May 2, 2005, RJR Tobacco and RJR Packaging, LLC sold the
assets and business of RJR Packaging, LLC to five packaging
companies. In connection with this sale, RJR Tobacco entered
into agreements with four of the purchasers, pursuant to which
those companies supply RJR Tobacco with certain of its tobacco
packaging materials requirements.
As a result, RJR Tobacco is now dependent upon third parties for
its packaging requirements. Consequently, the risks of an
interruption in the supply of packaging materials to RJR
Tobacco, or a decline in the quality of such packaging
materials, have increased. A decline in the quality of packaging
materials could negatively affect sales. If the supply of
packaging materials is interrupted, RJR Tobaccos own
shipments of tobacco products could be materially slowed, which
could decrease sales and adversely impact RJR Tobaccos
relationships with wholesalers and retailers. Delays in the
shipments of RJR Tobaccos products may result in certain
RJR Tobacco brand styles being out of stock at the retail level,
increasing the potential that consumers may switch to brands
made by RJR Tobaccos competitors. In the third quarter of
2006, RJR Tobacco did experience a shortage of packaging
materials for certain of its brand styles, however, RJR Tobacco
does not believe this shortage materially affected the results
of operations of RJR Tobacco or RAI.
If RJR Tobacco had to seek alternate suppliers, particularly on
an urgent basis, there is no guarantee that RJR Tobacco could
find alternate suppliers willing or able to supply packaging
materials on a timely basis (if at all), at an acceptable cost
and of the necessary quality. If, as a result of securing an
alternate supply of packaging materials, RJR Tobaccos
packaging related costs increased, its profits could
consequently decrease. Sales could also be negatively affected
if the quality of packaging from the alternate suppliers were
below RJR Tobaccos requirements.
A material increase in RJR Tobaccos packaging related
costs, a material decrease in the quality of packaging materials
or a material interruption in the supply of packaging materials
could materially adversely affect the results of operations,
cash flows and financial condition of RJR Tobacco and,
consequently, of RAI.
20
Certain of RAIs operating subsidiaries face a customer
concentration risk.
Sales made by RJR Tobacco to McLane Company, Inc., a
distributor, comprised 29%, 27% and 30% of RJR Tobaccos
revenue in 2006, 2005 and 2004, respectively. Sales made by
Conwood to McLane Company, Inc. comprised 17% of Conwoods
consolidated revenue for the last seven months of 2006. No other
customer accounted for 10% or more of RJR Tobaccos or
Conwoods revenue during those periods. The loss of this
customer, or a significant decline in its purchases from RJR
Tobacco or Conwood, could have a material adverse effect on the
business, financial condition and results of operations of RJR
Tobacco or Conwood, as the case may be, and, consequently, of
RAI.
Fire, violent weather conditions and other disasters may
adversely affect the operations of RAIs operating
subsidiaries.
A major fire, violent weather conditions or other disasters that
affect manufacturing and other facilities of RAIs
operating subsidiaries, or of their suppliers and vendors, could
have a material adverse effect on the operations of RAIs
operating subsidiaries. Although RAI has insurance coverage for
some of these events, a prolonged interruption in the
manufacturing operations of RAIs operating subsidiaries
could have a material adverse effect on the ability of its
operating subsidiaries to effectively operate their businesses.
RAIs credit facilities contain restrictive covenants
that may limit the flexibility of RAI and its subsidiaries, and
breach of those covenants may result in a default under the
agreement relating to the facilities.
RAIs credit facilities limit, and in some circumstances
prohibit, the ability of RAI and its subsidiaries to, among
other things:
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incur additional debt;
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pay dividends;
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make capital expenditures, investments or other restricted
payments;
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engage in sale-leaseback transactions;
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guarantee debt;
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engage in transactions with shareholders and affiliates;
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create liens;
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sell assets;
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issue or sell capital stock of subsidiaries;
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engage in mergers and acquisitions; and
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prepay certain indebtedness.
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These restrictions could limit the ability of RAI and its
subsidiaries to obtain future financing, withstand a future
downturn in their businesses or the economy in general, conduct
operations or otherwise take advantage of business opportunities
that may arise. In addition, if RAI does not comply with these
covenants or with financial covenants in its credit facilities
that require it to maintain certain minimum financial ratios,
any indebtedness outstanding under the credit facilities could
become immediately due and payable. In addition, the lenders
under RAIs credit facilities could refuse to lend funds if
RAI is not in compliance with the covenants or could terminate
the credit facilities. If RAI were unable to repay accelerated
amounts, the lenders under RAIs credit facilities could
initiate a bankruptcy proceeding or liquidation proceeding, or
proceed against any collateral securing that indebtedness.
21
RAI has substantial debt and may incur substantial additional
debt, which could adversely affect its financial health and its
ability to obtain financing in the future, react to changes in
its business and make payments on its outstanding debt.
As of December 31, 2006, on a consolidated basis, RAI had
an aggregate principal amount of $4.389 billion of
outstanding long-term indebtedness (less current maturities).
Because of RAIs substantial indebtedness:
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its ability to obtain additional financing for working capital,
capital expenditures, acquisitions, debt service requirements or
general corporate purposes and its ability to satisfy its
obligations with respect to its indebtedness may be impaired in
the future;
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a substantial portion of its cash flow from operations must be
dedicated to the payment of principal and interest on its
indebtedness, thereby reducing the funds available to it for
other purposes;
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it may be at a disadvantage compared to its competitors with
less debt or comparable debt at more favorable interest
rates; and
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its flexibility to adjust to changing market conditions and
ability to withstand competitive pressures could be limited, and
it may be more vulnerable to a downturn in general economic
conditions or its business or be unable to carry out capital
spending that is necessary or important to its growth strategy
and its efforts to improve operating margins.
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It is likely that RAI will refinance, or attempt to refinance, a
significant portion of this indebtedness prior to its maturity
through the incurrence of new indebtedness. There can be no
assurance that RAIs available cash or access to financing
on acceptable terms will be sufficient to satisfy such
indebtedness.
An increase in interest rates would increase the cost of
servicing RAIs variable rate indebtedness and could cause
its annual debt service obligations to increase significantly
and reduce its profitability.
RAIs borrowings under its credit facilities bear interest
at a variable or floating rate. As of December 31, 2006,
the borrowings outstanding under the credit facilities consisted
solely of the $1.54 billion floating rate term loan. In
addition, as of December 31, 2006, RAI and RJR had
outstanding interest rate swap agreements, the effect of which
was to convert the interest rate applicable to $750 million
principal amount of debt from a fixed to a floating rate. Any
increase in interest rates would increase the cost of servicing
RAIs floating rate debt and, consequently, RAIs net
income would decrease. A 100 basis-point increase in LIBOR (the
rate applicable as of December 31, 2006, to the term loan
and $750 million principal amount of debt subject to the
interest rate swaps) would increase RAIs annual interest
expense by $23 million. For a discussion of how RAI manages
its exposure to changes in interest rates, see note 13 to
consolidated financial statements in Item 8.
The ability of RAI to access the debt capital markets could
be impaired because of its credit rating.
The outstanding notes issued by RAI and RJR are rated below
investment grade. Because of these ratings, in the future RAI
may not be able to sell its debt securities or borrow money in
such amounts, at the times, at the lower interest rates or upon
the more favorable terms and conditions that might otherwise be
available to RAI if its debt was rated investment grade. The
below-investment grade credit rating of the notes may make it
more difficult for RAI to obtain future debt financing on an
unsecured basis. In addition, future debt security issuances or
other borrowings may be subject to further negative terms,
including limitations on indebtedness or similar restrictive
covenants, particularly if RAIs ratings decline further.
RAIs credit ratings are influenced by some important
factors not entirely within the control of RAI or its
affiliates, such as tobacco litigation, the regulatory
environment and the performance of suppliers and vendors to
RAIs operating subsidiaries. Moreover, because the kinds
of events and contingencies that impair RAIs credit
ratings and the ability of RAI and its affiliates to access the
debt capital markets are often the same kinds of events and
contingencies that could cause RAI and its affiliates to seek to
raise additional capital on an urgent basis, RAI and its
affiliates may not be able to issue debt securities or borrow
money upon acceptable terms, or at all, at the times at which
they may most need additional capital.
22
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Item 1B.
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Unresolved
Staff Comments
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None.
The executive offices of RAI, RJR Tobacco and GPI are located in
Winston-Salem, North Carolina, which are owned by RJR Tobacco.
All of the RAI operating subsidiaries facilities are
owned. RJR Tobaccos manufacturing facilities are located
in the Winston-Salem, North Carolina area and Conwoods
executive offices and primary manufacturing facility are located
in Memphis, Tennessee. Santa Fes primary
manufacturing facility is located in Oxford, North Carolina, and
Lanes manufacturing facility is located in Tucker,
Georgia. GPIs manufacturing facility is located in Puerto
Rico.
RJR Tobaccos and Conwoods facilities are pledged as
security for RJR Tobaccos and Conwoods obligations
as guarantors under RAIs credit facilities and RAIs
$2.9 billion guaranteed, secured notes. For further
information related to pledged security, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Financial
Condition in Item 7 and notes 11 and 12 to
consolidated financial statements.
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Item 3.
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Legal
Proceedings
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Tobacco
Litigation General
Introduction
Various legal proceedings, including litigation claiming that
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, Conwood or their affiliates, including RAI
and RJR, or indemnitees, including B&W. (As described in
greater detail below, RJR Tobacco has agreed to indemnify
B&W and its affiliates against certain litigation
liabilities.) These legal proceedings include claims relating to
cigarette products manufactured by RJR Tobacco or certain of its
affiliates and indemnitees, as well as claims relating to
smokeless tobacco products manufactured by Conwood. A discussion
of the legal proceedings relating to cigarette products is set
forth below under the heading Litigation
Affecting the Cigarette Industry. All of the references
under that heading to tobacco-related litigation, smoking and
health litigation and other similar references are references to
legal proceedings relating to cigarette products and are not
references to legal proceedings involving smokeless tobacco
products, and case numbers under that heading include only cases
involving cigarette products and not cases involving smokeless
tobacco products. The legal proceedings relating to the
smokeless tobacco products manufactured by Conwood are discussed
separately under the heading Smokeless Tobacco
Litigation below.
Certain
Terms and Phrases
Certain terms and phrases used in this disclosure may require
some explanation. The terms judgment or final
judgment refer 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. In most cases,
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.
23
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 below
under Accounting for Tobacco-Related
Litigation Contingencies.
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 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 alleged
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, Conwood and their 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, or by
the Comprehensive Smokeless Tobacco Health Education Act, 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.
Accounting
for Tobacco-Related Litigation Contingencies
In accordance with generally accepted accounting principles, RAI
and its subsidiaries, including RJR Tobacco and Conwood, as
applicable, 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, or the loss of any
particular claim concerning the use of smokeless tobacco against
Conwood, 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.
RJR Tobacco recorded less than $1 million related to the
judgment in the Thompson v. B&W individual case
in the fourth quarter of 2006, to be paid in 2007. No other
liability for pending smoking and health tobacco litigation was
recorded in RAIs consolidated balance sheet as of
December 31, 2006. RJR has liabilities totaling
$94 million that were recorded in 1999 in connection with
certain indemnification claims asserted by Japan Tobacco Inc.,
referred to as 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 Litigation Affecting the
Cigarette Industry Other Litigation and
Developments and Other Contingencies and
Guarantees below.
24
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 Litigation Affecting the Cigarette
Industry
Class-Action
Suits.
|
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
Litigation Affecting the Cigarette
Industry 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 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.
The U.S. Department of Justice case brought against various
industry members, including RJR Tobacco and B&W, discussed
below under Litigation Affecting the Cigarette
Industry Governmental Health-Care Cost Recovery
Cases, also can be distinguished from the circumstances
surrounding the MSA and the other state settlement agreements.
Under its Medical Care Recovery Act and Medicare Secondary Payer
Act 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 claim remaining in the
case involved alleged violations of civil provisions 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
U.S. Court of Appeals for the District of Columbia held
that disgorgement is not an available remedy. Trial of the case
concluded on June 9, 2005. On August 17, 2006, the
court found certain defendants liable for the RICO claims and
issued an order for injunctive and other relief, but did not
impose any direct financial penalties. Certain defendants,
including RJR Tobacco, have appealed to the U.S. Court of
Appeals for the District of Columbia. The government also has
appealed. A comprehensive discussion of this case is set forth
below under Litigation Affecting the Cigarette
Industry Governmental Health-Care Cost Recovery
Cases.
25
Similarly, the other cases settled by RJR Tobacco can be
distinguished from existing cases pending against RJR Tobacco
and its affiliates and indemnitees, including B&W. The
original Broin case, discussed below under
Litigation Affecting the Cigarette
Industry
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
Litigation Affecting the Cigarette
Industry Antitrust Cases, was 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 Litigation
Affecting the Cigarette Industry MSA
Enforcement 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 the merits and should not be
affected by the settlement of prior MSA enforcement cases.
Conwood also believes that it has a number of valid defenses to
the smokeless tobacco litigation against it. Conwood has
asserted and will continue to assert some or all of these
defenses in each case at the time and in the manner deemed
appropriate by Conwood and its counsel. No verdict or judgment
has been returned or entered against Conwood on any claim for
personal injuries allegedly resulting from the use of smokeless
tobacco. Conwood intends to defend vigorously all smokeless
tobacco litigation claims asserted against it. No liability for
pending smokeless tobacco litigation currently is recorded in
RAIs consolidated balance sheet as of December 31,
2006.
Cautionary
Statement
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, or the loss of any particular case concerning the
use of smokeless tobacco against Conwood, 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, Conwood or their affiliates or indemnitees,
or to reasonably estimate the amount or range of any possible
loss.
Although RJR Tobacco believes that it has valid bases for
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 or its affiliates or indemnities, 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,
26
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 against RJR
Tobacco or its affiliates or indemnitees.
Similarly, smokeless tobacco litigation is subject to many
uncertainties. Notwithstanding the quality of defenses available
to Conwood, 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 against Conwood.
Litigation
Affecting the Cigarette Industry
Overview
Introduction. 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, certain 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.
During the fourth quarter of 2006, 21 tobacco-related cases were
served against RJR Tobacco or its affiliates or indemnitees,
including B&W. On December 31, 2006, there were 1,237
cases (including 942 individual smoker cases pending in West
Virginia state court as a consolidated action) pending in the
United States against RJR Tobacco or its affiliates or
indemnitees, including B&W, as compared with 1,270 on
December 31, 2005, and 1,333 on December 31, 2004,
pending against RJR Tobacco or its affiliates or indemnitees,
including B&W.
As of February 2, 2007, 1,271 tobacco-related cases were
pending against RJR Tobacco or its affiliates or indemnitees:
1,263 in the United States; four in Puerto Rico; three in Canada
and one in Israel. Of the 1,263 total U.S. cases, 34 cases
are pending against B&W that are not also pending against
RJR Tobacco. The U.S. case number does not include the
2,624 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 February 2, 2007,
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
February 2, 2007:
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|
Number of
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|
State
|
|
U.S. Cases
|
|
|
West Virginia
|
|
|
947
|
*
|
Florida
|
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100
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|
Missouri
|
|
|
27
|
|
New York
|
|
|
26
|
|
Maryland
|
|
|
23
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|
Louisiana
|
|
|
20
|
|
Mississippi
|
|
|
19
|
|
California
|
|
|
13
|
|
Illinois
|
|
|
9
|
|
Alabama
|
|
|
5
|
|
Pennsylvania
|
|
|
4
|
|
Tennessee
|
|
|
4
|
|
Delaware
|
|
|
4
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|
New Jersey
|
|
|
4
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|
District of Columbia
|
|
|
3
|
|
Georgia
|
|
|
3
|
|
Connecticut
|
|
|
3
|
|
Minnesota
|
|
|
2
|
|
Michigan
|
|
|
2
|
|
Ohio
|
|
|
2
|
|
North Carolina
|
|
|
2
|
|
South Dakota
|
|
|
2
|
|
Vermont
|
|
|
2
|
|
Massachusetts
|
|
|
2
|
|
Kentucky
|
|
|
2
|
|
Oregon
|
|
|
2
|
|
Kansas
|
|
|
2
|
|
Indiana
|
|
|
2
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|
New Mexico
|
|
|
2
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|
Washington
|
|
|
2
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|
Arizona
|
|
|
2
|
|
South Carolina
|
|
|
2
|
|
Texas
|
|
|
1
|
|
Arkansas
|
|
|
1
|
|
27
|
|
|
|
|
|
|
Number of
|
|
State
|
|
U.S. Cases
|
|
|
Colorado
|
|
|
1
|
|
Hawaii
|
|
|
1
|
|
Iowa
|
|
|
1
|
|
Idaho
|
|
|
1
|
|
Montana
|
|
|
1
|
|
North Dakota
|
|
|
1
|
|
Nebraska
|
|
|
1
|
|
New Hampshire
|
|
|
1
|
|
Nevada
|
|
|
1
|
|
Utah
|
|
|
1
|
|
Virginia
|
|
|
1
|
|
Mariana Islands
|
|
|
1
|
|
Alaska
|
|
|
1
|
|
Maine
|
|
|
1
|
|
Rhode Island
|
|
|
1
|
|
Wisconsin
|
|
|
1
|
|
Wyoming
|
|
|
1
|
|
|
|
|
|
|
Total
|
|
|
1,263
|
|
|
|
|
|
|
|
|
|
* |
|
942 of the 947 cases are pending as a consolidated action. |
Of the 1,263 pending U.S. cases, 49 are pending in federal
court, 1,213 in state court and one in tribal court.
The following table lists the categories of the
U.S. tobacco-related cases pending against RJR Tobacco or
its affiliates or indemnitees as of February 2, 2007,
compared with the number of cases pending against RJR Tobacco,
its affiliates or indemnitees as of October 13, 2006, as
reported in RAIs Quarterly Report on
Form 10-Q
for the fiscal quarter ended September 30, 2006, filed with
the SEC on November 7, 2006, and a cross-reference to the
discussion of each case type.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in
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|
|
|
|
|
|
|
|
|
Number of
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|
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|
|
|
|
RJR Tobaccos
|
|
|
Cases Since
|
|
|
|
|
|
|
Case Numbers as of
|
|
|
October 13,
|
|
|
Page
|
|
Case Type
|
|
February 2, 2007
|
|
|
2006
|
|
|
Reference
|
|
|
Individual Smoking and Health
|
|
|
1,169
|
|
|
|
−184
|
|
|
|
34
|
|
Flight Attendant ETS
(Broin II)
|
|
|
2,624
|
|
|
|
−2
|
|
|
|
36
|
|
Class-Action
|
|
|
23
|
|
|
|
+3
|
|
|
|
37
|
|
Governmental Health-Care Cost
Recovery
|
|
|
3
|
|
|
|
No Change
|
|
|
|
45
|
|
Other Health-Care Cost Recovery
and Aggregated Claims
|
|
|
3
|
|
|
|
No Change
|
|
|
|
49
|
|
Master Settlement
Agreement-Enforcement And Validity
|
|
|
49
|
|
|
|
+12
|
|
|
|
50
|
|
Asbestos Contribution
|
|
|
0
|
|
|
|
No Change
|
|
|
|
52
|
|
Antitrust
|
|
|
6
|
|
|
|
+1
|
|
|
|
53
|
|
Other Litigation
|
|
|
10
|
|
|
|
+1
|
|
|
|
54
|
|
Three pending cases against RJR Tobacco and B&W that have
attracted significant media attention are the Florida state
court
class-action
case Engle v. R. J. Reynolds Tobacco Co., the
federal RICO case brought by the U.S. Department of
Justice, and the federal lights class action, Schwab
[McLaughlin] v. Philip Morris USA, Inc.
In 2000, a jury in Engle rendered a punitive damages
verdict in favor of the Florida class of
approximately $145 billion against all defendants. On
July 6, 2006, the Florida Supreme Court, among other
things, affirmed an appellate courts dismissal of the
punitive damages award, decertified the class going forward,
preserved several
class-wide
findings from the trial, including that nicotine is addictive
and cigarettes are defectively designed, and authorized class
members to avail themselves of these findings in individual
lawsuits under certain conditions. On December 21, 2006,
the Florida Supreme Court, in response to motions from both
sides, issued a revised opinion in which it set aside the
jurys finding of a conspiracy to misrepresent. The court
also clarified that the future plaintiffs could rely on the
Engle jurys findings on express warranty. The
Supreme Court mandate was issued on January 11, 2007, thus
beginning a one-year period in which class members may file
individual lawsuits.
28
In the U.S. Department of Justice case, brought in 1999 in
the U.S. District Court for the District of Columbia, the
government sought, among other forms of relief, the disgorgement
of profits pursuant to the civil provisions of RICO. The
U.S. Court of Appeals for the District of Columbia ruled in
2005 that disgorgement is not an available remedy in the case.
The bench trial ended in June 2005, and the court, in August
2006, issued its ruling, among other things, finding the
defendants liable for the RICO claims, imposing no direct
financial penalties on the defendants, but ordering the
defendants to make certain corrective communications
in a variety of media and enjoining the defendants from using
certain brand descriptors. Both sides have appealed to the
U.S. Court of Appeals for the District of Columbia and the
trial courts order has been stayed pending the appeal.
In September 2006, the U.S. District Court for the Eastern
District of New York in Schwab certified a nationwide
class of lights smokers and set a trial date of
January 22, 2007. On November 16, 2006, the Second
Circuit granted the defendants motions to stay the
district court proceedings and for review of the class
certification ruling. Briefing is complete. Oral argument has
not been scheduled.
For a detailed description of these cases, see
Class Action Suits Engle
Case, Governmental Health-Care Cost
Recovery Cases Department of Justice Case and
Class Action Suits
Lights Cases below.
In November 1998, the major U.S. cigarette manufacturers,
including RJR Tobacco and B&W, entered into the MSA with 46
U.S. states and certain U.S. territories and
possessions. These cigarette manufacturers previously settled
four other cases, brought on behalf of Mississippi, Florida,
Texas and Minnesota, by separate agreements with each state. The
MSA and other state settlement agreements:
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|
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 $2.6 billion,
$2.7 billion and $2.0 billion in 2006, 2005 and 2004,
respectively. RJR Tobacco estimates its payments will be
approximately $2.6 billion in 2007 and will be
approximately $2.8 billion thereafter. These payments are
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.
29
Scheduled Trials. Trial schedules are subject
to change, and many cases are dismissed before trial. Compared
to prior years, however, it is possible that there will be an
increased number of tobacco-related trials against RJR Tobacco
or its affiliates and indemnitees, during 2007. The following
table lists the trial schedule, as of February 2, 2007, for
RJR Tobacco or its affiliates and indemnitees, including
B&W, through December 31, 2007.
|
|
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|
|
|
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Trial Date
|
|
Case Name/Type
|
|
Defendant(s)
|
|
Jurisdiction
|
|
January 22, 2007 [ONGOING]
|
|
Whiteley v. R.J. Reynolds
Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
Superior Court San Francisco
County (San Francisco, CA)
|
April 18, 2007
|
|
Falconer v. R.J. Reynolds
Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
Circuit Court
Jackson County
(Kansas City, MO)
|
September 17, 2007
|
|
Hausrath v. Philip Morris
USA, Inc.
[Individual]
|
|
B&W
|
|
NY Supreme Court
Erie County
(Buffalo, NY)
|
October 29, 2007
|
|
Williams v.
Brown & Williamson Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
City of St. Louis
(St. Louis, MO)
|
November 20, 2007
|
|
Ryan v. Philip Morris USA,
Inc.
[Individual]
|
|
RJR Tobacco, B&W
|
|
U.S. District Court Northern
District Fort Wayne Division (Indianapolis, IN)
|
Trial Results. From January 1, 1999
through February 2, 2007, 52 smoking and health and
health-care cost recovery cases in which RJR Tobacco or B&W
were defendants were tried. Verdicts in favor of RJR Tobacco,
B&W and, in some cases, RJR Tobacco, B&W and other
defendants, were returned in 36 cases (including four mistrials)
tried in Florida (10), New York (4), Missouri (4), Tennessee
(3), Mississippi (2), California (2), West Virginia (2),
Ohio (2), Connecticut (1), Louisiana (1), New Jersey (1),
Pennsylvania (1), South Carolina (1), Texas (1) and
Washington (1).
Additionally, from January 1, 1999 through February 2,
2007, verdicts were returned in 20 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 11 cases four 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, two in each of Florida and Oregon and one in
Illinois. The defendants appeals or post-trial motions are
pending in these cases.
There were no cases in which RJR Tobacco or B&W was a
defendant tried in the third or fourth quarters of 2006.
One case was tried in the second quarter of 2006 in which RJR
Tobacco was a defendant. In Kimball v. R.J. Reynolds
Tobacco Co., an individual smoker case, a Washington state
court jury returned a verdict in favor of RJR Tobacco on
May 15, 2006. On June 20, 2006, the plaintiff waived
his right to appeal or to pursue the case further and RJR
Tobacco agreed to reduce the amount of costs taxed against the
plaintiff.
One case was tried in the first quarter of 2006 in which RJR
Tobacco and B&W were defendants. In VanDenBurg v.
Brown & Williamson Tobacco Corp., an individual
smoker case, a Missouri state court jury returned a verdict in
favor of the defendants, including RJR Tobacco and B&W, on
February 22, 2006. The plaintiffs motion for a new
trial was denied on June 19, 2006. The plaintiffs
deadline for seeking an appeal has passed.
30
The following chart reflects the verdicts and post-trial
developments in the smoking and health cases that have been
tried since January 1, 1999 and remain pending as of
February 2, 2007, in which verdicts have been returned in
favor of the plaintiffs and against RJR Tobacco or B&W, or
both.
|
|
|
|
|
|
|
|
|
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. The Florida
Supreme Court on July 6, 2006 affirmed the dismissal of the
punitive damages award and decertified, on a going-forward
basis, the class. The court preserved a number of classwide
findings from Phase I of the Engle trial, and
authorized class members to avail themselves of those findings
in individual lawsuits, provided they commence those lawsuits
within one year of the date the courts decision becomes
final. In addition, the court reinstated compensatory damage
verdicts in favor of two plaintiffs in the amounts of
$2.85 million and $4.023 million, respectively. On
December 21, 2006, the Florida Supreme Court, in response
to motions from both sides issued a revised opinion in which it
set aside the jurys finding of a conspiracy to
misrepresent and clarified that the future plaintiffs could rely
on the Engle jurys findings on express warranty.
The Supreme Court mandate issued on January 11, 2007. On
January 12, 2007, the defendants asked Floridas Third
District Court of Appeals to review issues that had been raised
but not addressed by either appellate court. The Third District
Court of Appeals denied the motion on February 21, 2007.
|
31
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
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 non-economic 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. On August 2, 2006, the
plaintiffs filed a motion for entry of partial judgment and
notice of jury trial on punitive damages. The court granted the
defendants motion to strike as premature the
plaintiffs motion. On January 2, 2007, the defendants
moved to set aside the June 11, 2002, verdict to dismiss
the plaintiffs punitive damages claim. On January 3,
2007, the plaintiffs filed a motion for entry of judgment. A
hearing on the motion is scheduled for March 15, 2007.
|
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.
|
|
On August 22, 2006, the Court
of Appeals for the Western District of Missouri affirmed the
judgment. The Missouri Supreme Court refused to hear the case.
On January 3, 2007, RJR Tobacco, due to its obligation to
indemnify B&W, paid the plaintiff approximately $268,100
(judgment plus interest).
|
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. The defendants motion
to stay entry and enforcement of the final judgment pending
further appeals was granted on January 5, 2007. The
defendants filed a notice of appeal on January 25, 2007.
|
32
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
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, jointly and severally, for a smoking cessation
program.
|
|
On September 29, 2004, the
defendants posted a $50 million bond and noticed their
appeal to the Louisiana Court of Appeal. RJR Tobacco posted
$25 million toward the bond. On February 7, 2007, the
Louisiana Court of Appeal found that any class member who
started smoking or whose right to participate in the program
accrued after September 1, 1988, is not entitled to
recovery. The court also rejected the award of pre-judgment
interest and most of the specific components of the smoking
cessation program. However, the court upheld the class
certification and found the defendants responsible for funding
smoking cessation for eligible class members. On
February 21, 2007, the defendants filed a motion for
rehearing.
|
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 June 1, 2005, B&W filed
its notice of appeal. Oral argument occurred on October 5,
2006. A decision is pending.
|
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.
|
|
On August 18, 2005, B&W
filed its notice of appeal. Pursuant to its agreement to
indemnify B&W, RJR Tobacco posted a supersedeas bond in the
amount of $2.058 million on February 7, 2006. Oral
argument occurred on December 12, 2006. A decision is
pending.
|
33
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
August 17, 2006
|
|
United States v. Philip
Morris USA, Inc.
[Governmental
Health-Care Cost Recovery]
|
|
U.S. District Court, District
of Columbia (Washington, DC)
|
|
RJR Tobacco and B&W were found
liable for civil RICO claims; were enjoined from using certain
brand descriptors and from making certain misrepresentations;
and were ordered to make corrective communications on five
subjects, including smoking and health and addiction, required
to reimburse the U.S. Department of Justice appropriate
costs associated with the lawsuit, and maintain document web
sites.
|
|
On September 11, 2006, RJR
Tobacco and B&W filed their notices of appeal. On
October 16, 2006, the government filed its notice of
appeal. In addition, the government has requested the defendants
pay a total of approximately $1.9 million in costs. The
court of appeals granted the defendants motion to stay the
district courts order on October 31, 2006. On
November 28, 2006, the court of appeals stayed the appeals
pending the defendants motion for clarification of the
trial courts ruling on the order.
|
Individual
Smoking and Health Cases
As of February 2, 2007, 1,169 individual cases, including
942 individual smoker cases in West Virginia state court in a
consolidated action, were pending in the U.S. 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 1,163 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, 2006.
On March 20, 2000, in Whiteley
v. Raybestos-Manhattan, Inc. (a case filed in
April 1999, and pending in Superior Court, San Francisco
County, California), a jury awarded the plaintiffs
$1.72 million in compensatory damages and $20 million
in punitive damages. RJR Tobacco and Philip Morris were each
assigned $10 million of the punitive damages award. The
defendants appealed the final judgment to the California Court
of Appeals. On April 7, 2004, the court of appeals reversed
the judgment and remanded the case for a new trial. On
April 28, 2006, the plaintiffs filed a consolidated amended
complaint for survival/loss of consortium/wrongful death. The
plaintiffs allege that use of the defendants products,
along with exposure to asbestos, caused Mrs. Whiteley to
develop lung cancer and ultimately die. With the filing of the
consolidated complaint, the case name became Whiteley v.
R. J. Reynolds Tobacco Co. Jury selection began on
January 22, 2007. Opening statements occurred on
February 26, 2007.
On October 12, 2000, in Jones v. Brown &
Williamson Tobacco Corp. (a case filed in July 1997, and
pending in Circuit Court, Hillsborough County, Florida), a jury
found against RJR Tobacco and awarded approximately $200,000 in
compensatory damages only. The action was brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, seeking to recover an amount in excess of $150,000.
The plaintiff was also allowed to make a claim for punitive
damages. The plaintiff alleged that Mrs. Joness use
of the defendants products caused her to develop lung
cancer, emphysema, heart disease, chronic obstructive pulmonary
disease, referred to as COPD, and ultimately caused her death.
The judge granted RJR Tobacco a new trial on December 28,
2000, and the new trial decision was affirmed by the Second
District Court of Appeal of Florida on August 30, 2002. On
April 27, 2005, the Florida Supreme Court dismissed the
plaintiffs notice of appeal without prejudice. The
plaintiff dismissed all claims against RJR Tobacco on
April 19, 2006.
34
On December 21, 2001, in Kenyon v. R. J.
Reynolds Tobacco Co. (a case filed in July 2000 in Circuit
Court, Hillsborough County, Florida), a jury awarded the
plaintiff $165,000 in compensatory damages only in an action
brought by Florence Kenyon against RJR Tobacco seeking to
recover compensatory damages and costs. The plaintiff alleged
that Mr. Kenyons use of the defendants products
caused his development of lung cancer
and/or other
illnesses. On May 30, 2003, the Second District Court of
Appeal of Florida affirmed per curiam (that is, without writing
an opinion) the trial courts final judgment. After
exhausting its state court appeals, RJR Tobacco paid the
plaintiff approximately $196,000 (judgment plus interest) in
2003. In 2005, RJR Tobacco also paid approximately
$1.3 million in attorneys fees to the
plaintiffs counsel.
On August 15, 2003, a jury returned a verdict in favor of
B&W in Eiser v. Brown & Williamson Tobacco
Corp. (a case filed in March 1999, and pending in the Court
of Common Pleas, Philadelphia County, Pennsylvania). The
plaintiff, Lois Eiser, sought compensatory and punitive damages
in an amount in excess of $50,000, together with interest, costs
of suit and attorneys fees in this wrongful death action
against B&W. The plaintiff contends the decedents
injury and death were directly related to the actions of the
defendants. On January 19, 2006, the Superior Court of
Pennsylvania affirmed the verdict. On September 22, 2006,
the Pennsylvania Supreme Court granted the plaintiffs
petition to appeal. Oral argument is scheduled for
April 16, 2007.
On November 4, 2003, in Thompson
v. Brown & Williamson Tobacco Corp. (a
case filed in August 2000 in Circuit Court, Jackson County,
Missouri), a jury awarded $2.1 million in compensatory
damages against B&W and Philip Morris in an action brought
against the major U.S. cigarette manufacturers, including
RJR Tobacco and B&W, seeking an unspecified amount of
compensatory and punitive damages. The plaintiffs,
Michael Thompson and Christi Thompson, alleged that the
defendants manufactured, sold and placed in the stream of
commerce cigarettes that caused Mr. Thompsons throat
cancer. 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 Missouri Court of
Appeals affirmed the judgment on August 22, 2006 and denied
the defendants motion to transfer the case to the Missouri
Supreme Court. The defendants application for transfer in
the Missouri Supreme Court was denied on December 19, 2006.
On January 3, 2007, RJR Tobacco, due to its obligation to
indemnify B&W, paid the plaintiff approximately $268,100
(judgment plus interest) in satisfaction of the judgment.
On December 18, 2003, in Frankson
v. Brown & Williamson Tobacco Corp. (a
case filed in August 2000, and pending in Supreme Court, Kings
County, New York), a 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, in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking $270 million in compensatory damages,
unspecified punitive damages, attorneys fees, costs and
disbursements. The plaintiff, Gladys Frankson, alleged that
Mr. Frankson became physically and psychologically addicted
to nicotine, was unable to cease smoking, developed lung cancer
and subsequently died as a result. 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 July 5, 2006, the Appellate Division denied the
defendants appeal of the trial courts decision
denying the defendants post-trial motions. The
defendants motion for rehearing, or in the alternative,
for leave to appeal to the New York Court of Appeals was denied
on October 5, 2006. On November 20, 2006, the
plaintiff filed a motion to enter judgment in the sums of
$175,000 in compensatory damages (the original jury award
reduced by 50%) and $5 million in punitive damages (the
amount the plaintiff stipulated to). The motion was granted on
December 8, 2006, and the defendants filed a notice of
appeal on January 25, 2007. The defendants motion to
stay entry and enforcement of the final judgment pending further
appeals was granted on January 5, 2007. The stay is in
effect for 15 days after the plaintiff serves notice of
entry of judgment in order to allow the defendants to post a
supersedeas bond. Once the plaintiff serves the notice of entry
of judgment, the defendants will file a notice of appeal within
15 days.
35
On February 1, 2005, a jury returned a split verdict in
Smith v. Brown & Williamson Tobacco Corp.
(a case filed in May 2003, and pending in Circuit Court, Jackson
County, Missouri), finding in favor of B&W on two counts,
fraudulent concealment and conspiracy, and finding in favor of
the plaintiff on the negligence count (which incorporates
failure to warn and product defect claims). The plaintiff,
Lincoln Smith, claimed that the defendants tobacco
products caused Mrs. Smiths death from lung cancer
and sought an unspecified amount of compensatory and punitive
damages. The plaintiff was 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
aggravating circumstances, which provided an entitlement to
punitive damages. On February 2, 2005, the jury awarded the
plaintiff $20 million in punitive damages. On June 1,
2005, B&W filed its notice of appeal with the Missouri Court
of Appeals. Oral argument occurred on October 5, 2006. A
decision is pending. Pursuant to its agreement to indemnify
B&W, RJR Tobacco will post a supersedeas bond in the amount
of $24.3 million if necessary.
On March 18, 2005, in Rose
v. Brown & Williamson Tobacco Corp. (a
case filed in December 1996, and pending in New York Supreme
Court, County of New York), a 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. The action was
brought against the major U.S. cigarette manufacturers,
including RJR Tobacco and B&W, seeking to recover
$15 million in compensatory damages and $35 million in
punitive damages. The plaintiffs, Norma Rose and Leonard Rose,
allege that their use of the defendants products caused
them to become addicted to nicotine and develop lung cancer,
COPD and other smoking related conditions
and/or
diseases. Oral argument on B&Ws appeal occurred on
December 12, 2006. A decision is pending. Pursuant to its
agreement to indemnify B&W, RJR Tobacco posted a supersedeas
bond in the amount of $2.058 million on February 7,
2006.
On February 22, 2006, in VanDenBurg v.
Brown & Williamson Tobacco Corp. (a case filed
in January 2003, and pending in Circuit Court, Jackson County,
Missouri), a jury returned a verdict in favor of the defendants,
including RJR Tobacco and B&W in an action brought against
the major U.S. cigarette manufacturers seeking an
unspecified amount of compensatory and punitive damages. This
individual case was part of a multi-plaintiff action and was
served on the defendants in June and July of 2003. The group of
plaintiffs alleged that their use of the defendants
tobacco products caused each to be inflicted with various types
of cancer. The plaintiffs motion for new trial requesting
an evidentiary hearing was denied on June 19, 2006. The
plaintiffs deadline for seeking an appeal has passed.
On May 15, 2006, in Kimball v. R. J. Reynolds
Tobacco Co. (a case filed in January 2003, and pending in
Superior Court, Whatcom County, Washington), a jury returned a
verdict in favor of the only defendant, RJR Tobacco, in an
action seeking in excess of $75,000 in compensatory and punitive
damages. The plaintiff, Philip Kimball, alleged that
Mrs. Kimball sustained personal injury as a result of using
the defendants products causing damages, including medical
expenses, pain and suffering, anxiety and severe emotional
distress. On June 20, 2006, the plaintiff agreed to waive
his right to appeal or to pursue the case further and RJR
Tobacco agreed to reduce the amount of costs taxed against the
plaintiff.
Broin II
Cases
As of February 2, 2007, there were 2,624 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. Punitive damages are not available in these cases.
On October 5, 2000, the Broin court 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
36
by exposure to ETS. Below is a description of the
Broin II cases against RJR Tobacco and B&W that
went to trial, were decided, remained on appeal or were
otherwise pending, since January 1, 2006.
In Janoff v. Philip Morris, Inc. (a case
filed in February 2000 in Circuit Court, Dade County, Florida),
a jury found in favor of the defendants, including RJR Tobacco
and B&W, on September 5, 2002, in an action brought
against the major U.S. cigarette manufacturers seeking to
recover compensatory damages pursuant to the Broin
settlement. The plaintiff, Suzette Janoff, alleged that as a
result of exposure to ETS in airline cabins, she suffered from,
among other illnesses, chronic sinusitis, chronic bronchitis and
other respiratory and pulmonary problems. The judge granted the
plaintiffs motion for a new trial 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. On November 1, 2005, the Florida
Supreme Court refused to hear the case. At this time, the
plaintiff has not indicated whether the case will be retried.
In Swaty v. Philip Morris, Inc. (a case filed in
September 2000 in Circuit Court, Dade County, Florida), a jury
found in favor of the defendants, including RJR Tobacco and
B&W, on May 3, 2005, in an action brought against the
major U.S. cigarette manufacturers seeking to recover an
unspecified amount of compensatory damages pursuant to the
Broin settlement. The plaintiff, Lorraine Swaty, alleged
that as a result of exposure to ETS in airline cabins, she
suffered from chronic sinusitis and asthma. On November 8,
2006, the Third District Court of Appeal affirmed the verdict.
The plaintiffs motion for rehearing and motion for
clarification was denied on January 11, 2007. The mandate
issued on January 29, 2007.
Class-Action
Suits
Overview. As of February 2, 2007, 23
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
nation-wide 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
nation-wide, 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, West Virginia and the District of Columbia.
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 12 cases alleging that the use of the term
lights constitutes unfair and deceptive trade
practices under state law or violates the federal RICO statute.
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, certain 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. Eighteen federal courts, including two courts of
appeals, and most state courts that have considered the issue
have rejected class certification in such cases. Apart from the
Castano case discussed above, only two federal district
courts have certified a smoker class action In re
Simon (II) Litigation (in which the class was
ultimately decertified) and Schwab [McLaughlin] v.
Philip Morris USA, Inc., discussed below under
Lights Cases, both of
which were filed in the U.S. District Court for the Eastern
District of New York.
In Simon (II) (a case filed in September 2000, and
pending in U.S. District Court, Eastern District, New
York), on September 19, 2002, the court certified a
nationwide mandatory, non-opt-out punitive damages class in an
action brought against the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, and parent
companies of U.S. cigarette manufacturers seeking an
unspecified amount in punitive damages. The class sought to
represent persons who suffered from or have died from diseases
allegedly caused by smoking of cigarettes designed,
manufactured, marketed and sold by the defendant cigarette
companies. The plaintiffs alleged that the cigarette companies
designed, manufactured, marketed and sold cigarettes in a
defective condition, that they fraudulently
37
and deceptively denied and concealed that they were defective
and posed significant health risks to those who used them. On
May 6, 2005, the Second Circuit, in a unanimous opinion,
decertified the class. On August 8, 2005, the Second
Circuit denied plaintiffs petition for rehearing and
remanded the case to the District Court for further proceedings.
On March 20, 2006, the court entered final judgment
dismissing the case. The class did not appeal.
On February 10, 2003, in Simms v. Philip Morris,
Inc. (a case filed in May 2001, and pending in the
U.S. District Court, District of Columbia), the court
denied certification of a proposed nation-wide class of smokers
who purchased cigarettes while underage in an action brought
against the major U.S. cigarette manufacturers, including
RJR Tobacco and B&W, seeking: treble damages; disgorgement
of unjust enrichment; to enjoin defendants from engaging in
marketing or advertising campaigns that target
and/or
encourage under-age youth to purchase cigarettes, and from
making false, misleading or deceptive statements concerning the
health effects and addictive natures of cigarettes; to require
the defendants to make corrective statements; and the recovery
of attorneys fees, expert fees and costs. The action was brought
to recover the purchase price paid by the plaintiffs and class
members for defendants products while they were underage,
or in the alternative, to recover the unjust enrichment obtained
by the defendants from the plaintiffs and class members while
they were underage through the use of fraud, deception,
misrepresentation, and other activities constituting
racketeering, in violation of federal law. On December 21,
2006, the court denied the plaintiffs motions for
reconsideration and reversal of the order that denied class
certification.
Medical
Monitoring and Smoking Cessation Cases
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 case filed in May 1996, and pending in District
Court, Orleans Parish, Louisiana), an 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, in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking to recover an unspecified amount of
compensatory and punitive damages. The plaintiffs allege that
their use of the defendants products caused them to become
addicted to nicotine. Opening statements occurred on
January 21, 2003. On July 28, 2003, the jury returned
a verdict in favor of the defendants on the plaintiffs
claim for medical monitoring and found that cigarettes were not
defectively designed. However, the jury also made certain
findings against the defendants on claims relating to fraud,
conspiracy, marketing to minors and smoking cessation.
Notwithstanding 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 pay for a program to help people stop
smoking. On March 31, 2004, phase two of the trial began to
address only 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 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. The Louisiana Court of
Appeal issued its opinion on February 7, 2007. The court
found that any class member who started smoking or whose right
to participate in the program accrued after September 1,
1988, is not entitled to any recovery under Louisiana law. The
court also rejected the award of pre-judgment interest and most
of the specific components of the smoking cessation program.
However, the court upheld the class certification and found the
defendants responsible for funding smoking cessation for
eligible class members. On February 21, 2007, the
defendants filed a motion for rehearing.
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 on May 6,
2004. In Lowe v. Philip Morris, Inc. (a case filed
in November 2001, and pending in Circuit Court, Multnomah
County, Oregon), a judge dismissed the complaint on
November 4, 2003, for failure to state a claim in an action
against the major U.S. cigarette manufacturers, including
RJR Tobacco and B&W, seeking creation of a court-supervised
program of medical monitoring, smoking cessation and education,
and recovery of attorneys fees. The plaintiffs appealed,
and on September 6, 2006, the Court of Appeals affirmed
38
the trial courts dismissal of the plaintiffs
complaint. On December 27, 2006, the plaintiffs filed a
petition for review with the Oregon Supreme Court. Briefing is
underway.
Engle
Case
Trial began in July 1998 in Engle v. R. J. Reynolds Tobacco
Co. (a case filed in May 1994, and pending in Circuit Court,
Dade County, Florida), in which a class consisting of Florida
residents, or their survivors, alleges diseases or medical
conditions caused by their alleged addiction to
cigarettes. The action was brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking actual damages and punitive damages in excess
of $100 billion each and the creation of a medical fund to
compensate individuals for future health care costs. The
plaintiffs alleged that their use of the defendants
products caused their development of various illnesses and their
addiction. 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 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 November 6, 2000, the trial judge denied all 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-Dade County Circuit Court with instructions to
decertify the class. The class appealed, and the Florida Supreme
Court accepted the case on May 12, 2004.
On July 6, 2006, the court issued its decision. The court
affirmed the dismissal of the punitive damages award and
decertified the class, on a going-forward basis. The court
preserved a number of
class-wide
findings from Phase I of the trial, including that
cigarettes can cause certain diseases, that nicotine is
addictive and that defendants placed defective and unreasonably
dangerous cigarettes on the market, and authorized class members
to avail themselves of those findings in individual lawsuits,
provided they commence those lawsuits within one year of the
date the courts decision becomes final. The court
specified that the class is confined to those Florida residents
who developed smoking-related illnesses that
manifested themselves on or before November 21,
1996. In addition, the court reinstated the compensatory damages
awards of $2.85 million to Mary Farnan and
$4.023 million to Angie Della Vecchia, but ruled that the
claims of Frank Amodeo were barred by the statute of
limitations. Finally, the court reversed the Third District
Court of Appeals 2003 ruling that class counsels
improper statements during trial required reversal.
On August 7, 2006, RJR Tobacco and the other defendants
filed a rehearing motion arguing, among other things, that the
findings from the Engle trial are not sufficiently
specific to serve as the basis for further proceedings and that
the Florida Supreme Courts application of the
class-action
rule denies defendants due process. On the same day, the
plaintiffs also filed a rehearing motion arguing that some
smokers who became sick after November 21, 1996, and who
are therefore not class members, should nevertheless have the
statute of limitations tolled since they may have refrained from
filing suit earlier in the mistaken belief that they were
Engle class members. On December 21, 2006, the
Florida Supreme Court withdrew its July 6, 2006, decision
and issued a revised opinion, in which it set aside the
jurys findings of a conspiracy to misrepresent and
clarified that the future plaintiffs could rely on the Engle
jurys findings on express warranty. The court issued
its mandate on January 11, 2007, which begins the one-year
period for individual class members to file lawsuits.
39
On January 12, 2007, the defendants asked the Third
District Court of Appeal to rule on certain issues that were
raised by the parties, but not addressed by the court in its
prior rulings. That motion was denied on February 21, 2007.
RAI anticipates that individual case filings in Florida will
increase as a result of the Engle decision.
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,
Lukacs v. Philip Morris, Inc. (a case filed in
February 2001, and pending in Circuit Court, Dade County,
Florida), was tried against Philip Morris, Liggett and B&W,
and resulted in a verdict for the plaintiffs on June 11,
2002, in a personal injury action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking to recover an unspecified amount in
compensatory and punitive damages. The plaintiff alleged that
his use of the defendants brands caused his development of
bladder, throat, oral cavity and tongue cancer. RJR Tobacco was
voluntarily dismissed on May 1, 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. On August 2, 2006, the
plaintiff filed a motion for entry of partial judgment and
notice of jury trial on punitive damages. Trial was scheduled to
begin on November 27, 2006; however, on September 27,
2006, the trial court granted the defendants motion to
strike as premature the plaintiffs motions and removed the
case from the trial calendar. On January 2, 2007, the
defendants asked the court to set aside the jurys
June 11, 2002, verdict for the plaintiffs and to dismiss
the plaintiffs punitive damages claim. On January 3,
2007, the plaintiffs filed a motion for entry of judgment. A
hearing on the motion is scheduled for March 15, 2007.
California
Business and Professions Code Cases
On November 30, 2000, in Daniels v. Philip Morris Cos.,
Inc. (a case filed in April 1998, and pending in Superior
Court, San Diego County, California), a judge, 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 action had
been brought against the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, seeking to
recover an unspecified amount of compensatory and punitive
damages, restitution to each member of the class and to the
general public, and an injunction prohibiting the defendants
from engaging in further violation of California
Business & Professions Code §17200 and
§17500. The plaintiffs allege that due to the deceptive
practices of the defendants, they became addicted to cigarettes
as teenagers. 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 affirmed
the trial court. On February 16, 2005, the California
Supreme Court granted the plaintiffs petition for review.
Briefing is complete. Oral argument has not been scheduled.
On April 11, 2001, in Brown v. American Tobacco Co.,
Inc. (a case filed in June 1997, and pending in Superior
Court, San Diego County, California), the same judge in
Daniels granted in part the plaintiffs motion for
certification of a class 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. The action was brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, seeking to recover restitution, disgorgement of
profits and other equitable relief under California Business and
Professions Code §17200 et seq. and §17500 et seq.
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 and on the plaintiffs common
law claims. 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 granted the defendants
motion. The plaintiffs filed a notice of appeal on May 19,
2005. On September 5, 2006, the California Court of Appeal
affirmed the judges order decertifying the class. On
October 13, 2006, the plaintiffs filed a petition for
review with the California Supreme Court. The petition for
review was granted on November 1, 2006. Briefing is
underway.
40
Lights
Cases
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 (2),
Washington (1) and New York (1). The class in these cases
generally seek to recover $50,000 to $75,000 per class
member for compensatory and punitive damages, attorneys
fees and costs from RJR Tobacco
and/or
B&W, unless otherwise noted.
On November 14, 2001, in Turner v. R. J. Reynolds
Tobacco Co. (a case filed in February 2000, and pending in
Circuit Court, Madison County, Illinois), a judge 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... The plaintiffs
claim that the defendants sold and packaged light
cigarettes as having lowered tar and nicotine delivery
when in reality they were designed to deliver higher levels of
tar and nicotine. On June 6, 2003, RJR Tobacco filed a
motion to stay the case pending Philip Morris appeal of
the Price v. Philip Morris Inc. case, which is
discussed below. RJR Tobacco filed an emergency stay/supremacy
order request 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.
On December 18, 2001, in Howard v. Brown &
Williamson Tobacco Corp. (another case filed in February
2000, and pending in Circuit Court, Madison County, Illinois), a
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. The plaintiffs allege that the
defendants violated the Illinois Consumer Fraud and Deceptive
Business Practices Act by not fully disclosing the true nature
of light cigarettes and carried out false and
deceptive advertising concerning light cigarettes.
On June 6, 2003, the trial judge issued an order staying
all proceedings pending resolution of the Price v.
Philip Morris, Inc. case, discussed below. The plaintiffs
appealed this stay order to the Illinois Fifth District Court of
Appeals, which 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. The
case was filed on February 10, 2000, in the Circuit Court
for the Third Judicial Circuit, Madison County, Illinois. The
class members claim that the defendants sold and packaged
light cigarettes as having lowered tar and nicotine
delivery when in reality they were designed to deliver higher
levels of tar and nicotine. 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 the 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. On December 15, 2005, the Illinois Supreme
Court reversed the lower state courts decision and sent
the case back to the lower court with instructions to dismiss
the case. On May 8, 2006, the plaintiffs filed a motion to
stay mandate until final disposition of their petition for
certiorari to the U.S. Supreme Court. The motion was
granted on May 19, 2006. The plaintiffs petition for
writ of certiorari was denied on November 27, 2006. On
December 15, 2006, the Illinois Supreme Court reversed the
Circuit Courts judgment and remanded the case with
instructions to dismiss. On December 18, 2006, the
defendants filed a motion to dismiss and for entry of final
judgment, which was granted by the court. Judgment was entered
dismissing the case with prejudice on the same day. The
plaintiffs filed a motion to vacate
and/or
withhold judgment in the Circuit Court on January 17, 2007.
In the event RJR Tobacco and its affiliates or indemnitees,
including B&W, lose the Turner or Howard
cases, or one or more of the other pending
lights class action suits, RJR Tobacco could face
similar bonding difficulties depending upon the amount of
damages ordered, if
41
any, which could have a material adverse effect on RJR
Tobaccos, and consequently RAIs, results of
operations, cash flows or financial condition.
Schwab [McLaughlin] v. Philip Morris USA, Inc., a
nation-wide lights
class-action,
was filed on May 11, 2004, in the U.S. District Court
for the Eastern District of New York, against RJR Tobacco and
B&W, as well as other tobacco manufacturers. The plaintiffs
seek compensatory and treble damages against each defendant,
jointly and severally, for all losses and damages suffered as a
result of the defendants alleged wrong-doings complained
of, including pre- and post-judgment interest, costs and
disbursements of the action, including attorneys fees and
experts fees and costs. The plaintiffs also seek
temporary, preliminary and permanent equitable
and/or
injunctive relief, including enjoining future wrong-doing,
rescission, disgorgement of defendants ill-gotten funds,
and attaching, impounding or imposing a constructive trust upon
or otherwise restricting the proceeds of defendants
ill-gotten funds. The plaintiffs brought the case pursuant to
RICO, challenging the practices of the defendants in connection
with the manufacturing, marketing, advertising, promotion,
distribution and sale of cigarettes that were labeled as
lights or light. The plaintiffs
motion for class certification and summary judgment motions by
both sides were heard in September 2005. Although trial was
scheduled to commence in January 2006, the court decided to
permit several months of additional discovery before deciding
the class certification issue. The defendants motions for
summary judgment, the plaintiffs supplemental brief in
support of class certification and various other motions were
filed on June 9, 2006. On September 25, 2006, the
court issued its decision, among other things, granting class
certification and setting a trial date of January 22, 2007.
On October 6, 2006, the defendants filed a petition asking
the U.S. Court of Appeals for the Second Circuit to review
the class certification ruling. The defendants also filed a
motion to stay the case pending resolution of the proposed
interlocutory appeal. On November 16, 2006, the Second
Circuit granted the defendants motions to stay the
district court proceedings and for review of the class
certification ruling. Briefing is complete. Oral argument has
not been scheduled.
A lights
class-action
case is pending against each of RJR Tobacco and B&W in
Missouri. On December 31, 2003, in Collora v. R. J.
Reynolds Tobacco Co. (a case filed in May 2000, and pending
in Circuit Court, St. Louis County, Missouri), a 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. The plaintiffs seek
mandatory injunctive relief sufficient to inform consumers of,
among other things, the fact that light smoke is
actually more mutagenic than regular tobacco smoke. The
plaintiffs claim that while promoting low tar and
nicotine deliveries, the defendants designed light cigarettes to
deliver higher levels of tar and nicotine than could be measured
by the standard testing apparatus, therefore achieving support
for the claim that the cigarettes were light and
that they contained low tar and nicotine. On
January 14, 2004, RJR and RJR Tobacco removed this case to
the U.S. 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 again removed the case to
the U.S. District Court for the Eastern District of
Missouri, based on the U.S. 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. The plaintiffs motion
to remand was granted on April 18, 2006. On
December 22, 2006, the plaintiffs filed a motion to
reassign Collora and the following cases to a single
general division: Craft v. Philip Morris Companies,
Inc. and Black v. Brown & Williamson
Tobacco Corp. (discussed below).
In Black v. Brown & Williamson Tobacco Corp. (a
case filed in November 2000, pending in Circuit Court, City of
St. Louis, Missouri), B&W removed the case to the
U.S. District Court for the Eastern District of Missouri on
September 23, 2005. The plaintiffs claim that while
promoting low tar and nicotine deliveries, the
defendants designed light cigarettes to deliver higher levels of
tar and nicotine than could be measured by the standard testing
apparatus. They also claim that the defendants failed to
disclose that the smoke produced by the light
cigarettes is more mutagenic than regular tobacco smoke. On
October 25, 2005, the plaintiffs filed a motion to remand,
which was granted on March 17, 2006. As discussed in the
prior paragraph, on December 22, 2006, the plaintiffs filed
a motion to reassign this case and certain other cases to a
single general division.
RJR Tobacco and B&W, respectively, removed two Louisiana
lights
class-actions
to federal court. In Harper v. R. J. Reynolds Tobacco
Co. (filed in May 2003, and pending in U.S. District
Court, Western District, Louisiana), on January 27, 2005,
the judge denied the plaintiffs motions to remand. The
plaintiffs are claiming
42
economic losses for the purchase of RJR Tobaccos
light cigarette brands in Louisiana. The plaintiffs
appealed the denial of the motion, and on July 17, 2006,
the Fifth Circuit Court of Appeals affirmed the district
courts order. On June 17, 2005, RJR Tobacco and RJR
filed a motion for summary judgment based on federal preemption.
In Brown v. Brown & Williamson Tobacco Corp. (a
case filed in April 2003, and pending in U.S. District
Court, Western District, Louisiana), B&W filed a similar
motion for summary judgment on July 5, 2005. The plaintiffs
are seeking economic losses for the purchase of B&Ws
light cigarette brands in Louisiana, claiming that
these products were defective and marked in a fraudulent and
deceptive manner by defendants. On September 14, 2005, the
court granted the motion in part by dismissing with prejudice
the plaintiffs Louisiana Unfair Trade and Consumer
Protection Act claims. The remainder of the motion was denied.
On December 2, 2005, the judge denied B&Ws motion
for reconsideration, but certified the case for interlocutory
appeal. On February 10, 2006, the U.S. Court of
Appeals for the Fifth Circuit granted B&Ws petition to
appeal. On February 14, 2007, the Fifth Circuit reversed
the judgment and remanded the case with directions to dismiss
all claims with prejudice.
In Dahl v. R. J. Reynolds Tobacco Co. (a case filed in
April 2003 and pending in District Court, Hennepin County,
Minnesota), a judge dismissed the case on May 11, 2005,
because the lights claims are preempted by the
Federal Cigarette Labeling and Advertising Act. The plaintiffs
claim that while promoting low tar and nicotine
deliveries, the defendants designed light cigarettes
to deliver higher levels of tar and nicotine than could be
measured by the standard testing apparatus. They also claim that
the defendants failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes. On July 11, 2005,
the plaintiffs filed a notice of appeal with the Minnesota Court
of Appeals for the Fourth Judicial District. During the pendency
of the appeal, RJR Tobacco removed the case to the
U.S. 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, which was denied on February 14, 2006. On
March 7, 2006, the parties requested that the case be
transferred to the U.S. Court of Appeals for the Eighth
Circuit, which was granted on March 9, 2006. Briefing is
complete. Oral argument occurred on December 14, 2006. A
decision is pending.
In Thompson v. R. J. Reynolds Tobacco Co.(a case filed in
February 2003, and also pending in District Court, Hennepin
County, Minnesota), RJR Tobacco removed the case on
September 23, 2005 to the United States District Court for
the District of Minnesota, also based on Watson v.
Philip Morris Companies, Inc. The plaintiffs claim that
while promoting low tar and nicotine deliveries, the
defendants designed light cigarettes to deliver
higher levels of tar and nicotine than could be measured by the
standard testing apparatus. They also claim that the defendants
failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes. The plaintiffs
motion to remand was denied on February 14, 2006. On
August 7, 2006, the parties filed a stipulation to stay the
case pending resolution of the appeal in Dahl v. R. J.
Reynolds Tobacco Co.
In Huntsberry v. R. J. Reynolds Tobacco Co. (a case filed
in April 2004, and pending in Superior Court, King County,
Washington), the plaintiffs motion for class certification
was denied on April 21, 2006. The case was brought against
RJR Tobacco seeking, among other things, actual economic damages
in the form of a refund of amounts paid by each plaintiff and
the class to purchase RJR Tobaccos light
cigarettes, or in the alternative, diminished value as proven at
trial, treble damages in an amount up to $10,000 per
plaintiff and class member, and attorneys fees. The sum of
all actual damages, treble damages, and attorneys fees is
less than $75,000 per plaintiff or class member. The
plaintiffs allege that the defendants have misrepresented and
continue to misrepresent the tar and nicotine delivery and other
qualities of light cigarettes, deliberately design
and market light cigarettes to cause smokers to
believe the cigarettes are less hazardous to smokers and deliver
lower tar and nicotine than regular cigarettes. On
September 18, 2006, the plaintiffs motion for
discretionary review was denied. The plaintiffs motion to
modify the ruling with the Washington Court of Appeals was
denied on December 18, 2006. On January 18, 2007, the
plaintiffs filed a petition for review with the Washington
Supreme Court, asking the court to review the rulings that
denied their motions for class certification. The petition will
be considered during a February 22, 2007, motion calendar.
Rios v. R. J. Reynolds Tobacco Co. (a case filed in
February 2002, and pending in Circuit Court, Palm Beach County,
Florida), is dormant pending plaintiffs counsels
attempt to appeal the Florida Fourth District Court of
Appeals decertification in Hines v. Philip Morris,
Inc. The plaintiffs in Rios brought the action
against RJR Tobacco and RJR seeking to recover an unspecified
amount in compensatory (in excess of $15,000 but less than
43
$75,000 per claimant) and an unspecified amount in punitive
damages. The plaintiffs claim that while promoting
low tar and nicotine deliveries, the defendants
designed light cigarettes to deliver higher levels
of tar and nicotine than could be measured by the standard
testing apparatus. They also claim that the defendants failed to
disclose that the smoke produced by the light
cigarettes is more mutagenic per milligram of tar than
regular cigarettes.
Finally, in Rivera v. Brown & Williamson Tobacco
Corp. (filed in October 2006, pending in Circuit Court,
Broward County, Florida), B&W removed the case to the
U.S. District Court for the Southern District of Florida on
November 15, 2006, and filed their answers to the complaint
on November 22, 2006. The plaintiffs claim that while
promoting low tar and nicotine deliveries, the
defendants designed light cigarettes to deliver
higher levels of tar and nicotine than could be measured by the
standard testing apparatus. They also claim that the defendants
failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes.
Other
Class Actions
In Cleary v. Philip Morris, Inc. (a case filed in June
1998, and pending in Circuit Court, Cook County, Illinois), the
plaintiffs filed their motion for class certification on
December 21, 2001 in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W. The action is brought on behalf of persons who have
allegedly been injured by (1) the defendants
purported conspiracy pursuant to which defendants concealed
material facts regarding the addictive nature of nicotine,
(2) the defendants alleged acts of targeting its
advertising and marketing to minors, and (3) the
defendants claimed breach of the public right to
defendants compliance with the laws prohibiting the
distribution of cigarettes to minors. The plaintiffs request
that the defendants be required to disgorge all profits unjustly
received through its sale of cigarettes to plaintiffs and
classes, which in no event will be greater than $75,000 each,
inclusive of punitive damages, interest and costs. On
April 8, 2005, the plaintiffs filed a second amended
complaint. On February 3, 2006, a hearing on the
defendants motion to dismiss occurred. The court dismissed
count V (public nuisance) and count VI (unjust enrichment) on
March 27, 2006. On April 5, 2006, the plaintiffs filed
a motion to reconsider certain of the findings in the
courts ruling on defendants motion to dismiss counts
V and VI of the plaintiffs second amended complaint. The
plaintiffs motion for reconsideration was granted in part
and denied in part. The court stated that reconsideration would
not revive the plaintiffs public nuisance and unjust
enrichment claims because the plaintiffs still cannot allege a
special or separate harm. The court merely reconsidered certain
components of its analysis, but did not modify its original
decision. On July 11, 2006, the plaintiffs filed a motion
for class certification.
Young v. American Tobacco Co., Inc. (a case filed in
November 1997, and pending in Circuit Court, Orleans Parish,
Louisiana), is an ETS class action against U.S. cigarette
manufacturers, including RJR Tobacco and B&W, and parent
companies of U.S. cigarette manufacturers, including RJR,
on behalf of all residents of Louisiana who, though not
themselves cigarette smokers, have been exposed to secondhand
smoke from cigarettes which were manufactured by the defendants,
and who suffer injury as a result of that exposure. The
plaintiffs seek to recover an unspecified amount of compensatory
and punitive damages. On October 13, 2004, the trial court
stayed this case pending the outcome of the appeal in
Scott v. American Tobacco Co., Inc., discussed under
Medical Monitoring and Smoking Cessation
Cases above.
In Parsons v. A C & S, Inc. (a case filed in
February 1998, and pending in Circuit Court, Ohio County, West
Virginia), the plaintiff sued asbestos manufacturers,
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and parent companies of U.S. cigarette
manufacturers, including RJR, seeking to recover $1,000,000 in
compensatory and punitive damages individually and an
unspecified amount for the class in both compensatory and
punitive damages. The plaintiffs allege that
Mrs. Parsons use of tobacco products and exposure to
asbestos products caused her to develop lung cancer and to
become addicted to tobacco. The case has been stayed pending a
final resolution of the plaintiffs motion to refer tobacco
litigation to the judicial panel on multi-district litigation
filed in In Re: Tobacco Litigation in the Supreme Court
of Appeals of West Virginia. On December 26, 2000, three
defendants (Nitral Liquidators, Inc., Desseaux Corporation of
North American and Armstrong World Industries) filed bankruptcy
petitions in the U.S. Bankruptcy Court for the District of
Delaware, In re Armstrong World Industries, Inc. Pursuant
to section 362(a) of the Bankruptcy Code, Parsons is
automatically stayed with respect to all defendants.
44
In Jones v. American Tobacco Co., Inc. (a case filed in
December 1998, and pending in Circuit Court, Jackson County,
Missouri), the defendants removed the case to the
U.S. District Court for the Western District of Missouri on
February 16, 1999. The action was brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and parent companies of U.S. cigarette
manufacturers, including RJR, on behalf of tobacco product users
and purchasers on behalf of all similarly situated Missouri
consumers. The plaintiffs allege that their use of the
defendants tobacco products has caused them to become
addicted to nicotine. The plaintiffs seek to recover an
unspecified amount of compensatory and punitive damages. The
case was remanded to the Circuit Court on February 17,
1999. There has been limited activity in this case.
Finally, a class action complaint was filed against certain
cigarette manufacturers and their parents, including RAI and RJR
Tobacco, in December 2006, in the Circuit Court for Cook County,
Illinois. In Espinosa v. Philip Morris USA, Inc.,
the plaintiffs brought the case on behalf of any and all persons
similarly situated throughout Illinois
and/or the
United States who, from 1996 to the date of judgment, purchased,
not for resale, the defendants cigarettes. The plaintiffs
allege that the defendants increased the nicotine in their
cigarette products and failed to inform the plaintiff
and/or the
class. The plaintiffs seek to recover an amount not less than
the purchase price of defendants cigarette products, plus
interest, attorneys fees and costs and such other relief
as the court deems appropriate. The plaintiffs filed a motion
for class certification and a motion for preservation of
documents on December 11, 2006. On December 12, 2006,
the defendants removed the case to the U.S. District Court
for the Northern District of Illinois.
Broin
Settlement
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 approved the settlement. 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 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 with each such
state.
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,
45
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.
|
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
2004 and beyond:
Unadjusted
Original Participating Manufacturers Settlement Payment
Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 and
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
Thereafter
|
|
|
First Four States
Settlements:(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mississippi Annual Payment
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
Florida Annual Payment
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
Texas Annual Payment
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
Minnesota Annual Payment
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
Remaining States Settlement:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Payments(1)
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,143
|
|
|
|
7,143
|
|
|
|
7,143
|
|
Additional Annual Payments (through
2017)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
861
|
|
|
|
861
|
|
|
|
861
|
|
Base Foundation Funding
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
|
|
|
|
|
|
Growers Trust (through
2010)(2)
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
295
|
|
|
|
295
|
|
Offset by federal tobacco buyout(2)
|
|
|
|
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(295
|
)
|
|
|
(295
|
)
|
Minnesota Blue Cross and Blue Shield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
8,889
|
|
|
$
|
8,389
|
|
|
$
|
8,389
|
|
|
$
|
8,389
|
|
|
$
|
9,389
|
|
|
$
|
9,364
|
|
|
$
|
9,364
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAIs Operating
Subsidiaries Settlement Expenses and Payment
Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement expenses
|
|
$
|
2,183
|
|
|
$
|
2,600
|
|
|
$
|
2,611
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement cash payments
|
|
$
|
2,046
|
|
|
$
|
2,732
|
|
|
$
|
2,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected settlement expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
>$
|
2,800
|
|
|
>$
|
2,750
|
|
|
>$
|
2,800
|
|
|
> $
|
2,900
|
|
Projected settlement cash payments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
>$
|
2,600
|
|
|
>$
|
2,800
|
|
|
>$
|
2,750
|
|
|
> $
|
2,800
|
|
|
|
|
(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. |
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, apparel and other
46
merchandise, outdoor and transit 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 condition 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 value categories, RJR Tobaccos share of
the domestic premium and value 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 U.S. Department of Justice
brought an action against RJR Tobacco, B&W and other tobacco
companies in the U.S. District Court for the District of
Columbia. The government initially sought to recover federal
funds expended by the federal government in providing health
care to smokers who have developed diseases and injuries alleged
to be smoking-related. In addition, the government sought,
pursuant to the civil provisions of RICO, disgorgement of
profits the government contends were earned as a consequence of
a RICO racketeering enterprise. In September 2000,
the court dismissed the governments claims asserted under
the Medical Care Recovery Act as well as those under the
Medicare Secondary Payer provisions of the Social Security Act,
but did not dismiss the RICO claims. In February 2005, the
U.S. Court of Appeals for the District of Columbia ruled
that disgorgement is not an available remedy in this case. The
governments petition for rehearing was denied in April
2005, and its petition for writ of certiorari with the
U.S. Supreme Court was denied in October 2005. The bench
(non-jury) trial began in September 2004, and closing arguments
concluded on June 10, 2005.
On August 17, 2006, the court found certain defendants
liable for the RICO claims, but did not impose any direct
financial penalties. The court instead enjoined the defendants
from committing future racketeering acts, participating in
certain trade organizations, making misrepresentations
concerning smoking and health and youth marketing, and using
certain brand descriptors such as low tar,
light, ultra light, mild and
natural. The court also ordered defendants to issue
corrective communications on five subjects,
including smoking and health and addiction, and to comply with
further undertakings, including maintaining web sites of
historical corporate documents and disseminating certain
marketing information on a confidential basis to the government.
The court also placed restrictions on the ability of the
defendants to dispose of certain assets for use in the United
States, unless the transferee agrees to abide by the terms of
the courts order, and ordered the defendants to reimburse
the U.S. Department of Justice its taxable costs incurred
in connection with the case.
Certain defendants, including RJR Tobacco, filed notices of
appeal to the U.S. Court of Appeals for the District of
Columbia on September 11, 2006. The government filed its
notice of appeal on October 16, 2006. In addition, the
defendants, including RJR Tobacco, filed joint motions asking
the district court to clarify and to stay its order pending
defendants appeal. On September 28, 2006, the
district court denied defendants motion to stay. On
September 29, 2006, the defendants, including RJR Tobacco,
filed a motion asking the court of appeals to stay the district
courts order pending the defendants appeal. The
court granted the motion on October 31, 2006. On
November 28, 2006, the court of appeals stayed the appeals
pending the trial courts ruling on the defendants
motion for clarification.
The stay of the district courts order suspends the
enforcement of the order pending the outcome of defendants
appeal. RJR Tobacco does not know the timing of an appellate
decision or, if the order is affirmed, the compliance deadlines
that will be imposed. If the order is affirmed without
modification, then RJR Tobacco believes that certain provisions
of the order (such as the ban on certain brand style descriptors
and the corrective advertising requirements) would have adverse
business effects on the marketing of RJR Tobaccos current
product portfolio and that such effects could be material. Also,
if the order is affirmed, then RJR Tobacco would incur costs in
connection with complying with the order (such as the costs of
changing its current packaging to conform to the ban on certain
brand descriptors and the costs of corrective communications).
Given the uncertainty over the timing and substance of an
appellate decision, RJR Tobacco currently is not able to
estimate reasonably the costs of such compliance. Moreover, if
the order were ultimately affirmed and RJR Tobacco were to fail
to comply with the order on a timely basis, then RJR Tobacco
could be subject to substantial monetary fines or penalties.
47
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. All of the cases filed by local governments have been
dismissed. As of February 2, 2007, no such cases were
pending.
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. 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 two health-care reimbursement cases currently pending
against RJR Tobacco and its affiliates or indemnitees, including
B&W, in the United States. In the Republic of
Panama v. The American Tobacco Co. and State of Sao
Paulo v. The American Tobacco Co., the cases,
originally filed in Louisiana, were consolidated and then
dismissed by the trial court on the basis that Louisiana is not
an appropriate forum. These plaintiffs filed new cases in the
Superior Court for the State of Delaware in and for New Castle
County on July 19, 2005, against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking restitution, damages and compensation for all
past and future damages including, but not limited to, all past
and future health-care expenditures for illnesses associated
with tobacco products, punitive or exemplary damages as may be
allowed by law, pre- and post-judgment interest and all costs as
provided by law, reasonable attorneys fees and costs for
all general and equitable relief. The plaintiffs allege that the
defendants are liable under breach of duty, negligence, breach
of implied warranty, breach of express warranty,
misrepresentation and conspiracy. On July 13, 2006, the
Delaware Superior Court granted the defendants motion to
dismiss. The plaintiffs filed notices of appeal to the Delaware
Supreme Court on July 19, 2006. On August 28, 2006,
the appeals were consolidated. Oral argument occurred on
December 6, 2006. On February 23, 2007, the Delaware
Supreme Court affirmed the dismissals.
Two 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 governments subsequent suit
against Canadian defendants and foreign defendants (including
RJR Tobacco) was dismissed in February 2000, when the B.C.
Supreme Court ruled that the legislation was unconstitutional
and set aside service ex juris against the foreign defendants
for that reason. The government then enacted a revised statute
and brought a new action (filed in January 2001, and pending in
Supreme Court, British Columbia). The plaintiff seeks to recover
the present value of the total expenditure by the government for
health-care benefits provided for insured persons resulting from
tobacco-related disease or the risk of tobacco-related disease,
the present value of the estimated total expenditure by the
government for health-care benefits that could reasonably be
expected will be provided for those insured persons resulting
from tobacco-related disease or the risk of tobacco-related
disease, court ordered interest, and costs, or in the
alternative, special or increased costs. The plaintiff alleges
that the defendants are liable under the following theories:
defective product, failure to warn, sale of cigarettes to
children and adolescents, strict liability, deceit and
misrepresentation, and violation of trade practice and
competition acts. In response to motions of certain defendants
challenging, among other things, the constitutionality of the
new statute, the court, in June 2003, dismissed the
governments action and set aside service ex juris. 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 23, 2005, the trial court found that
service was proper. On July 19, 2005, RJR Tobacco filed its
notice of appeal of this ruling. On September 28, 2005, the
Supreme Court, in response to motions of certain defendants,
ruled that the statute is constitutionally valid. On
September 15, 2006, the B.C. Court of Appeal unanimously
ruled that the foreign defendants served ex juris are subject to
British Columbia law, allowing the government to proceed with
its lawsuit against them. On November 10, 2006, RJR Tobacco
filed an application for leave to appeal. The defendants, on
48
November 24, 2006, filed a motion on consent to stay of
proceedings pending the Supreme Court of Canadas decision
on the leave to appeal.
On September 1, 1998, the General Health Services filed a
statement of claim against certain cigarette manufacturers,
including RJR Tobacco and B&W, in the District Court of
Jerusalem, Israel. The plaintiff seeks to recover the past and
future value of the total expenditures for health-care services
provided to residents of Israel resulting from tobacco-related
disease, court ordered interest for past expenditures from date
of filing the statement of claim, increased
and/or
punitive
and/or
exemplary damages and costs. The plaintiffs allege that the
defendants are liable under the following theories: negligence,
public nuisance, fraud, misleading advertisement, defective
product, failure to warn, sale of cigarettes to children and
adolescents, strict liability, deceit, concealment,
misrepresentation and conspiracy. In 2002, the plaintiff
obtained leave to serve RJR Tobacco and B&W outside the
jurisdiction. On behalf of RJR Tobacco, JTI filed a motion
challenging the grant of leave, which was denied. JTI appealed
the decision to the Supreme Court. A hearing occurred on
February 14, 2005, and a decision is pending.
Pursuant to the terms of the 1999 sale of RJR Tobaccos
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
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.
As of February 2, 2007, three other health-care cost
recovery cases were pending in the United States against RJR
Tobacco, B&W, as its indemnitee, or both, discussed below.
Union Cases. As of February 2, 2007,
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 U.S. 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 U.S. Supreme
Court has denied petitions for certiorari filed by unions in
cases from the Second, Third, Ninth and District of Columbia
Circuits.
Native American Tribe Cases. As of
February 2, 2007, 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. (a case filed in September 1997, and pending in
Tribal Court, Crow Creek Sioux, South Dakota). The plaintiffs
seek to recover actual and punitive damages, restitution,
funding of a clinical cessation program, funding of a corrective
public education program, and disgorgement of unjust profits
from sales to minors. The plaintiffs claim that the defendants
are liable under the following theories: unlawful marketing and
targeting of minors, contributing to the delinquency of minors,
unfair and deceptive acts or practices, unreasonable restraint
of trade and unfair method of competition, negligence,
negligence per se, conspiracy and restitution of unjust
enrichment. The case is dormant at this time.
Hospital Cases. As of February 2, 2007,
one case brought by hospitals was pending against cigarette
manufacturers, including RJR Tobacco and B&W: City of
St. Louis v. American Tobacco Co., Inc., filed in
November 1998, and pending in the Circuit Court of the City of
St. Louis, Missouri. This case seeks recovery of
uncompensated, unreimbursed health-care costs expended or to be
expended by hospitals on behalf of patients who
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suffer, or have suffered, from illnesses allegedly resulting
from the use of cigarettes. On June 28, 2005, the court
granted the 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. The case is in
discovery.
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 U.S. District Court for the District of
Massachusetts. 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. The plaintiff
alleges that the defendants concealed, denied and manipulated
the addictive properties of their cigarettes; and engaged in
tortious and other wrongful conduct. On October 24, 2005,
the defendants filed a motion to dismiss or, in the alternative,
transfer the case to the U.S. District Court for the Middle
District of Florida where a virtually identical case against
Philip Morris and Liggett was dismissed. On August 28,
2006, the defendants motion to dismiss was granted. On
September 7, 2006, the plaintiff filed a notice of appeal
with the U.S. Court of Appeals for the First Circuit. Oral
argument is scheduled for March 6, 2007.
Effective August 1, 2005, Minnesota enacted a health
impact fee that imposes a $0.75 per pack fee on
cigarettes, which is in addition to that states cigarette
excise tax of $0.48 per pack. The stated purpose of the
health impact fee is to recover for the state health care
costs related to or caused by tobacco use. RJR Tobacco and
other cigarette manufacturers filed a motion in Minnesota state
court asserting that imposition of the health impact fee
violated the terms of the settlement agreement entered into
between participating manufacturers and Minnesota in 1998. After
a hearing on this motion, the court ruled, on December 20,
2005, that the health impact fee violated the terms of the
settlement agreement and was unconstitutional. The state
appealed the courts ruling, and on May 16, 2006, the
Minnesota Supreme Court held that the health impact fee neither
violated the terms of the settlement agreement nor was
unconstitutional. On February 20, 2007, the U.S. Supreme
Court denied the defendants petition for writ of
certiorari.
Minnesotas health impact fee also led to the January 2006
filing of a
class-action
complaint in the Fourth Judicial District, Hennepin County,
Minnesota on behalf of consumers of cigarettes and other
tobacco products in the State of Minnesota from August 1,
2005 to the present. The
class-action
complaint named RJR Tobacco and various other entities as
defendants, and asserted an unjust enrichment claim, sought the
imposition of a constructive trust with respect to the monies
collected pursuant to the health impact fee, and requested that
these monies be distributed by the best means practicable
to the Class members. The plaintiffs allege that the
defendants were primarily responsible for remitting the health
impact fee to the State of Minnesota, but the ultimate burden of
the fees was passed on to end-purchase tobacco consumers. This
case was transferred to the court presiding over RJR
Tobaccos above-referenced motion seeking to enforce the
terms of the parties 1998 settlement agreement. On
August 28, 2006, following the ruling by the Minnesota
Supreme Court on RJR Tobaccos challenge to the health
impact fee, the plaintiffs voluntarily dismissed this action.
MSA-Enforcement
and Validity
As of February 2, 2007, there were 49 cases concerning the
enforcement, validity or interpretation of the MSA and other
state settlement agreements in which RJR Tobacco or B&W is a
party. This number includes those cases relating to disputed
payments under the MSA (discussed below).
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 case and, on June 9, 2004, filed
a new action in the U.S. 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
Attorney General for the State of California. 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
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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 U.S. District Court
for the Northern District of California granted the
defendants motion to dismiss with prejudice. The plaintiff
appealed to the U.S. Court of Appeals for the Ninth Circuit.
Oral argument occurred on February 15, 2007.
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
approximately $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. On
March 28, 2005, the U.S. 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 U.S. Court of Appeals for
the Fifth Circuit. On September 1, 2006, the Court of
Appeals affirmed the trial court.
On March 28, 2005, the National Association of Attorneys
General, referred to as NAAG, sent a notice, signed by 40
Attorneys General that one or more of the states intend to
initiate proceedings against RJR Tobacco for violating
Section III(r) of the MSA, the various Consent Decrees
implementing the MSA
and/or
consumer fraud statutes in various states, all in connection
with RJR Tobaccos advertisements for Eclipse cigarettes.
After a June 2005 meeting between representatives of RJR Tobacco
and NAAG, the Vermont Attorney General filed suit in July 2005,
in the Vermont Superior Court, Chittenden County, alleging that
certain Eclipse advertising violated both the MSA and the
Vermont Consumer Fraud Statute. The State of Vermont is seeking
declaratory, injunctive, and monetary relief. RJR Tobacco has
answered the complaint. Discovery is underway. The case is to be
trial ready on October 1, 2007.
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 in the Chancery Court of
Jackson County, Mississippi, 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. This matter is currently in the discovery
phase.
On May 17, 2006, the State of Florida filed a motion, in
the Circuit Court of the Fifteenth Judicial Circuit, in and for
Palm Beach County, Florida, to enforce the Settlement Agreement,
for an Accounting by Brown & Williamson Holdings,
Inc., and for Order of Contempt, raising substantially the same
issues as raised by the Mississippi Attorney General and seeking
approximately $12.4 million in additional payments under
the Florida Settlement Agreement, as well as $17.0 million
in interest payments. Discovery in this matter is underway.
Effective October 11, 2006, RJR Tobacco entered into a
voluntary agreement with the Attorneys General of 40 states
wherein they settled claims that certain Camel, Kool and Salem
brand styles with fruit, candy or alcoholic beverage names were
alleged to violate the MSAs prohibition against taking any
action, directly or indirectly, to target youth in the
advertising, promotion or marketing of tobacco products. These
brand styles accounted for less than one-tenth of one percent of
RJR Tobaccos annual cigarette volume and the last of these
styles was discontinued earlier in 2006. There were no fines,
penalties or fees paid by RJR Tobacco as part of the agreement.
The agreement bans the future sale of these brand styles in the
United States and contains restrictions on how flavored
cigarettes (as defined in the agreement) can be marketed and
sold in the future.
The MSA includes an adjustment, referred to as an NPM
Adjustment, that potentially reduces RJR Tobaccos and
other participating manufacturers annual payment
obligations. Certain requirements must be satisfied before the
NPM Adjustment, which relates to a specified market year, is
available. An independent auditor designated under the MSA must
determine that the participating manufacturers have experienced
a certain market share loss to
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those manufacturers, referred to as NPMs, that do not
participate in the MSA, and an independent firm of economic
consultants must find that the disadvantages of the MSA were a
significant factor contributing to such loss.
For 2003, the MSA independent auditor determined that the
participating manufacturers suffered a market share loss
sufficient to trigger an NPM Adjustment. In March 2006, the
independent economic consulting firm issued a final,
non-appealable determination that the disadvantages of the MSA
were a significant factor contributing to the 2003
market share loss. Based on the foregoing determinations, on
April 17, 2006, RJR Tobacco placed approximately
$647 million of its MSA payment into a disputed payments
account, in accordance with a procedure established by the MSA.
That amount represented RJR Tobaccos share of the 2003 NPM
Adjustment as calculated by the MSA independent auditor.
The settling states contend they have diligently enforced their
respective Qualifying Statutes, within the meaning of the MSA,
and that RJR Tobacco and other participating manufacturers are
not entitled to the 2003 NPM Adjustment. The settling states
also contend that this dispute must be resolved by MSA courts in
each of the 52 settling states and territories. RJR Tobacco
believes that the MSA requires that this dispute be resolved by
arbitration before a panel of three former federal judges.
Between April 13, 2006 and February 2, 2007, 37 of the
settling states filed legal proceedings in their respective
courts seeking declaratory orders that they diligently enforced
their Qualifying Statutes during 2003
and/or
orders compelling RJR Tobacco and the other participating
manufacturers that placed money in the disputed payments account
to pay such disputed amounts to the settling states. RJR Tobacco
intends to defend these proceedings vigorously by, among other
things, moving to compel arbitration as provided in the MSA.
As of February 2, 2007, 34 out of 35 courts that had
addressed the question whether disputes concerning the 2003 NPM
Adjustment are arbitrable had ruled that arbitration is required
under the MSA.
On September 13, 2006, RJR Tobacco and certain of the other
participating manufacturers sent letters to the 15 settling
states that had not yet objected to the arbitration noticed by
the tobacco manufacturers
and/or filed
legal proceedings relating to the dispute regarding the 2003 NPM
Adjustment in their respective MSA courts. These letters stated
that unless the settling states indicated otherwise, the tobacco
manufacturers would assume that these settling states would not
object to the required arbitration. All but one of the settling
states that received these letters responded that they would not
agree to submit the dispute to arbitration and would oppose any
effort to compel arbitration of the dispute. The tobacco
manufacturers have filed motions to compel arbitration in the
MSA courts of all of these settling states, except certain of
the territories.
During 2006, proceedings were initiated and prosecuted with
respect to an NPM Adjustment for 2004. The independent auditor
determined that the participating manufacturers again suffered a
market share loss sufficient to trigger an NPM Adjustment for
2004. On April 17, 2006, RJR Tobacco and the other
cigarette manufacturers initiated the significant
factor proceedings called for under the MSA. On
February 12, 2007, the independent economic consulting firm
retained by the settling states and the cigarette manufacturers
issued a final, non-appealable determination that the
disadvantages of the MSA were a significant factor
contributing to the 2004 market share loss. RJR Tobacco is
evaluating what action to take in light of this determination.
On October 12, 2006, the State of New York sent a
30-day
notice, signed by twenty-six additional attorneys general, that
one or more of these states intended to initiate proceedings
seeking declarations construing one or more terms under the MSA.
The terms that the signatory states identified relate to the
questions presented to the economic consulting firm in the
context of the significant factor proceedings
relating to the expected NPM Adjustment for the year 2004. To
date, no actions have been filed pursuant to this notice.
Asbestos
Contribution Cases
As of February 2, 2007, no lawsuits were 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. The last of those cases,
Fibreboard Corp. v. R. J. Reynolds Tobacco Co.,
filed in November 1997, pending in Superior Court, Alameda
County, California, was dismissed with prejudice on
July 28, 2006. The plaintiffs brought the action against
the major U.S. cigarette manufacturers, including RJR
Tobacco and B&W, seeking: to recover an unspecified amount
in
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actual and punitive damages; a declaratory judgment determining,
among other things, that there has existed and currently exists
among defendants a conspiracy to abuse the legal process and
spread disinformation and that such conspiracy has allowed
tobacco companies to escape liability for their relative
contribution to injuries caused or contributed to by a
combination of smoking and exposure to asbestos; and an order
barring advertising directed in part to those segments of the
population exposed to asbestos. The plaintiffs alleged that the
use of the defendants products is a substantial
contributing factor, if not the predominant factor, in the
development of lung cancer and other cancers in persons exposed
to asbestos.
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 U.S. 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
U.S. Court of Appeals for the Eleventh Circuit affirmed
that decision on September 22, 2003. As of February 2,
2007, all state court cases on behalf of indirect purchasers
have been dismissed, except for two cases pending in Kansas and
in New Mexico.
In Smith v. Philip Morris Cos., Inc. (a case filed in
February 2000, pending in District Court, Seward County,
Kansas), the court granted class certification on
November 15, 2001, in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and the parent companies of the major
U.S. cigarette manufacturers, including RJR, seeking to
recover an unspecified amount in actual and punitive damages.
The plaintiffs allege that the defendants participated in a
conspiracy to fix or maintain the price of cigarettes sold in
the United States. Discovery is underway.
In Romero v. Philip Morris Cos., Inc. (a case filed in
April 2000, pending in District Court, Rio Arriba County, New
Mexico), a court granted class certification on May 14,
2003, but granted the defendants motion for summary
judgment on June 30, 2006, in an action brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, and the parent companies of the major
U.S. cigarette manufacturers, including RJR, seeking to
recover an amount not to exceed $74,000 per class member in
actual and punitive damages, exclusive of interest and costs.
The plaintiffs allege that the defendants conspired to fix,
raise, advance
and/or
stabilize prices for cigarettes in the State of New Mexico from
at least as early as January 1, 1998, through the present.
On August 14, 2006, the plaintiff filed a notice of appeal
to the New Mexico Court of Appeals.
In a gray market trademark suit originally brought by RJR
Tobacco in February 1999 in the U.S. District Court for the
Northern District of Illinois, Cigarettes Cheaper! asserted
antitrust counterclaims, alleging that it was denied promotional
resources in violation of the Robinson-Patman Act and that RJR
Tobacco had violated Section 1 of the Sherman Antitrust
Act. The defendants counterclaim sought to recover actual
and treble damages, attorneys fees and costs. 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. The court
severed RJR Tobaccos trademark claims (including a
trademark dilution claim) from the defendants
Robinson-Patman claims. Trial on the trademark claims began on
April 25, 2004, and on May 5, 2004, the jury returned
a verdict in favor of RJR Tobacco on all counts in the amount of
$3.5 million. Trial began on the Robinson-Patman claims 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
U.S. Court of Appeals for the Seventh Circuit. On
August 24, 2006, the Court of Appeals affirmed the judgment
of the district court. On September 7, 2006, the plaintiff
filed a petition for rehearing and a petition for rehearing en
banc. Both petitions were denied on September 15, 2006. On
December 14, 2006, the plaintiff filed a petition for writ
of certiorari with the U.S. Supreme Court, which was denied
on February 20, 2007.
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On February 16, 2000, an antitrust
class-action
complaint, DeLoach v. Philip Morris Cos., Inc., was
brought against RJR Tobacco, B&W and other cigarette
manufacturers and others, in the U.S. District Court for
the District of Columbia on behalf of a class of all tobacco
growers and tobacco allotment holders. The plaintiffs asserted
that the defendants conspired to fix the price of tobacco leaf
and to destroy the federal governments tobacco quota and
price support program. On November 30, 2000, the case was
moved to U.S. District Court for the Middle District of
North Carolina. In May 2003, the plaintiffs reached a
court-approved settlement with B&W and other cigarette
manufacturer defendants, but not RJR Tobacco. 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 $9.8 million, 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 April 22, 2004, RJR Tobacco and the plaintiffs settled,
and the court approved that settlement on March 21, 2005.
Under that settlement, RJR Tobacco paid $33 million into a
settlement fund, which included costs and attorneys fees. 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. The obligation to purchase leaf was extended an
additional year because the federal government eliminated the
tobacco price quota and price support program at the end of 2005.
Pursuant to an amended complaint filed in the U.S. District
Court for the Eastern District of Tennessee on October 23,
2003, in Smith Wholesale Co. v. R.J. Reynolds Tobacco
Co., Smith Wholesale and Rice Wholesale asserted federal
antitrust claims in connection with RJR Tobaccos
termination of distribution agreements with the plaintiffs. The
plaintiffs seek preliminary and permanent injunctive relief,
enjoining RJR Tobacco from, among other things: continuing with
the termination of the plaintiffs distributorship;
continuing to refuse to honor invoices from the plaintiffs
toward retail buydowns and retail contract payments; further
reducing the price discounts and back-end monies received by the
plaintiffs; and continuing its discriminatory pricing scheme.
The plaintiffs allege that RJR Tobacco, in August 2000,
implemented a discriminatory pricing scheme whereby it sold
cigarettes at different prices to competing distributors,
placing certain distributors at an extreme competitive
disadvantage. As a result of the purported pricing scheme, the
plaintiffs allegedly have suffered substantial damages in the
form of lost profits and sales, loss of customers, loss of
goodwill and additional injuries. Additional wholesalers,
together with the states of Tennessee and Mississippi, have
joined the case as plaintiffs. On June 3, 2005, the
district court granted summary judgment in RJR Tobaccos
favor. 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. Oral
argument in the U.S. Court of Appeals for the Sixth Circuit
occurred on April 21, 2006. RJR Tobacco reached a
non-monetary settlement with one wholesaler and with the states
of Tennessee and Mississippi on July 22, 2005. RJR Tobacco
terminated its distribution agreement with four plaintiffs, and
those plaintiffs moved for preliminary injunctions in the
district court and court of appeals. The courts denied those
motions on November 28 and November 29, 2005, respectively.
In March 2006, McLane Company, Inc., a distributor and RJR
Tobaccos largest customer, acquired one of the remaining
wholesaler plaintiffs, whose claim for damages in this case is
approximately $3 million.
On January 11, 2006, Smith Wholesale filed another lawsuit
against RJR Tobacco and its customer, H.T. Hackney Corp., in
Carter County, Tennessee Circuit Court. Smith Wholesale seeks
$60 million in damages and a preliminary injunction against
RJR Tobaccos termination of Smith Wholesales
direct-buying status. Smith Wholesale alleges that the
defendants, through agreements with one another and other
actions, engaged in a scheme to damage competition in the
distribution of cigarettes and specifically damage the
plaintiff. The court has not set a hearing date on the
preliminary injunction. The case was removed to federal court on
January 26, 2006. RJR Tobacco filed a motion to dismiss on
February 13, 2006. On February 21, 2006, the
plaintiffs filed, among other things, a motion to remand. On
September 28, 2006, the court granted the plaintiffs
motion to remand the case to the Circuit Court for Carter
County, Tennessee. RJR Tobacco filed a motion to dismiss the
first amended and reinstated complaints on November 27,
2006. The plaintiff filed a motion for temporary injunction on
the same day.
Other
Litigation and Developments
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
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and distribution of cigarettes in international markets. RJR and
RJR Tobacco have responded appropriately to the subpoena and
otherwise cooperated with this grand jury investigation.
Although this investigation has been dormant for some time now,
it remains a pending matter.
By purchase agreement dated May 12, 1999, referred to as
the 1999 Purchase Agreement, RJR and RJR Tobacco sold the
international tobacco business to JTI. RJR and RJR Tobacco
retained certain liabilities relating to the activities of
Northern Brands International, Inc., referred to as Northern
Brands, including those relating to a 1998 guilty plea entered
in the U.S. District Court for the Northern District of New
York, as well as an investigation conducted by the 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-Macdonald, Inc., referred to as
RJR-MI, which led to the termination of his severance agreement.
Under its reading of the indemnification provisions of the 1999
Purchase Agreement, JTI has requested indemnification for any
damages arising out of the matters described below.
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In February 2003, the RCMP filed criminal charges in the
Province of Ontario against and purported to serve summonses on
JTI-Macdonald Corp., referred to as 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 allege 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
each challenged both the propriety of the service of the
summonses and the jurisdiction of the court. On February 9,
2004, the Superior Court of Justice ruled in favor of these
companies. The government filed a notice of appeal from that
ruling on February 18, 2004, but has not actively pursued
an appeal. A preliminary hearing was 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. A decision is still pending.
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In July 2003, a Statement of Claim was filed against JTI-MC and
others in the Superior Court of Justice, Ontario, Canada by
Leslie and Kathleen Thompson. Mr. Thompson is a former
employee of Northern Brands and JTI-MCs predecessor,
RJR-MI. Mr. and Mrs. Thompson have alleged breach of
contract, breach of fiduciary duty and negligent
misrepresentation, among other claims. They are seeking lost
wages and other damages, including punitive damages, in an
aggregate amount exceeding $12 million.
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On September 18, 2003, RJR, RJR Tobacco, RJR-TI, RJR-PR,
and Northern Brands were served with a Statement of Claim filed
in August 2003 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 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. (However, in the
Companies Creditor Arrangement Act proceeding described
below, the Attorney General amended and increased Canadas
claim to $4.3 billion Canadian). The parties have agreed to
a stay of all proceedings pending in the Superior Court of
Justice, subject to notice by one of the parties that it wishes
to terminate the stay. On January 19, 2007, the court
ordered that the case be scheduled for trial no later than
December 31, 2008, subject to further order of the court.
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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, against JTI-MC for alleged unpaid
duties, penalties and interest in an amount of about
$1.36 billion Canadian; (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 in the Ontario Superior
Court of Justice, Toronto, Canada, referred to as CCAA
Proceedings, and the court entered an order staying the Quebec
Ministry of Revenues proceedings as well as other claims
and proceedings against JTI-MC. The stay has been extended to
May 31, 2007. 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
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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
($450 million Canadian); Nova Scotia ($326 million
Canadian); Prince Edward Island ($75 million Canadian) and
Manitoba ($23 million Canadian). In the CCAA Proceedings,
the Canadian federal government and some of the provincial
governments have asserted that they can make the same tax and
related claims against RJR and certain of its subsidiaries,
including RJR Tobacco. To date, none of those provincial
governments have filed and served RJR or any of its affiliates
with a formal Statement of Claim like the Canadian federal
government did in August and September 2003.
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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. 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.
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In addition, in a letter dated March 31, 2006, counsel for
JTI stated that JTI would be seeking indemnification under the
1999 Purchase Agreement for any damages it may incur or may have
already incurred arising out of the Southern District of New
York grand jury investigation mentioned above, a now-terminated
Eastern District of North Carolina grand jury investigation, and
various actions filed by the European Community and others in
the U.S. District Court for the Eastern District of New
York, referred to as the EDNY, against RJR Tobacco and certain
of its affiliates on November 3, 2000, August 6, 2001
and October 30, 2002 (see below) and against JTI on
January 11, 2002.
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 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 below.
On October 30, 2002, the European Community and ten of its
member states filed a complaint in the EDNY against RJR, RJR
Tobacco and several currently and formerly related companies.
The complaint contains many of the same or similar allegations
found in an earlier complaint (now dismissed) filed in August
2001 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 that were eventually sold in Iraq in
violation of U.S. sanctions. The plaintiffs seek
compensatory, punitive and treble damages among other types of
relief. This matter remains pending, but all proceedings were
stayed while the plaintiffs sought review first by the Court of
Appeals for the Second Circuit and then by the Supreme Court of
the dismissal of their August 2001 complaint. The Court of
Appeals for the Second Circuit affirmed the dismissal, and, on
January 9, 2006, the Supreme Court denied the
plaintiffs petition for a writ of certiorari. This case
remains stayed while the court and the parties work out a
scheduling order.
On December 20, 2000, October 15, 2001, and
January 9, 2003, RJR and the other defendants named in each
of the European Community cases mentioned above filed
applications in the Court of First Instance in Luxembourg
challenging the 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
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 was
stayed pending resolution of the appeals from the
56
January 15, 2003, judgment denying the admissibility of the
first two applications. On September 12, 2006, the European
Court of Justice upheld the judgment of the Court of First
Instance and dismissed the appeals filed by RJR and its
affiliates. In light of that decision, on October 12, 2006,
RJR and its affiliates withdrew their pending application for
annulment filed in connection with the third European Community
complaint filed on October 30, 2002.
RJR Tobacco has been served in two reparations actions (filed in
October 2002) 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
the U.S. District Court for the Northern District of
Illinois by the Judicial Panel on Multi-District Litigation for
coordinated or consolidated pretrial proceedings with other
reparation actions. The plaintiffs in these actions are asking
for judgment in an amount to satisfy the jurisdictional
limitations of the court, punitive damages sufficient to punish
the defendants, an accounting, imposition of a constructive
trust, restitution of the value of their ancestors slave
labor, and restitution of the value of defendants unjust
enrichment based upon slave labor and the cost of the action.
RJR Tobacco is named, but has not been served, in another
reparations case. That case 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 U.S. 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. On December 13, 2006, the
Seventh Circuit affirmed the dismissal of all claims except the
consumer protection claims. The case was remanded to the
district court for further proceedings.
On June 8, 2001, in California v. R. J. Reynolds
Tobacco Co., the Attorney General of the State of California
sued RJR Tobacco in the Supreme Court of the State of California
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. The plaintiff was seeking a
permanent injunction, enjoining the defendants from distributing
coupons or rebate offers at public events for tobacco products,
that the defendants be ordered to pay a civil penalty for the
violation of unfair competition laws, and that the defendants be
permanently enjoined from the use of any information or other
material collected pursuant to the non-sale distribution of
coupons or other tobacco products. 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 22, 2005, the Supreme
Court of California affirmed the decision with respect to
liability, but remanded the case to the trial court to determine
if the fine imposed was excessive under the
U.S. Constitution. On January 19, 2006, RJR Tobacco
filed a motion to stay issuance of the remittitur pending
petition for a writ of certiorari to the U.S. Supreme
Court, which was granted on February 1, 2006. The parties
settled the case on March 22, 2006. RJR Tobacco agreed to
pay a total of $5 million in penalties, fees and costs.
After the California Supreme Court approved the settlement, RJR
Tobacco paid the settlement amount on June 7, 2006.
On May 23, 2001 and July 30, 2002, Star Scientific,
Inc., referred to as Star, filed two patent infringement
actions, which have been consolidated, against RJR Tobacco in
the U.S. District Court for the District of Maryland. Both
patents at issue are entitled Method of Treating Tobacco
to Reduce Nitrosamine Content, and Products Produced
Thereby, and bear U.S. Patent Nos. 6,202,649 and
6,425,401. The plaintiffs seek: the entry of an injunction
restraining RJR Tobacco from further acts of infringement,
inducement of infringement, or contributory infringement of the
patents; an award of damages to compensate the plaintiffs
lost profits; an award of enhanced damages on account that the
defendants conduct was willful; an award of prejudgment
interest and a further award of post-judgment interest; an award
of reasonable attorneys fees; and an order requiring RJR Tobacco
to deliver up to the court for destruction all products
manufactured from any process which infringes upon, directly or
indirectly or otherwise, any claim of such patent. RJR Tobacco
has filed counterclaims seeking a declaration that the claims of
the two Star patents are invalid, unenforceable and not
infringed by RJR Tobacco. Between January 31 and
57
February 8, 2005, the court held a first bench trial on RJR
Tobaccos affirmative defense and counterclaim based upon
inequitable conduct. Additionally, in response to the
courts invitation, RJR Tobacco filed two summary judgment
motions on January 20, 2005. On January 19, 2007, the
court released decisions on those two summary judgment motions.
The court granted RJR Tobaccos motion for summary judgment
of invalidity based on indefiniteness. The court granted in part
and denied in part RJR Tobaccos other summary
judgment motion concerning the effective filing date of the
patents in suit. The court also advised the parties on
January 19, 2007, that it expects to issue its ruling on
the inequitable conduct trial before the end of February 2007.
The court further stated that, by virtue of the grant of RJR
Tobaccos summary judgment motion of invalidity based on
indefiniteness, it will enter a final judgment in RJR
Tobaccos favor after the decision on the inequitable
conduct trial irrespective of whether that decision is in RJR
Tobaccos favor.
On September 22, 2005, RJR Tobacco filed a case in the
U.S. District Court for the Western District of North
Carolina against Market Basket Food Stores and other cigarette
retailers and wholesalers located in the states of North
Carolina, Tennessee, Virginia and Kentucky to stop and remedy
the ongoing conspiracy to abuse RJR Tobaccos marketing
programs, including the buy-down and coupon programs. The
complaint alleged violations of the federal and North Carolina
RICO statutes and the North Carolina Unfair and Deceptive Trade
Practices Act, along with common law fraud, breach of contract
and conspiracy. RJR Tobacco seeks actual damages in an amount to
be proven at trial, treble damages, an accounting of the
defendants profits, disgorgement of the defendants
ill-gotten proceeds and gains, a constructive trust on all funds
or property that are the proceeds or profits of defendants
participation in the scheme, costs of investigating the acts
giving rise to this cause of action, attorneys fees and
experts fees, and such other and further relief as the
court deems appropriate. A motion for preliminary injunction
requested that the court enjoin certain defendants from
performing the fraudulent acts detailed in the complaint. On
August 21, 2006, the court denied the outstanding motions
to dismiss in their entirety and lifted the earlier stay of
discovery. On January 30, 2007, the court granted RJR
Tobaccos motion for preliminary injunction. Discovery is
underway. As of February 2, 2007, RJR Tobacco had settled
with 12 of the 20 defendants.
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. 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. The scope of the indemnity will be at issue and has
not been determined.
Smokeless
Tobacco Litigation
As of February 2, 2007, Conwood is a defendant in 8 actions
brought by individual plaintiffs in West Virginia state court
seeking damages in connection with personal injuries allegedly
sustained as a result of the usage of Conwoods smokeless
tobacco products. These actions are pending before the same West
Virginia court as the 942 consolidated individual smoker cases
against RJR Tobacco, B&W, as RJR Tobaccos indemnitee,
or both. On December 3, 2001, the court severed the
smokeless tobacco defendants, and this litigation has been
dormant.
Pursuant to an amended complaint filed in July 2005, Conwood is
a defendant in Vassallo v. United States Tobacco
Company, pending in the Eleventh Circuit Court in Miami-Dade
County, Florida. The individual plaintiff in this case alleges
that he sustained personal injuries including addiction and
cancer as a result of his use of smokeless tobacco products,
allegedly including products manufactured by Conwood. The
plaintiff seeks unspecified compensatory and consequential
damages in an amount greater than $15,000, as well as punitive
damages. This case is still in its early stages.
Tobacco
Buyout Legislation
On October 22, 2004, the President signed the Fair and
Equitable Tobacco Reform Act of 2004, referred to as FETRA,
eliminating the U.S. governments 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
58
aggregate cost of the buyout to the industry is approximately
$9.9 billion, including approximately $9.6 billion
payable to quota tobacco holders and growers through industry
assessments over ten years and approximately $290 million
for the liquidation of quota tobacco stock. As a result of the
tobacco buyout legislation, the MSA Phase II obligations
established in 1999 will be continued as scheduled through the
end of 2010, 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 $230 million
to $280 million. RAIs operating subsidiaries incurred
$81 million in 2005 related to assessments from quota
tobacco stock liquidation. In the first quarter of 2006, a
$9 million favorable adjustment was recorded relating to
the tobacco stock liquidation assessment. Remaining contingent
liabilities for liquidation of quota tobacco stock, if any, will
be recorded when an assessment is made. See note 1 to
consolidated financial statements for additional information
related to federal tobacco buyout expenses.
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. In addition, future market
pricing could impact the carrying value of inventory, and
adversely affect RJR Tobaccos financial condition and
results of operations.
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 U.S. 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 require 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
U.S. 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. The parties
have filed supplemental briefs regarding the motion to dismiss.
On June 6, 2006, the plaintiff filed a motion to amend the
complaint to name as party defendants six individuals who were
members of the two defendant committees. The defendants have
opposed that motion, 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 with third parties under the
Comprehensive Environmental Response, Compensation and Liability
Act 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.
59
Regulations promulgated by the U.S. Environmental
Protection Agency 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.
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 certain liabilities, costs and
expenses incurred by B&W or its affiliates arising out of
the U.S. cigarette and tobacco business of B&W. As a
result of this indemnity, RJR Tobacco has assumed the defense of
pending B&W-specific tobacco-related litigation, has paid
the judgments and costs related to certain pre-business
combination tobacco-related litigation of B&W, and has
posted bonds on behalf of B&W, where necessary, in
connection with cases decided since the business combination. In
addition, pursuant to this indemnity, RJR Tobacco expensed
$4 million and $36 million during 2006 and 2005,
respectively, for funds to be reimbursed to BAT for costs and
expenses incurred arising out of tobacco-related litigation.
Although it is impossible to predict the possibility or amount
of any additional future payments by RJR Tobacco under this
indemnity, a significant indemnification claim by B&W
against RJR Tobacco could have an adverse effect on any or all
of RAI, RJR and RJR Tobacco.
As a result of the business combination of RJR Tobacco and the
U.S. cigarette and tobacco business of B&W, RJR Tobacco
also has agreed to indemnify Commonwealth Brands, Inc. for
certain claims brought in two individual smoking and health
cases, Croft v. Akron Gasket and Ryan v.
Philip Morris, U.S.A., Inc., to the extent, if any, such
indemnification is required by the 1996 Purchase Agreement. See
Litigation Affecting the Cigarette
Industry Other Litigation and Developments
above for further information on these cases.
In connection with the sale of the international tobacco
business to JTI, on May 12, 1999, pursuant to the 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.
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As described above in Litigation Affecting the
Cigarette Industry 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 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 $94 million that were
recorded in 1999 in connection with these indemnification claims.
RJR Tobacco, Santa Fe, Conwood 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, Conwood 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.
60
Under certain circumstances, any fair value that results in a
liability position of the interest rate swaps will require full
collateralization with cash or securities. See note 13 to
consolidated financial statements in Item 8 for further
information.
Except as otherwise noted above, RAI is not able to estimate the
maximum potential amount of future payments, if any, related to
these guarantees and indemnification obligations.
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Item 4.
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Submission
of Matters to a Vote of Security Holders
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None.
Executive
Officers and Certain Significant Employees of the
Registrant
The executive officers of RAI are set forth below:
Susan M. Ivey. Ms. Ivey, 48, has been
President and Chief Executive Officer of RAI since January 2004,
and was elected the Chairman of the Board of RAI effective
January 1, 2006, and, since July 2004, has been Chairman of
the Board of RJR Tobacco. From July 2004 to December 2006, she
also served as Chief Executive Officer of RJR Tobacco. She
served as President and Chief Executive Officer of B&W from
2001 to 2004. Ms. Ivey also served as a director of B&W
from 2000 to 2004 and Chairman of the Board of B&W from
January 2003 to 2004. Ms. Ivey commenced serving on the
Board of RAI as of January 2004. She also is a member of the
board of directors of the Winston-Salem YWCA, Wake Forest
University, the University of Florida Foundation, and the
Winston-Salem Alliance. She also serves on the Board of Advisers
for the Center for Women in Business and Economics at Salem
College and is a member of The Business Council, a national
organization of chief executive officers.
Lisa J. Caldwell. Ms. Caldwell, 46, was
named Senior Vice President-Human Resources of RAI in November
2006, after serving as Vice President-Human Resources of RAI
since September 2004 and as Vice President-Human Resources of
RJR Tobacco from 2002 until November 2006. Prior to 2002,
Ms. Caldwell held numerous human resources positions with
RJR Tobacco and RAI since joining RJR Tobacco in 1991.
Ms. Caldwell serves on the board of directors of the
Winston-Salem State University Foundation.
Daniel (Daan) M. Delen. Mr. Delen, 41,
joined RJR Tobacco as President and Chief Executive Officer in
January 2007. Prior to joining RJR Tobacco, Mr. Delen was
President of BAT Ltd. Japan since August 2004 and
Senior Vice President of Marketing and Sales for B&W from
2001 to July 2004. He held various other positions with BAT
after joining BAT in 1989.
Michael S. Desmond. Mr. Desmond, 40,
joined RAI in April 2005 and was elected Senior Vice President
and Chief Accounting Officer of RAI in May 2005. Prior to
joining RAI, Mr. Desmond was a partner in audit and
enterprise-risk services at Deloitte & Touche LLP from
June 2002 to March 2005 and was a partner in audit and advisory
services at Arthur Andersen LLP from September 2001 to May 2002,
having joined that firm in 1988. Mr. Desmond serves as a
member of the board of R. J. Reynolds-Gallaher International
Sarl, the accounting advisory board of Appalachian State
University, the board of directors of the YMCA of Northwest
North Carolina, as well as the board of the Piedmont Triad
Entrepreneurial Network.
Jeffrey A. Eckmann. Mr. Eckmann, 54, has
been RAI Group President since October 2006. He was named
Executive Vice President Strategy, Integration, IT
and Business Development of RAI in May 2005, and Executive
Vice President Strategy and Business Development of
RAI in January 2006. He also served as Executive Vice
President Strategy, Integration and IT of RJR
Tobacco from May 2005 to February 2006, and as
Executive Vice President Strategy and Business
Development of RJR Tobacco from February 2006 until
November 2006. Mr. Eckmann joined RAI in July 2004 as
Executive Vice President-Strategy, Planning and Integration.
Mr. Eckmann served as Senior Vice President and Chief
Financial Officer of B&W from 2001 to July 2004. He serves
on the board of directors of the Northern Illinois University
Foundation, Dare to Care Food Bank and Soteria Imaging Services.
Daniel A. Fawley. Mr. Fawley, 49, has
served as Senior Vice President and Treasurer of RAI, RJR
Tobacco and RJR since September 2004. He was previously Vice
President and Assistant Treasurer of RJR from 1999 until
61
July 2004 and of RAI from July until September 2004. He served
as Director-Treasury from 1997 to 1999, and as senior
manager-Treasury from 1996 to 1997, of RJR Nabisco, Inc., now
known as RJR.
McDara P. Folan, III. Mr. Folan, 48,
has been Senior Vice President, Deputy General Counsel and
Secretary of RAI since July 2004. Mr. Folan served as Vice
President, Deputy General Counsel and Secretary of RJR from June
1999 to July 2004, and has been Senior Vice President and
Secretary and Director of RJR since July 2004. He also was Vice
President, Deputy General Counsel and Secretary of RJR Tobacco
from June 1999 to March 2000, and currently serves as Assistant
Secretary of RJR Tobacco. Mr. Folan serves on the board of
directors of the Piedmont Triad Chapter of the Juvenile Diabetes
Research Foundation, the advisory board for Brenner
Childrens Hospital and the board of advisors of Salem
College and Academy and is Vice Chairman of the board of
trustees of the Arts Council of Winston-Salem and Forsyth County.
E. Julia (Judy)
Lambeth. Ms. Lambeth, 55, joined RAI as
Executive Vice President and General Counsel in September 2006.
Prior to joining RAI, Ms. Lambeth served as Corporate
Secretary and Deputy General Counsel, Corporate Services for
Conoco Phillips from 2002 to 2006. Ms. Lambeth is a member
of the Wake Forest Law School Board of Visitors.
Dianne M. Neal. Ms. Neal, 47, has been
Executive Vice President and Chief Financial Officer of RAI
since July 2004 and of RJR since February 2005. Ms. Neal
served as Executive Vice President and Chief Financial Officer
of RJR Tobacco from July 2003 to December 2006. Ms. Neal
also served as Executive Vice President and Chief Financial
Officer of RJR from July 2003 to July 2004, after serving as
Vice President Investor Relations of RJR from 1999
to 2003. Ms. Neal is a member of the National Advisory
Council of Reynolda House Museum of American Art and serves on
the board of directors of LandAmerica Financial Group, Inc.
Tommy J. Payne. Mr. Payne, 49, has been
Executive Vice President Public Affairs of RAI since
July 2004. In November 2006, his title was changed from
Executive Vice President External Relations.
Mr. Payne served as Executive Vice President
External Relations at RJR from July 1999 to July 2004.
Mr. Payne serves on the board of trustees of Winston-Salem
State University and serves on the board of directors of North
Carolina Citizens for Business and Industry.
E. Kenan Whitehurst. Mr. Whitehurst, 50,
has been Senior Vice President Strategy and Business
Development of RAI since November 2006. He was previously Vice
President Investor Relations of RAI from July 2004
until November 2006. From January 2001 to July 2004,
Mr. Whitehurst served as Vice President
Corporate Business Development for RJR Tobacco, after serving as
Vice President Marketing from 2000 to 2001. He held
various positions with RJR Tobacco since joining RJR Tobacco in
1988.
The chief executive officers of RAIs other principal
operating companies are set forth below:
Luis R. Davila. Mr. Davila, 47,
became President of GPI in January 2006. Mr. Davila served
as Vice President Export Markets for GPI from July 2004 to
January 2006. Mr. Davila joined R.J. Reynolds Tobacco
Co. (Puerto Rico) in 1985 and held various international
positions with RAI affiliates through July 2004. Mr. Davila
serves as a member of the board of R.J. Reynolds-Gallaher
International, Sarl.
William Rosson. Mr. Rosson, 58, has been
President and Chief Executive Officer of Conwood since January
2005. From 2001 until January 2005, Mr. Rosson served as
Vice President of Administration of Conwood Company, LLC.
Mr. Rosson held a number of positions at Conwood since
joining Conwood in 1975.
Richard M. Sanders. In connection with
RJRs acquisition of Santa Fe in January 2002,
Mr. Sanders, 53, was named President and Chief Executive
Officer of Santa Fe. From December 1999 until January 2002,
he served as Senior Vice President Marketing of RJR
Tobacco while continuing his role as President
Sports Marketing Enterprises, a former division of RJR Tobacco.
Mr. Sanders joined RJR Tobacco in Marketing in 1977 and has
held several positions during his career, including Vice
President Advertising and Brand Management, Vice
President Marketing and Sales Operations and Area
Vice President Sales. He is Chairman of the board of
directors of the Santa Fe Natural Tobacco Company
Foundation, Vice-Chair of the board of directors of
Santa Fe Economic Development, Inc., Chair of Santa Fe
Future, and board member of Minnesota Resources.
62
PART II
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Item 5.
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Market
for Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
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RAIs common stock, par value $.0001 per share, is
listed on the NYSE under the trading symbol RAI and
began trading on August 2, 2004. Prior to the B&W
business combination, RJR common stock was listed on the NYSE
under the trading symbol RJR. On February 16,
2007, there were approximately 19,900 holders of record of
RAIs common stock. Shareholders whose shares are held of
record by a broker or clearing agency are not included in this
amount; however, each of those brokers or clearing agencies is
included as one holder of record. The closing price of
RAIs common stock on February 16, 2007, was
$63.94 per share.
The cash dividends declared and high and low sales prices per
share for RAIs common stock on the NYSE Composite Tape, as
reported by the NYSE, were as follows(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Dividends
|
|
|
|
Price Per Share
|
|
|
Declared per
|
|
|
|
High
|
|
|
Low
|
|
|
Share
|
|
|
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$
|
54.97
|
|
|
$
|
47.48
|
|
|
$
|
0.625
|
|
Second Quarter
|
|
|
58.06
|
|
|
|
51.82
|
|
|
|
0.625
|
|
Third Quarter
|
|
|
66.26
|
|
|
|
56.78
|
|
|
|
0.750
|
|
Fourth Quarter
|
|
|
67.09
|
|
|
|
60.87
|
|
|
|
0.750
|
|
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$
|
44.50
|
|
|
$
|
38.43
|
|
|
$
|
0.475
|
|
Second Quarter
|
|
|
42.58
|
|
|
|
38.24
|
|
|
|
0.475
|
|
Third Quarter
|
|
|
42.87
|
|
|
|
38.29
|
|
|
|
0.525
|
|
Fourth Quarter
|
|
|
51.19
|
|
|
|
38.88
|
|
|
|
0.625
|
|
|
|
|
(1) |
|
All per share amounts have been retroactively adjusted to
reflect the August 14, 2006,
two-for-one
stock split. See Business in Item 1
for additional information. |
The fourth quarter 2006 cash dividend declared of $0.75 per
share equals $3.00 on an annualized basis. The dividend
increases over the past two years reflect 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.
RAI conducts its business through its subsidiaries and is
dependent upon the earnings and cash flows of its subsidiaries
to satisfy its obligations and other cash needs. Under
RAIs revolving credit facility, RAIs cumulative
dividends generally may not exceed the sum of $625 million
plus 75% of cumulative adjusted net income (as defined in the
credit agreement). For more information, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations Liquidity and
Financial Condition in Item 7 and notes 11, 12
and 13 to consolidated financial statements. RAI believes that
the provisions of its credit facilities and the guarantees of
its credit facilities, interest rate swaps and guaranteed,
secured notes will not impair its payment of quarterly dividends.
RAI repurchases and cancels shares of its common stock forfeited
with respect to the tax liability associated with certain option
exercises and vesting of restricted stock grants under the RAI
Long-Term Incentive Plan. During 2006, RAI repurchased and
cancelled 207 shares of its common stock. On
February 6, 2007, the board of directors of RAI authorized
the repurchase by RAI of up to $75 million of its
outstanding shares of common stock to offset dilution from
restricted stock grants under employee incentive programs and
the exercise of previously granted options.
63
The following table summarizes RAIs purchases of its
common stock during the fourth quarter of 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Approximate Dollar
|
|
|
|
|
|
|
|
|
|
Shares Purchased
|
|
|
Value that May
|
|
|
|
Total Number
|
|
|
|
|
|
as Part of Publicly
|
|
|
Yet Be Purchased
|
|
|
|
of Shares
|
|
|
Average Price
|
|
|
Announced Plans
|
|
|
Under the Plans
|
|
|
|
Purchased
|
|
|
Paid Per Share
|
|
|
or Programs
|
|
|
or Programs
|
|
|
October 1, 2006 to
October 31, 2006
|
|
|
18
|
|
|
$
|
62.64
|
|
|
|
|
|
|
|
N/A
|
|
November 1, 2006 to
November 30, 2006
|
|
|
89
|
|
|
$
|
64.94
|
|
|
|
|
|
|
|
N/A
|
|
December 1, 2006 to
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth Quarter Total
|
|
|
107
|
|
|
$
|
64.55
|
|
|
|
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For equity compensation plan information, see note 16 to
consolidated financial statements.
On February 6, 2007, the board of directors of RAI approved
an amendment to RAIs articles of incorporation increasing
the number of authorized shares of common stock from
400 million to 800 million. This proposed amendment is
subject to the approval of RAIs shareholders at RAIs
2007 Annual Meeting of Shareholders scheduled for May 11,
2007.
While the number of shares of RAI common stock outstanding
doubled as a result of the 2006 two-for-one stock split, the
number of authorized shares was not changed and, therefore, had
the effect of substantially reducing the number of shares of RAI
common stock available for issuance. If RAIs Shareholders
approve the increase in authorized shares, the number of
authorized but unissued shares of common stock compared with
shares outstanding will be approximately the same as that on a
pre-split
basis.
64
Performance
Graph
Set forth below is a line graph comparing, for the period which
commenced on July 30, 2004 and ended on December 31,
2006, the cumulative shareholder return of $100 invested in RAI
common stock with the cumulative return of $100 invested in the
Standard & Poors 500 Index and the
Standard & Poors Tobacco Index.
COMPARISON
OF 29 MONTH CUMULATIVE TOTAL RETURN(1)
Among
Reynolds American Inc. Common Stock, the S&P 500 Index
and the S&P Tabacco Index
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7/30/04(1)
|
|
|
|
12/31/04
|
|
|
|
12/31/05
|
|
|
|
12/31/06
|
|
Reynolds American Inc.
|
|
|
|
100.00
|
|
|
|
|
108.49
|
|
|
|
|
138.18
|
|
|
|
|
198.80
|
|
S&P 500 Index
|
|
|
|
100.00
|
|
|
|
|
110.86
|
|
|
|
|
116.31
|
|
|
|
|
134.68
|
|
S&P Tobacco Index
|
|
|
|
100.00
|
|
|
|
|
129.88
|
|
|
|
|
162.60
|
|
|
|
|
198.64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Assumes that $100 was invested in RAI common stock on
August 2, 2004 (the first day of trading of RAI common
stock), or in each index on July 30, 2004, and that in each
case all dividends were reinvested. |
65
|
|
Item 6.
|
Selected
Financial Data
|
The selected historical consolidated financial data as of
December 31, 2006 and 2005, and for each of the years in
the three-year period ended December 31, 2006, are derived
from the consolidated financial statements and accompanying
notes, which have been audited by RAIs independent
registered public accounting firm. The consolidated financial
statements of RAI include the results of RJR through
July 30, 2004, and of RAI, including the acquired
operations of B&W and Lane subsequent to July 30, 2004,
and Conwood subsequent to May 31, 2006. The selected
historical consolidated financial data as of December 31,
2004, 2003 and 2002, and for the years ended December 31,
2003 and 2002, are derived from audited consolidated financial
statements not presented or incorporated by reference. For
further information, including the impact of new accounting
developments, acquisitions, restructuring and impairment
charges, you should read this table in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations in Item 7 and the
consolidated financial statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
|
|
|
(Dollars in Millions, Except Per Share Amounts)
|
|
|
|
|
|
Results of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales(1)
|
|
$
|
8,510
|
|
|
$
|
8,256
|
|
|
$
|
6,437
|
|
|
$
|
5,267
|
|
|
$
|
6,211
|
|
|
|
|
|
Income (loss) from continuing
operations
|
|
|
1,136
|
|
|
|
985
|
|
|
|
627
|
|
|
|
(3,689
|
)
|
|
|
418
|
|
|
|
|
|
Income from discontinued operations
|
|
|
|
|
|
|
2
|
|
|
|
12
|
|
|
|
122
|
|
|
|
40
|
|
|
|
|
|
Extraordinary items
gain on acquisition
|
|
|
74
|
|
|
|
55
|
|
|
|
49
|
|
|
|
121
|
|
|
|
|
|
|
|
|
|
Cumulative effect of accounting
change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(502
|
)
|
|
|
|
|
Net income (loss)
|
|
|
1,210
|
|
|
|
1,042
|
|
|
|
688
|
|
|
|
(3,446
|
)
|
|
|
(44
|
)
|
|
|
|
|
Per Share Data(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income (loss) from continuing
operations
|
|
|
3.85
|
|
|
|
3.34
|
|
|
|
2.83
|
|
|
|
(22.04
|
)
|
|
|
2.36
|
|
|
|
|
|
Diluted income (loss) from
continuing operations
|
|
|
3.85
|
|
|
|
3.34
|
|
|
|
2.81
|
|
|
|
(22.04
|
)
|
|
|
2.32
|
|
|
|
|
|
Basic income from discontinued
operations
|
|
|
|
|
|
|
0.01
|
|
|
|
0.06
|
|
|
|
0.73
|
|
|
|
0.22
|
|
|
|
|
|
Diluted income from discontinued
operations
|
|
|
|
|
|
|
0.01
|
|
|
|
0.06
|
|
|
|
0.73
|
|
|
|
0.22
|
|
|
|
|
|
Basic income from extraordinary
items
|
|
|
0.25
|
|
|
|
0.18
|
|
|
|
0.22
|
|
|
|
0.72
|
|
|
|
|
|
|
|
|
|
Diluted income from extraordinary
items
|
|
|
0.25
|
|
|
|
0.18
|
|
|
|
0.22
|
|
|
|
0.72
|
|
|
|
|
|
|
|
|
|
Basic net loss from cumulative
effect of accounting change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2.83
|
)
|
|
|
|
|
Diluted net loss from cumulative
effect of accounting change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2.78
|
)
|
|
|
|
|
Basic net income (loss)
|
|
|
4.10
|
|
|
|
3.53
|
|
|
|
3.11
|
|
|
|
(20.59
|
)
|
|
|
(0.25
|
)
|
|
|
|
|
Diluted net income (loss)
|
|
|
4.10
|
|
|
|
3.53
|
|
|
|
3.09
|
|
|
|
(20.59
|
)
|
|
|
(0.24
|
)
|
|
|
|
|
Basic weighted average shares, in
thousands
|
|
|
295,033
|
|
|
|
294,790
|
|
|
|
221,556
|
|
|
|
167,394
|
|
|
|
177,467
|
|
|
|
|
|
Diluted average shares, in thousands
|
|
|
295,384
|
|
|
|
295,172
|
|
|
|
222,873
|
|
|
|
167,394
|
|
|
|
180,351
|
|
|
|
|
|
Cash dividends declared per share
of common stock
|
|
$
|
2.75
|
|
|
$
|
2.10
|
|
|
$
|
1.90
|
|
|
$
|
1.90
|
|
|
$
|
1.865
|
|
|
|
|
|
Balance Sheet Data (at end of
periods):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
18,178
|
|
|
|
14,519
|
|
|
|
14,428
|
|
|
|
9,677
|
|
|
|
14,651
|
|
|
|
|
|
Long-term debt (less current
maturities)
|
|
|
4,389
|
|
|
|
1,558
|
|
|
|
1,595
|
|
|
|
1,671
|
|
|
|
1,755
|
|
|
|
|
|
Shareholders equity
|
|
|
7,043
|
|
|
|
6,553
|
|
|
|
6,176
|
|
|
|
3,057
|
|
|
|
6,716
|
|
|
|
|
|
Cash Flow Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash from operating activities
|
|
|
1,457
|
|
|
|
1,273
|
|
|
|
736
|
|
|
|
581
|
|
|
|
489
|
|
|
|
|
|
Net cash (used in) from investing
activities(3)
|
|
|
(3,531
|
)
|
|
|
(989
|
)
|
|
|
260
|
|
|
|
641
|
|
|
|
(901
|
)
|
|
|
|
|
Net cash from (used in) financing
activities
|
|
|
2,174
|
|
|
|
(450
|
)
|
|
|
(467
|
)
|
|
|
(1,122
|
)
|
|
|
(105
|
)
|
|
|
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of earnings to fixed
charges(4)
|
|
|
7.4
|
|
|
|
12.2
|
|
|
|
9.5
|
|
|
|
|
|
|
|
5.2
|
|
|
|
|
|
Deficiency in the coverage of fixed
charges by earnings before fixed charges(4)
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(3,913
|
)
|
|
$
|
|
|
|
|
|
|
|
|
|
(1) |
|
Net sales and costs of products sold exclude excise taxes of
$2.124 billion, $2.175 billion, $1.850 billion,
$1.572 billion and $1.751 billion for the years ended
December 31, 2006, 2005, 2004, 2003 and 2002, respectively. |
66
|
|
|
(2) |
|
All share and per share amounts have been retroactively adjusted
to reflect the August 14, 2006,
two-for-one
stock split. See Business in Item 1
for additional information. |
|
(3) |
|
Reflects reclassification of auction rate notes from cash and
cash equivalents to short-term investments, resulting in an
increase of $161 million in net cash flows from investing
activities in 2003 and an increase of $81 million in net
cash flows used in investing activities in 2002. |
|
(4) |
|
Earnings consist of income from continuing operations before
equity earnings, income taxes and fixed charges. Fixed charges
consist of interest on indebtedness, amortization of debt
issuance costs and one-third of operating rental expense,
representative of the interest factor. |
|
|
Item 7.
|
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 results of operations and financial condition.
Following the overview and discussion of business 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 is presented in two comparative sections, 2006
compared with 2005, and 2005 compared with 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
consolidated financial statements and the related notes as of
December 31, 2006 and 2005, and for each of the years in
the three-year period ended December 31, 2006.
Overview
and Business Initiatives
RAIs operating subsidiaries include RJR Tobacco, Conwood,
Santa Fe, Lane and GPI. RAIs largest reportable
operating segment, RJR Tobacco, 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, MISTY and CAPRI, are manufactured in a
variety of styles and marketed in the United States to meet a
range of adult smoker preferences. RJR Tobacco also manages a
contract manufacturing business through arrangements with BAT
affiliates.
RAIs other reportable operating segment, Conwood, is the
second largest smokeless tobacco products manufacturer in the
United States. RAI acquired Conwood on May 31, 2006.
Conwoods primary brands include its largest selling moist
snuff brands, GRIZZLY and KODIAK, two of the six best-selling
brands of moist snuff in the United States, and LEVI GARRETT, a
loose leaf brand. Conwoods other products include dry
snuff, plug and twist tobacco products. All of Conwoods
products held the first or second position in market share in
their respective categories in 2006.
The disclosures classified as All Other include the total assets
and results of operations of Santa Fe, Lane and GPI.
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
DUNHILL and CAPTAIN BLACK tobacco products. GPI manufactures and
exports cigarettes to U.S. territories, U.S. duty-free
shops and U.S. overseas military bases, and manages a
contract manufacturing business. Beginning on January 1,
2007, Conwood will distribute certain of Lanes
non-cigarette products, and RJR Tobacco will distribute DUNHILL
cigarettes. Also, beginning on January 1, 2007, GPI will
manage Santa Fes international business.
RJR
Tobacco
RJR Tobacco primarily conducts 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.
Trade inventory adjustments may result in short-term changes in
demand for its products if, and when, wholesale and retail
tobacco distributors adjust the timing of their
67
purchases of product to manage their inventory levels. RJR
Tobacco believes it is not appropriate for it to speculate on
other external factors that may impact the purchasing decisions
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.
RJR Tobacco is committed to building and maintaining a portfolio
of profitable 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 strength 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 brand portfolio strategy during 2005 and 2006
included three categories of brands: investment, selective
support and non-support. The investment brands were CAMEL and
KOOL, which received significant resources focused on
accelerating their
share-of-market
growth. The selective support brands included two premium
brands, WINSTON and SALEM, and two value brands, DORAL and PALL
MALL, all of which received limited support in an effort to
optimize profitability. The non-support brands were managed to
maximize near-term profitability.
At the beginning of 2007, RJR Tobacco further refined its brand
portfolio strategy and modified the three categories of brands
to growth, support and non-support. The growth brands include
two premium brands, CAMEL and KOOL, and a value brand, PALL
MALL. Although all of these brands are managed for long-term
accelerated growth and profit, CAMEL and KOOL will continue to
receive significant investment support, consistent with their
previous investment brand status. The support brands include
three premium brands, WINSTON, SALEM and CAPRI, and two value
brands, DORAL and MISTY, all of which receive limited support
for scale and long-term profit. The non-support brands include
all remaining brands and are managed to maximize near-term
profitability. RJR Tobacco expects that, within the next four
years, this focused portfolio strategy will result in growth in
total RJR Tobacco share, as gains on growth brands more than
offset declines among other brands.
Conwood
On May 31, 2006, RAI, through its newly formed subsidiary,
Conwood Holdings, Inc., completed its $3.5 billion
acquisition of 100% of the capital stock of a newly formed
holding company owning Conwood Company, L.P., Conwood Sales Co.,
L.P., Rosswil LLC, Scott Tobacco LLC, Conwood LLC, Conwood-1 LLC
and Conwood-2 LLC. Conwood is engaged in the business of
developing, manufacturing and marketing smokeless tobacco
products. Conwoods headquarters and primary manufacturing
facility are located in Memphis, Tennessee. The Conwood
acquisition was funded by RAI borrowings, new debt RAI
securities and available cash. See
Liquidity below for additional
information relating to borrowing arrangements and long-term
debt. The transaction was treated as a purchase of the Conwood
net assets by RAI for financial accounting purposes. RAI
believes the Conwood acquisition will enhance shareholder value
and will continue to be accretive to operating earnings.
The Conwood acquisition also is expected to enhance RAIs
efforts to offer a range of differentiated tobacco products to
adult consumers. RAI intends to combine certain operations of
Lane with Conwood, to be completed by the end of 2007, in order
to consolidate and strengthen the companies portfolio of
smokeless tobacco products and other non-cigarette tobacco
products.
Conwood is the only company with brands in every category of the
smokeless tobacco market, including moist snuff, loose leaf, dry
snuff, plug and twist tobacco. Conwoods moist snuff
products accounted for approximately 75% of its total net sales
in 2006.
In contrast to the declining U.S. cigarette market,
U.S. moist snuff volumes have grown at an average rate of
approximately 4% per year over the last four years with an
accelerated growth of price-value brands. Also, the profit
68
margins on moist snuff are significantly higher than in the
cigarette industry. Moist snuffs growth is partially
attributable to cigarette smokers switching from cigarettes to
smokeless tobacco products or using both. Within the moist snuff
category, premium brands have lost market share to price-value
brands, led by GRIZZLY, in recent years.
Conwoods U.S. moist snuff market share was 25.15% for
the year ended December 31, 2006, based on distributor
reported data processed by MSAi, for distributor shipments to
retail. Conwood has more than doubled its total share in the
past six years. Conwoods continued growth is attributable
to its innovation, product development and brand building,
including the launch of the GRIZZLY moist snuff brand in 2001
which, for 2006, had a 19.45% market share.
Conwood faces significant competition in the smokeless tobacco
categories. Similar to the cigarette market, competition is
based primarily on brand positioning and price, as well as
product attributes and packaging, consumer loyalty, promotions,
advertising and retail presence.
Critical
Accounting Policies and Estimates
GAAP requires estimates and assumptions to be made that affect
the reported amounts in RAIs 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 and their application
are considered to be critical to understanding the business
operations, financial condition and results of operations of RAI
and its subsidiaries. For information related to these and other
significant accounting policies, see note 1 to consolidated
financial statements.
Purchase
Accounting
RAI accounts for business combination transactions in accordance
with Statement of Financial Accounting Standards 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. Estimates of fair values for property,
plant and equipment, trademarks and other identifiable
intangibles generally are based on independent appraisals;
pension and postretirement obligations are based on actuarial
studies; and other accounts are based on managements best
estimates using assumptions that are believed to be reasonable.
In addition, depreciation of property, plant and equipment and
amortization of trademarks and other intangibles with finite
lives, are directly related to estimated fair values and
estimated useful lives determined as of the acquisition date.
The determination of fair values involves considerable
estimation and judgment. Among other things, it requires
developing forecasts of cash flows and discount rates for
trademarks and other intangibles; selecting appropriate
valuation bases and methodologies for property, plant and
equipment; determining appropriate actuarial assumptions for
pensions and postretirement plans; and determining the number
and timing of employees to be terminated or relocated and the
associated costs. The value of goodwill and trademarks and other
intangibles with indefinite lives will be subjected to annual
impairment testing that could result in future impairment
charges. Changes in the useful lives of property, plant and
equipment, trademarks or other intangibles could impact
depreciation or, in certain situations, impairment charges.
Tobacco-Related
Litigation
RAI discloses information concerning tobacco-related litigation
for which an unfavorable outcome is more than remote. RAI and
its subsidiaries 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 its subsidiaries 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 14 to consolidated financial
statements, RJR Tobacco, Conwood and their affiliates, including
RAI, and indemnitees, have been named in a number of
tobacco-related legal actions, proceedings or
69
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 case,
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. The July 2000 Engle
punitive damages verdict was reversed by the intermediate
appellate court on May 21, 2003, and the reversal was
upheld by the Florida Supreme Court on July 6, 2006. RJR
Tobacco has paid approximately $18 million since
January 1, 2003, related to unfavorable smoking and health
judgments, including pre-acquisition contingencies related to
the B&W business combination.
RAI and its subsidiaries believe, however, that they have valid
bases for appeals in their pending cases, and believe they have
a number of valid defenses to all actions and intend to defend
all actions vigorously. RAIs management continues to
conclude that the loss of any particular smoking and health
tobacco litigation claim against RJR Tobacco or its affiliates
or indemnitees, including B&W, or the loss of any particular
claim concerning the use of smokeless tobacco against Conwood,
when viewed on an individual basis, is not probable or
estimable. RJR Tobacco recorded less than $1 million
related to the judgment in the Thompson v. B&W
individual case in the fourth quarter of 2006, to be paid in
2007. No other liability for smoking and health tobacco
litigation or smokeless tobacco litigation was recorded in
RAIs consolidated balance sheet as of December 31,
2006. As discussed in more detail in note 14 to
consolidated financial statements, RJR has liabilities totaling
$94 million that were recorded in 1999 in connection with
certain indemnification claims, not related to smoking and
health, 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, Conwood
or their affiliates, including RAI, and indemnitees. 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 Litigation Affecting the
Cigarette Industry in note 14 to consolidated
financial statements, 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 state 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 cost 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. Conwood is
not a participant in the MSA. For more information related to
historical and expected settlement expenses and payments under
the MSA and other state settlement agreements, see
Governmental Health-Care Cost Recovery
Cases MSA and Other State Settlement
Agreements in note 14 to consolidated financial
statements.
Intangible
Assets
Intangible assets include goodwill, trademarks and other
intangibles and are accounted for under SFAS No. 142,
Goodwill and Other Intangible Assets. See
note 1 to consolidated financial statements for a
discussion of the impairment charges in connection with
RAIs ongoing application of SFAS No. 142.
RAI generally engages an independent appraisal firm to assist it
in determining the fair value of its reporting units and
trademarks with indefinite lives annually in the fourth quarter.
The determination of fair value involves considerable estimates
and judgment. In particular, the fair value of a reporting unit
involves, among other things, developing forecasts of future
cash flows, determining an appropriate discount rate, and when
goodwill impairment is implied, determining the fair values of
individual assets and liabilities, including unrecorded
intangibles. Although RAI believes it has based its impairment
testing and impairment charges on reasonable estimates and
assumptions, the use of different estimates and assumptions
could result in materially different results. Generally, if the
current competitive environment worsens or RAIs operating
companies strategic initiatives adversely affect
70
their financial performance, the fair value of goodwill,
trademarks and other intangibles could be impaired in future
periods.
Pension
and Postretirement Benefits
RAI and certain of its subsidiaries sponsor a number of
non-contributory defined benefit pension plans covering most of
their employees, and also provide certain health and life
insurance benefits for most of their retired employees and their
dependents. These benefits are generally no longer provided to
employees hired on or after January 1, 2004. For additional
information relating to pension and postretirement benefits, see
note 17 to consolidated financial statements.
As part of the Conwood acquisition, RAI assumed certain pension
and postretirement benefit obligations and the related assets of
Conwoods plans. The liability for the projected benefit
obligation in excess of plan assets was recorded in accordance
with SFAS No. 87, Employers Accounting for
Pensions and SFAS No. 106, Employers
Accounting for Postretirement Benefits Other Than
Pensions. All previously existing unrecognized net gain or
loss, unrecognized prior service cost, or unrecognized
transition obligation or asset existing at the date of the
Conwood acquisition were eliminated. As a result of the Conwood
acquisition, RAIs pension benefit obligation and pension
assets increased by $45 million and $35 million,
respectively, and the postretirement benefit obligation
increased by $37 million.
In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and
Other Postretirement Plans-an amendment of FASB Statements
No. 87, 88, 106, and 132(R), which became effective
for RAI at December 31, 2006. SFAS No. 158
requires balance sheet recognition of the net asset or liability
for the overfunded or underfunded status of defined benefit
pension and other postretirement benefit plans, on a
plan-by-plan
basis, and recognition of changes in the funded status in the
year in which the changes occur. The adoption of
SFAS No. 158 had no effect on RAIs net income or
cash flow.
Pension expense is determined in accordance with the provisions
of SFAS No. 87, Employers Accounting for
Pensions, and SFAS No. 88, Employers
Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits. Postretirement
benefit expense is determined in accordance with the provisions
of SFAS No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions. Because
pension and other postretirement obligations will ultimately be
settled in future periods, the determination of annual expense
and liabilities is subject to estimates and assumptions. With
the assistance of independent actuarial and investment
management firms, RAI reviews these assumptions annually based
on historic experience and expected future trends or
coincidentally with a major event and modifies them as needed.
Demographic assumptions such as termination of employment,
mortality or retirement are reviewed periodically as
expectations change.
Gains or losses are annual 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
excludes deferred asset gains of $311 million and
recognizes changes in fair value in a systematic and rational
manner over five years. If the market value of assets had been
used to determine pension expense, the impact would have been a
decrease to the 2006 costs of $45 million. Approximately
$27 million is attributable to the expected return on asset
component of expense and $18 million is due to the
gain/loss amortization component.
The minimum amortization of unrecognized gains or losses, as
described in SFAS No. 106, Employers
Accounting for Postretirement Benefits Other Than
Pensions, is also included in the postretirement benefit
expense. Prior service costs, which are changes in benefit
obligations due to plan amendments, are amortized on a
straight-line basis over the service to expected full
eligibility age for active employees, or average remaining life
expectancies for inactive employees if most of the plan
obligations are due to inactive employees. The market-related
value of plan assets excludes deferred asset losses of
$20 million and recognizes changes in fair value in a
systematic and rational manner over five years. If the market
value of assets had been used to determine
71
postretirement benefit expense, the impact would have been an
increase to the 2006 costs of $2 million, all attributable
to the expected return on asset component of expense.
The most critical assumptions and their sensitivity to change
are presented below:
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|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
Postretirement Benefits
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Weighted-average assumptions used
to determine benefit obligations at December 31:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
|
6.10
|
%
|
|
|
5.90
|
%
|
|
|
6.10
|
%
|
|
|
5.90
|
%
|
Rate of compensation increase
|
|
|
4.98
|
%
|
|
|
4.97
|
%
|
|
|
5.00
|
%
|
|
|
5.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
Postretirement Benefits
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Weighted-average assumptions used
to determine net periodic benefit cost for years ended
December 31:
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|
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|
|
|
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|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
|
5.90
|
%
|
|
|
6.05%;5.70
|
%(1)
|
|
|
6.15%;6.27
|
%(2)
|
|
|
5.91%
|
|
|
|
6.05%;5.70%;5.75%
|
(3)
|
|
|
6.15%;6.45
|
%(4)
|
Expected long-term return on plan
assets
|
|
|
8.74
|
%
|
|
|
8.79
|
%
|
|
|
8.79
|
%
|
|
|
8.00%
|
|
|
|
8.50%
|
|
|
|
8.50
|
%
|
Rate of compensation increase
|
|
|
4.98
|
%
|
|
|
4.97
|
%
|
|
|
4.77
|
%
|
|
|
5.00%
|
|
|
|
5.00%
|
|
|
|
4.79
|
%
|
|
|
|
(1) |
|
The January 1, 2005 overall beginning discount rate of
6.05% was changed to 5.70% for the period from April 30,
2005 to December 31, 2005, for plans impacted by the sale
of RJR Tobaccos packaging operations. |
|
(2) |
|
A discount rate of 6.15% was used for the period from
January 1, 2004 to July 31, 2004, and a
weighted-average discount rate of 6.27% was used for the period
from August 1, 2004 to December 31, 2004, to reflect
the impact of the B&W business combination. |
|
(3) |
|
The January 1, 2005 overall beginning discount rate of
6.05% was changed for the pre-combination RJR Tobacco benefit
plans only, to a discount rate of 5.70% for the period
April 30, 2005 to September 15, 2005, and a discount
rate of 5.75% was used for the period from September 16,
2005 to December 31, 2005. |
|
(4) |
|
A discount rate of 6.15% was used for the period from
January 1, 2004 to July 31, 2004, and a
weighted-average discount rate of 6.45% was used for the period
from August 1, 2004 to December 31, 2004, to reflect
the impact of the B&W business combination. |
RAI generally uses a hypothetical bond matching analysis to
determine the discount rate.
The overall expected long-term rate of return on assets
assumptions for pension and postretirement assets are based on:
(1) the target asset allocation for plan assets,
(2) long-term capital markets forecasts for asset classes
employed and (3) excess return expectations of active
management to the extent asset classes are actively managed.
72
Assumption
Sensitivity:
Assumed asset return and discount rates have a significant
effect on the amounts reported for the benefit plans. A
one-percentage-point change in assumed discount rate for the
pension plans and other postretirement plans would have had the
following effects:
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|
|
|
|
|
1-Percentage Point
|
|
|
|
|
|
|
Increase
|
|
|
1-Percentage Point Decrease
|
|
|
|
Pensions
|
|
|
Postretirement
|
|
|
Pensions
|
|
|
Postretirement
|
|
|
|
Plans
|
|
|
Plans
|
|
|
Plans
|
|
|
Plans
|
|
|
Effect on 2006 net periodic
benefit cost
|
|
$
|
(18
|
)
|
|
$
|
(5
|
)
|
|
$
|
19
|
|
|
$
|
2
|
|
Effect on December 31, 2006,
projected benefit obligation and accumulated postretirement
benefit obligation
|
|
|
(554
|
)
|
|
|
(141
|
)
|
|
|
622
|
|
|
|
156
|
|
A one-percentage-point change in assumed asset return would have
had the following effects:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1-Percentage Point
|
|
|
|
|
|
|
Increase
|
|
|
1-Percentage Point Decrease
|
|
|
|
Pensions
|
|
|
Postretirement
|
|
|
Pensions
|
|
|
Postretirement
|
|
|
|
Plans
|
|
|
Plans
|
|
|
Plans
|
|
|
Plans
|
|
|
Effect on 2006 net periodic
benefit cost
|
|
$
|
(42
|
)
|
|
$
|
(4
|
)
|
|
$
|
42
|
|
|
$
|
4
|
|
During 2005, pension plan assets increased $238 million, as
a result of the favorable 2005 equity market performance and
employer contributions, partially offset by benefit payments.
Pension benefit obligations increased by $161 million due
to a decline in discount rates, partially offset by benefit
payments and the sale of RJR Tobaccos packaging operations
in May 2005. At December 31, 2005, the pension benefit
obligation exceeded the fair value of plan assets by
$879 million.
During 2006, pension plan assets increased $641 million,
primarily as a result of the favorable 2006 equity market
performance and employer contributions, partially offset by
benefit payments. Pension benefit obligations decreased by
$55 million primarily due to the increase in discount rate
from 5.90% to 6.10%, net of the amounts assumed in the Conwood
acquisition. At December 31, 2006, the pension benefit
obligation exceeded the fair value of plan assets by
$183 million. Beginning in 2006, RAI adjusted its expected
long-term rate of return on pension assets to 8.75% for its
major plans, from 9.00% and 8.50% in 2005.
During 2005, postretirement plan assets increased
$15 million, as a result of favorable 2005 equity market
performance and employer contributions, partially offset by
benefit payments. Postretirement benefit obligations increased
by $97 million due to a decline in discount rates,
partially offset by benefit payments. At December 31, 2005,
the postretirement benefit obligation exceeded the fair value of
plan assets by $1.2 billion.
During 2006, postretirement plan assets increased
$24 million, as a result of favorable 2006 equity market
performance and employer contributions, partially offset by
benefit payments. Postretirement benefit obligations decreased
by $26 million due to an increase in discount rates, net of
the amounts assumed in the Conwood acquisition. At
December 31, 2006, the postretirement benefit obligation
exceeded the fair value of plan assets by $1.1 billion.
In 2005, RAI implemented a cap on how much it will pay for
medical and dental coverage for retirees as a group, excluding
pre-1993
retirees and former B&W retirees. The cap was raised above
previous amounts creating an unrecognized prior service cost of
$57 million. In 2006, RAI introduced new retiree medical
options and cost sharing for certain retirees creating a prior
service credit of $3 million. The prior service cost will
be amortized over the number of years, on average, it takes for
employees to be fully eligible for benefits.
Pension expense in 2007 is expected to be within a range of
$15 million expense to $15 million income, compared
with expense of $54 million in 2006, primarily due to
increased asset returns and employer contributions.
Postretirement benefit expense in 2007 is expected to be within
a range of $65 million to $75 million, compared with
expense of $72 million in 2006.
73
The amount by which the pension and postretirement benefit
obligations exceed the fair value of the plan assets could
increase to the extent of a decline in the fair value of plan
assets, as well as adverse changes in actuarial assumptions,
including a reduction in the discount rate used to calculate the
benefit obligations.
RAI expects to contribute approximately $300 million to its
pension plans in 2007, of which $289 million was
contributed in January 2007. Additional cash funding may be made
in the future. RAI expects payments related to its
postretirement plans to be $75 million in 2007.
Differences between actual results and actuarial assumptions are
accumulated and amortized over future periods. In recent years,
actual results have varied significantly from actuarial
assumptions. In particular, pension and postretirement
liabilities have decreased as a result of the increase in the
discount rate. These changes have resulted in a reduction in
charges to comprehensive income. These changes are expected to
result in a reduction in pension and postretirement expense in
future years. However, the Pension Protection Act passed into
law in 2006 may require additional cash funding of the pension
obligations in the future.
The target pension asset allocation is 59% equity investments,
which includes U.S. equity,
non-U.S. equity
and global equity, 27% fixed income, 10% opportunistic
investments, which includes hedge funds and global tactical
asset allocation, and 4% alternative investments, which includes
private equity investments and real estate, with a rebalancing
range of approximately plus or minus 3% to 5% around the target
asset allocations.
The target postretirement asset allocation is 43%
U.S. equity investments, including private equity
investments, 17%
non-U.S. equity
investments, 38% debt securities, 1% hedge fund investments and
1% real estate and other, with a rebalancing range of
approximately plus or minus 5% around the target asset
allocations.
RAIs pension and postretirement plans weighted-average
asset allocations at December 31, 2006 and 2005, by asset
category were as follows:
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|
|
|
|
|
Pension Plans
|
|
|
|
2006
|
|
|
2005
|
|
|
Asset Category:
|
|
|
|
|
|
|
|
|
Equities
|
|
|
60
|
%
|
|
|
61
|
%
|
Fixed income
|
|
|
25
|
%
|
|
|
26
|
%
|
Opportunistic
|
|
|
11
|
%
|
|
|
9
|
%
|
Alternative
|
|
|
4
|
%
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement Plans
|
|
|
|
2006
|
|
|
2005
|
|
|
Asset Category:
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
|
44
|
%
|
|
|
47
|
%
|
Debt securities
|
|
|
35
|
%
|
|
|
24
|
%
|
Non-U.S. equity
securities
|
|
|
19
|
%
|
|
|
18
|
%
|
Hedge funds
|
|
|
1
|
%
|
|
|
5
|
%
|
Real estate and other
|
|
|
1
|
%
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
In late 2005, RAI announced an enhancement to its current
qualified defined contribution plan beginning January 1,
2006. The amount of the retirement enhancement is based on a
sliding scale by providing higher, additional contributions to
certain employees closer to retirement with lower additional
contributions for certain other employees. This enhanced program
increased expense by approximately $20 million in 2006
compared with 2005.
74
Income
Taxes
Tax law requires certain items to be included in taxable income
at different times than is 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 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 recorded in RAIs
consolidated balance sheets 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.
In 2006, 2005 and 2004, the resolution of certain prior
years tax matters resulted in reduction of income tax
expense of $17 million, $78 million and
$126 million, respectively. In 2005 and 2004, RAI recorded
an adjustment to tax expense included in discontinued operations
of $1 million and $6 million, respectively, related to
the gain on the 1999 sale of RJRs international tobacco
business. Including these adjustments, the net after-tax gain on
the sale of the international tobacco business was
$2.5 billion.
In 2006, 2005 and 2004, RAI recorded an adjustment of
$74 million, $55 million and $49 million,
respectively, to the gain related to the acquisition of
RJRs former parent, NGH, which occurred in 2000, primarily
reflecting the favorable resolution of associated tax matters.
Including these adjustments, the net after-tax gain on the
acquisition of NGH was $1.8 billion.
The financial statements 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 2006, the FASB issued SFAS No. 157,
Fair Value Measurement. SFAS No. 157 does
not require any new fair value measurements but provides a
definition of fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value
measurements. SFAS No. 157 is effective for RAI as of
January 1, 2008. RAI has not yet determined the impact of
the adoption of SFAS No. 157 on its financial
position, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, referred
to as FIN No. 48. FIN No. 48 clarifies
SFAS No. 109, Accounting for Income Taxes,
by providing specific guidance for consistent reporting of
uncertain income taxes recognized in a companys financial
statements, including classification, interest and penalties and
disclosures. FIN No. 48 is effective for RAI as of
January 1, 2007. Based on preliminary analysis, RAI does
not expect the implementation of FIN 48, during the first
quarter of 2007, to have a material impact on its financial
position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities. SFAS No. 159 permits all entities
to choose to elect to measure eligible financial instruments at
fair value. SFAS No. 159 is effective for RAI as of
January 1, 2008. RAI has not yet determined the impact of
the adoption of SFAS No. 159 on its financial
position, results of operations or cash flows.
75
Results
of Operations
2006
Compared with 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31(1),
|
|
|
|
2006
|
|
|
2005
|
|
|
% Change
|
|
|
Net sales:(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
7,675
|
|
|
$
|
7,695
|
|
|
|
(0.0
|
)%
|
Conwood
|
|
|
291
|
|
|
|
|
|
|
|
NM(4
|
)
|
All other
|
|
|
544
|
|
|
|
561
|
|
|
|
(3.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
8,510
|
|
|
|
8,256
|
|
|
|
3.1
|
%
|
Cost of products sold(2),(3)
|
|
|
4,803
|
|
|
|
4,919
|
|
|
|
(2.4
|
)%
|
Selling, general and
administrative expenses
|
|
|
1,658
|
|
|
|
1,611
|
|
|
|
2.9
|
%
|
Amortization expense
|
|
|
28
|
|
|
|
41
|
|
|
|
(31.7
|
)%
|
Loss on sale of assets
|
|
|
|
|
|
|
24
|
|
|
|
NM(4
|
)
|
Restructuring and asset impairment
charges
|
|
|
1
|
|
|
|
2
|
|
|
|
(50.0
|
)%
|
Goodwill and trademark impairment
charges
|
|
|
90
|
|
|
|
200
|
|
|
|
(55.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
|
1,626
|
|
|
|
1,346
|
|
|
|
20.8
|
%
|
Conwood
|
|
|
160
|
|
|
|
|
|
|
|
NM(4
|
)
|
All other
|
|
|
194
|
|
|
|
144
|
|
|
|
34.7
|
%
|
Corporate expense
|
|
|
(50
|
)
|
|
|
(31
|
)
|
|
|
(61.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,930
|
|
|
$
|
1,459
|
|
|
|
32.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Conwoods net sales and operating income include results of
operations for the months of June through December 2006, only. |
|
(2) |
|
Excludes excise taxes of: |
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
RJR Tobacco
|
|
$
|
1,969
|
|
|
$
|
2,043
|
|
Conwood
|
|
|
8
|
|
|
|
|
|
All other
|
|
|
147
|
|
|
|
132
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,124
|
|
|
$
|
2,175
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) |
|
See below for further information related to MSA settlement and
federal tobacco buyout expense included in cost of products sold. |
|
(4) |
|
Percent change is not meaningful. |
RJR
Tobacco
Net
Sales
RJR Tobaccos net sales for the year ended 2006 decreased
$20 million from the comparable prior year, primarily due
to lower volumes of $268 million, offset in part by higher
pricing resulting from a January 2006 price increase. RJR
Tobaccos net sales are dependent upon its shipment volume
in a declining market, premium versus value brand mix and list
pricing, offset by promotional spending, trade incentives and
federal excise taxes.
76
Domestic shipment volume, in billions of units for RJR Tobacco
and the industry, were as follows(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31,
|
|
RJR Tobacco
|
|
2006
|
|
|
2005
|
|
|
% Change
|
|
|
Growth brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter
|
|
|
23.5
|
|
|
|
22.0
|
|
|
|
6.5
|
%
|
KOOL
|
|
|
11.7
|
|
|
|
11.8
|
|
|
|
(0.4
|
)%
|
PALL MALL Savings
|
|
|
6.4
|
|
|
|
5.8
|
|
|
|
10.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41.6
|
|
|
|
39.6
|
|
|
|
5.1
|
%
|
Support brands
|
|
|
44.1
|
|
|
|
46.6
|
|
|
|
(5.5
|
)%
|
Non-support brands
|
|
|
18.0
|
|
|
|
21.1
|
|
|
|
(14.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic
|
|
|
103.7
|
|
|
|
107.4
|
|
|
|
(3.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premium
|
|
|
63.8
|
|
|
|
64.8
|
|
|
|
(1.6
|
)%
|
Total value
|
|
|
40.0
|
|
|
|
42.6
|
|
|
|
(6.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic
|
|
|
103.7
|
|
|
|
107.4
|
|
|
|
(3.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium
|
|
|
270.0
|
|
|
|
271.4
|
|
|
|
(0.5
|
)%
|
Value
|
|
|
102.5
|
|
|
|
110.4
|
|
|
|
(7.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry total domestic
|
|
|
372.5
|
|
|
|
381.7
|
|
|
|
(2.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 MSAis revised
methodology adopted to better estimate industry volume. |
RJR Tobaccos total domestic shipment volume decreased 3.4%
in 2006 compared with 2005 due to declines in consumption, or
retail sales to consumers, and one less shipping day. The
overall cigarette industry decline was 2.4%.
Shipments in the premium tier increased to 61.5% of RJR
Tobaccos total domestic shipments during 2006 as compared
with 60.4% in the prior year. The industrys premium
shipments increased to 72.5% in 2006 from 71.1% in 2005.
The shares of RJR Tobacco as a percentage of total share of
U.S. retail cigarette sales according to data(1) from IRI,
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months
|
|
|
|
Ended December 31,(2)(3)
|
|
|
|
|
|
|
|
|
|
Share Point
|
|
|
|
2006
|
|
|
2005
|
|
|
Change
|
|
|
Growth brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter
|
|
|
7.42
|
%
|
|
|
6.74
|
%
|
|
|
0.68
|
|
KOOL
|
|
|
3.13
|
%
|
|
|
3.01
|
%
|
|
|
0.13
|
|
PALL MALL Savings
|
|
|
1.86
|
%
|
|
|
1.58
|
%
|
|
|
0.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12.41
|
%
|
|
|
11.33
|
%
|
|
|
1.09
|
|
Support brands
|
|
|
12.12
|
%
|
|
|
12.82
|
%
|
|
|
(0.70
|
)
|
Non-support brands
|
|
|
5.25
|
%
|
|
|
6.14
|
%
|
|
|
(0.89
|
)
|
RJR Tobacco total domestic
|
|
|
29.78
|
%
|
|
|
30.28
|
%
|
|
|
(0.50
|
)
|
77
|
|
|
(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) |
|
These amounts, including the restatement of prior periods,
reflect IRIs revised methodology adopted to better reflect
industry dynamics. |
|
(3) |
|
Amounts presented in this table are rounded on an individual
basis and, accordingly, may not sum on an aggregate basis. |
In 2006 retail share of market of CAMELs filtered styles
increased 0.68 share points from 2005. In the first quarter
of 2006, CAMEL introduced new CAMEL Wides packaging and
initiated efforts to enhance the performance of the brands
menthol styles, including new packaging and introducing the
CAMEL Wides Menthol style. Also in 2006, CAMEL introduced CAMEL
SNUS, a smokeless, spitless tobacco product, in test markets.
KOOL continues to maintain its appeal among adult menthol
smokers and had an increase in its retail share of market of
0.13 share points in 2006. In the fourth quarter of 2006,
KOOL introduced KOOL XL, a wide-gauge cigarette style, which
provides another tangible point of difference from competing
brands.
PALL MALL increased its share of market by 0.28 share
points in 2006 and continues to demonstrate its strength in the
value category based on its unique product platform of being a
longer-lasting
cigarette.
The combined share of market of RJR Tobaccos growth brands
grew 1.09 share points during 2006. However, the decline in
share of support and non-support brands more than offset the
gains on the growth brands. The share results for 2006 were in
line with the RJR Tobaccos brand portfolio strategy, and
the overall market share declines continue to moderate.
RJR Tobaccos premium share position of 18.76% in 2006
increased 0.26 share points from 2005 due to the increase
of its growth brands. RJR Tobaccos value share position of
11.02% of the market in 2006 declined 0.77 share points
from 2005.
Operating
Income
RJR Tobaccos operating income for 2006 increased to
$1,626 million from $1,346 million in 2005 primarily
due to favorable pricing, and lower trademark impairment
charges, offset in part by lower volumes and higher MSA and
tobacco quota buyout expenses, detailed below.
In connection with the annual impairment testing of goodwill and
certain intangible assets in the fourth quarter of 2006,
impairment occurred on four of RJR Tobaccos non-growth
brands, primarily DORAL and SALEM. The impairment primarily
reflects modification, during the fourth quarter of 2006, to the
previously anticipated level of support among certain brands,
and also results from increased decline rate in projected net
sales of certain brands, compared with that assumed in the 2005
annual impairment test, which resulted in $198 million of
trademark impairment charges. In 2006, RJR Tobacco recorded
impairment charges of $90 million based on the excess of
certain brands carrying values over their fair values,
determined with the assistance of an independent appraisal firm,
using the present value of estimated future cash flows assuming
a discount rate of 10.75%. The discount rate was determined by
adjusting the RJR Tobacco enterprise discount rate by an
appropriate risk premium to reflect an asset group risk.
RJR Tobaccos operating income also was impacted by lower
amortization expense of $13 million for the comparable
periods, primarily due to certain acquired consumer-related
intangibles being fully amortized prior to 2006. For information
relating to the 2003 and 2002 restructuring reserves, including
the $1 million adjustment recorded in 2006, see note 4
to consolidated financial statements.
78
RJR Tobaccos cost of products sold includes the following
components for MSA and other state settlements, and federal
tobacco buyout expenses for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Settlement
|
|
$
|
2,589
|
|
|
$
|
2,618
|
|
Phase II growers
liability offset
|
|
|
|
|
|
|
(79
|
)
|
Phase II growers
liability expense
|
|
|
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
Total settlement expense
|
|
$
|
2,589
|
|
|
$
|
2,577
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout
|
|
$
|
258
|
|
|
$
|
259
|
|
Federal quota tobacco stock
liquidation assessment
|
|
|
(9
|
)
|
|
|
79
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense
|
|
$
|
249
|
|
|
$
|
338
|
|
|
|
|
|
|
|
|
|
|
RJR Tobaccos MSA and other state settlement expenses are
expected to be approximately $2.8 billion in 2007, subject
to adjustment for changes in volume and other factors, and the
federal tobacco quota buyout is expected to be in the range of
$230 million to $280 million in 2007. For additional
information, see Litigation Affecting the
Cigarette Industry Governmental Health-Care Cost
Recovery Cases MSA and Other State Settlement
Agreements in note 14 to consolidated financial
statements and Governmental Activity
below.
Merger and integration costs related to the B&W business
combination decreased during 2006 compared with 2005, favorably
impacting cost of products sold by $14 million and selling,
general and administrative expenses by $60 million.
Selling, general and administrative expenses for RJR Tobacco
also were impacted by a $48 million decrease in product
liability defense costs during 2006 compared with the prior-year
period, offset by $46 million of expenditures relating to
ballot initiatives in 2006.
Selling, general and administrative expenses include the costs
of litigating and administering product liability claims, as
well as other legal expenses. During 2006 and 2005, RJR
Tobaccos product liability defense costs were
$105 million and $153 million, respectively. The
decrease in product liability defense costs in 2006 compared
with 2005 was primarily due to reduced litigation activity,
including a decrease in the number of cases tried or in trial
during 2006 (2 cases) compared with 2005 (5 cases, including the
U.S. 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 set forth in
Litigation Affecting the Cigarette
Industry Overview in note 14 to
consolidated financial statements:
|
|
|
|
|
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:
|
|
|
|
|
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.
|
79
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 14 to
consolidated financial statements for detailed information
regarding the number and type of cases pending, and
Litigation Affecting the Cigarette
Industry Scheduled Trials in note 14 for
detailed information regarding the number and nature of cases in
trial and scheduled for trial through December 31, 2007.
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, aside from the assumption of certain B&W
litigation and the potential for increased individual case
filings in Florida due to the Engle decision. See
Litigation Affecting the Cigarette
Industry Class-Action Suits Engle
Case in note 14 to consolidated financial statements
for additional information. 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.
Conwood
The Conwood acquisition occurred on May 31, 2006, and
consequently, the RAI consolidated statement of income includes
only the results of operations of Conwood for June through
December 2006. Conwoods moist snuff products accounted for
approximately 75% of Conwoods total net sales of
$291 million for June through December 2006. Conwoods
net sales are dependent upon premium versus price-value brand
mix and list pricing, offset by promotional spending, trade
incentives and federal excise taxes. Conwoods operating
income of $160 million for June through December 2006
includes $10 million of integration costs.
The shares of Conwoods moist snuff products and volume
discussion presented below include periods prior to the
acquisition by RAI for enhanced analysis. The Conwood shares of
the moist snuff category as a percentage of total share of
U.S. retail moist snuff sales, according to distributor
reported data(1) processed by MSAi, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31,(2)
|
|
|
|
|
|
|
|
|
|
Share Point
|
|
|
|
2006
|
|
|
2005
|
|
|
Change
|
|
|
Moist snuff:
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium
|
|
|
|
|
|
|
|
|
|
|
|
|
KODIAK
|
|
|
5.09
|
%
|
|
|
5.83
|
%
|
|
|
(0.74
|
)
|
Other
|
|
|
0.33
|
%
|
|
|
0.39
|
%
|
|
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.42
|
%
|
|
|
6.22
|
%
|
|
|
(0.80
|
)
|
Price-value
|
|
|
|
|
|
|
|
|
|
|
|
|
GRIZZLY
|
|
|
19.45
|
%
|
|
|
16.03
|
%
|
|
|
3.42
|
|
Other
|
|
|
0.28
|
%
|
|
|
0.41
|
%
|
|
|
(0.13
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19.73
|
%
|
|
|
16.44
|
%
|
|
|
3.29
|
|
Total moist snuff
|
|
|
25.15
|
%
|
|
|
22.67
|
%
|
|
|
2.48
|
|
|
|
|
(1) |
|
Distributor shipments to retail share of U.S. moist snuff
is included in this document because it is used by Conwood
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 distributors and
processed by MSAi as being a |
80
|
|
|
|
|
precise measurement of actual market share because this
distributor data set is not able to effectively track all volume. |
|
(2) |
|
Amounts presented in this table are rounded on an individual
basis and, accordingly, may not sum on an aggregate basis. |
GRIZZLYs growth led Conwoods share position to
25.15% of the moist snuff market in 2006, an increase of
2.48 share points from 2005. GRIZZLYs price-value
share position was 45.71% of that market in 2006, an increase of
4.22% from 2005. In 2006, Conwood introduced GRIZZLY long-cut
natural in 20 states to further enhance GRIZZLYs
growth potential.
Conwoods total moist snuff shipment volume increased 18.4%
in 2006 from 2005, including GRIZZLYs 29.1% volume growth.
For the industry, the overall moist snuff category volume
increase is estimated to be between 6% and 7% for 2006.
All
Other
All Other operating income for 2006 was favorably impacted by
the growth of Santa Fes NATURAL AMERICAN SPIRIT
brand. In addition, 2005 was impacted by the $24 million
loss relating to the sale of the packaging operations. See
note 4 to consolidated financial statements for information
relating to the sale of the packaging operations.
RAI
Consolidated
Interest and debt expense was $270 million for the
year ended December 31, 2006, an increase of
$157 million from 2005. This increase is primarily due to
higher debt balances resulting from the debt incurred by RAI to
fund the Conwood acquisition in May 2006.
Interest income was $136 million for the year ended
December 31, 2006, an increase of $51 million from
2005. This increase is primarily due to higher interest rates
and, to a lesser extent, higher average cash balances.
Other (income) expense, net was $13 million income
in 2006 compared with $15 million expense in 2005. The
change was primarily due to favorable foreign exchange
revaluation of $14 million and increased earnings relating
to the joint venture, coupled with the 2005 net costs of
$7 million related to the extinguishment of the 2006 notes.
Provision for income taxes was a provision of
$673 million, or an effective rate of 37.2%, for the year
ended December 31, 2006, compared with a provision of
$431 million, or an effective rate of 30.4%, in 2005. The
2006 provision was impacted by state taxes and nondeductible
items, including certain expenditures relating to ballot
initiatives, offset in part by the resolution of certain prior
years tax matters that resulted in a reduction of income
tax expense of $17 million.
The 2005 provision was impacted by the resolution of certain
prior years tax matters that resulted in a reduction of
income tax expense of $78 million, offset in part by state
taxes and certain nondeductible items.
RAI expects its effective tax rate to approximate 37% in 2007.
Discontinued operations reflect transactions related to
the 1999 sale of the international tobacco business to JTI.
During 2005, these transactions included $2 million of
after-tax reversals of indemnification accruals. Including these
adjustments, the net after-tax gain on the sale of the
international tobacco business was $2.5 billion.
Extraordinary items included a gain of $74 million
and $55 million in 2006 and 2005, respectively, related to
the 2000 acquisition of RJRs former parent, NGH, primarily
from settlement of tax matters. Including these adjustments, the
net after-tax gain on the acquisition was $1.8 billion.
81
2005
Compared with 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
% Change
|
|
|
Net sales(1)
|
|
$
|
8,256
|
|
|
$
|
6,437
|
|
|
|
28.3
|
%
|
Cost of products sold(1),(2)
|
|
|
4,919
|
|
|
|
3,872
|
|
|
|
27.0
|
%
|
Selling, general and
administrative expenses
|
|
|
1,611
|
|
|
|
1,455
|
|
|
|
10.7
|
%
|
Loss on sale of assets
|
|
|
24
|
|
|
|
|
|
|
|
NM
|
(3)
|
Amortization expense
|
|
|
41
|
|
|
|
24
|
|
|
|
70.8
|
%
|
Restructuring and asset impairment
charges
|
|
|
2
|
|
|
|
5
|
|
|
|
(60.0
|
)%
|
Goodwill and trademark impairment
charges
|
|
|
200
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
1,459
|
|
|
$
|
882
|
|
|
|
65.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Excludes excise taxes of $2,175 million and
$1,850 million for the years ended December 31, 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. |
Net sales for the year ended December 31, 2005,
increased $1.8 billion from the comparable prior year,
primarily due to increased volume of $1.3 billion, driven
by the B&W business combination, and higher pricing net of
higher discounting. Net sales also includes an increase of
$236 million due to related party sales, primarily relating
to contract manufacturing for BAT affiliates. RAIs net
sales are dependent upon its shipment volume in a declining
market, premium versus value brand mix, and list pricing, offset
by promotional spending, trade incentives and federal excise
taxes.
Domestic cigarette shipment volume, in billions of units, for
RAIs operating subsidiaries and the industry segments were
as follows(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
% Change
|
|
|
RJR Tobacco investment brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter
|
|
|
22.0
|
|
|
|
21.6
|
|
|
|
1.9
|
%
|
KOOL
|
|
|
11.8
|
|
|
|
4.9
|
|
|
|
NM
|
(3)
|
RJR Tobacco selective support
brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
DORAL
|
|
|
17.1
|
|
|
|
18.3
|
|
|
|
(6.4
|
)%
|
WINSTON
|
|
|
14.2
|
|
|
|
14.8
|
|
|
|
(4.0
|
)%
|
SALEM
|
|
|
7.6
|
|
|
|
8.9
|
|
|
|
(14.2
|
)%
|
PALL MALL Savings
|
|
|
5.8
|
|
|
|
2.5
|
|
|
|
NM
|
(3)
|
RJR Tobacco non-support brands
|
|
|
28.8
|
|
|
|
20.6
|
|
|
|
NM
|
(3)
|
RJR Tobacco total premium
|
|
|
64.8
|
|
|
|
57.0
|
|
|
|
13.8
|
%
|
RJR Tobacco total value
|
|
|
42.6
|
|
|
|
34.6
|
|
|
|
22.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco total domestic
|
|
|
107.4
|
|
|
|
91.6
|
|
|
|
17.2
|
%
|
Other
|
|
|
2.5
|
|
|
|
2.2
|
|
|
|
10.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAI total domestic
|
|
|
109.8
|
|
|
|
93.8
|
|
|
|
17.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium
|
|
|
271.3
|
|
|
|
274.4
|
|
|
|
(1.1
|
)%
|
Value
|
|
|
109.7
|
|
|
|
120.1
|
|
|
|
(8.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry total domestic
|
|
|
381.0
|
|
|
|
394.5
|
|
|
|
(3.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
82
|
|
|
(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 as provided for the year ended
December 31, 2005. |
|
(3) |
|
Percent change is not meaningful due to only five months of
sales in 2004 for KOOL, PALL MALL and other former B&W
brands. |
RJR Tobaccos full-year total domestic shipment volume
increased 17.2% reflecting the impact of the B&W business
combination offset in part by the changes in the brand strategy
implemented in 2005, the underlying declines in consumption, or
retail sales to consumers, and two less shipping days compared
with 2004.
Shipments in the premium tier decreased to 60.4% of RJR
Tobaccos total domestic shipments during 2005 as compared
with 62.2% in 2004. This decrease is primarily due to the
combination of the former B&W brands beginning in August
2004, which were more heavily weighted in the value category.
Industry premium shipments as a percentage of total domestic
shipments increased to 71.2% in 2005 from 69.6% in 2004.
The shares of U.S. retail cigarette sales of RJR Tobacco
are presented as if the portfolio resulting from the B&W
business combination had been combined as of the beginning of
2004. The shares of RJR Tobacco as a percentage of total share
of U.S. retail cigarette sales according to data(1) from
IRI were as follows(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Twelve Months Ended December 31,
|
|
|
Share Point
|
|
|
|
2005
|
|
|
2004
|
|
|
Change
|
|
|
RJR Tobacco investment brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter
|
|
|
6.68
|
%
|
|
|
6.28
|
%
|
|
|
0.40
|
|
KOOL
|
|
|
2.98
|
%
|
|
|
2.80
|
%
|
|
|
0.18
|
|
RJR Tobacco selective support
brands:
|
|
|
|
|
|
|
|
|
|
|
|
|
DORAL
|
|
|
4.68
|
%
|
|
|
4.98
|
%
|
|
|
(0.30
|
)
|
WINSTON
|
|
|
4.02
|
%
|
|
|
4.16
|
%
|
|
|
(0.14
|
)
|
SALEM
|
|
|
2.19
|
%
|
|
|
2.59
|
%
|
|
|
(0.39
|
)
|
PALL MALL Savings
|
|
|
1.54
|
%
|
|
|
1.49
|
%
|
|
|
0.05
|
|
RJR Tobacco non-support brands
|
|
|
7.88
|
%
|
|
|
8.52
|
%
|
|
|
(0.63
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco total domestic
|
|
|
29.98
|
%
|
|
|
30.82
|
%
|
|
|
(0.84
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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) |
|
During 2006, IRI revised its data regarding participants
shares of U.S. retail cigarette sales. Data provided herein
reflects previously published data using IRIs historical
methodology. |
The 2005 retail share of market of CAMELs filtered styles
continued to grow compared with 2004 based on the strength of
the brands equity, driven by its Pleasure to
Burn positioning. In addition, RJR Tobacco launched
Turkish Silver in April 2005. Initiatives launched in prior
years to actively market CAMELs three distinct product
families Classic, Turkish and Exotic
Blends also contributed to the brands
performance in 2005.
In 2005, KOOL also increased its share to its highest level
since 1999. During 2005, RJR Tobacco introduced KOOLs
Be True advertising campaign and launched the KOOL
menthol lights box style to support KOOLs future growth
potential.
83
The combined share of market of the investment brands grew 0.58%
during 2005 compared with 0.28% growth during 2004. However, the
decline in share of selective support and non-support brands
more than offset the gains on the investment brands. Within the
selective support brands, PALL MALL Savings continued to show
slight share growth during 2005. The share results for 2005 were
in line with RJR Tobaccos brand portfolio strategy.
RJR Tobaccos premium share position of 18.4% of the market
in 2005 declined 0.19 share points from 2004, compared with
the 2004 decline from 2003 of 0.40 share points. RJR
Tobaccos value share position of 11.6% of the market in
2005 declined 0.65 share points from 2004, compared with
the 2004 decline from 2003 of 0.87 share points.
Cost of products sold increased $1.0 billion from
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 also was driven by integration
costs of $14 million and $364 million higher product
costs primarily related to volume of acquired operations,
including contract manufacturing for certain BAT affiliates.
Cost of products sold includes the following components for MSA
and other state settlements, and federal tobacco buyout expenses
for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
Settlement
|
|
$
|
2,641
|
|
|
$
|
2,252
|
|
Phase II growers
liability offset
|
|
|
(79
|
)
|
|
|
(69
|
)
|
Phase II growers
liability expense
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total settlement expense
|
|
$
|
2,600
|
|
|
$
|
2,183
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout
|
|
$
|
264
|
|
|
$
|
70
|
|
Federal quota tobacco stock
liquidation assessment
|
|
|
81
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense
|
|
$
|
345
|
|
|
$
|
70
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses of
$1,611 million during 2005 increased $156 million,
compared with 2004, primarily due to increased legal expenses
and other increased costs related to acquired operations,
partially offset by $33 million growers settlement
and $17 million related to a California settlement recorded
in 2004 and lower integration costs of $93 million in 2005
compared with $130 million in 2004.
Selling, general and administrative expenses include the costs
of litigating and administering product liability claims, as
well as other legal expenses. During 2005 and 2004, RJR
Tobaccos product liability defense costs were
$153 million and $115 million, respectively. The
increase in product liability defense costs in 2005 compared
with 2004 was primarily related to the assumption of certain
B&W litigation as a result of the B&W business
combination and the Department of Justice case.
Loss on sale of assets of $24 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 $27 million for severance and related
benefits to be paid by RJR Tobacco to approximately 170
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 completed by mid-year 2007. With the termination
of the packaging employees, RJR Tobacco incurred a 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.
84
Amortization expense of $41 million and
$24 million were recorded during 2005 and 2004,
respectively, relating to intangibles acquired in the B&W
business combination and finite-lived trademarks. For additional
information, see note 1 to consolidated financial
statements.
Restructuring and asset impairment charge adjustments in
2005 resulted in net additional charges of $2 million
relating to the 2002 restructuring. Adjustments in 2004 resulted
in net additional charges of $38 million relating to the
2002 restructuring partially offset by net reversals of
$33 million relating to the 2003 restructuring. See
note 4 to consolidated financial statements for additional
information related to restructuring charges.
Goodwill and trademark impairment charges include
$198 million for trademark impairments in 2005 compared
with $199 million incurred during 2004. Also in 2005,
$2 million of goodwill impairment charges was incurred
relating to the excess of book value over fair value of assets
reclassified to
held-for-sale
concerning Lanes pipe manufacturing business. This
business was sold on January 26, 2006, for $4 million.
In connection with the annual impairment testing of goodwill and
indefinite-lived intangible assets in the fourth quarter of
2004, an impairment of $199 million occurred on certain of
RJR Tobaccos non-investment brands, reflecting RJR
Tobaccos decision in the fourth quarter of 2004, to
implement the brand strategies resulting from the B&W
business combination, and limit investment in these brands in an
effort to optimize profitability. In connection with the annual
impairment testing of goodwill and certain intangible assets in
the fourth quarter of 2005, an impairment of $198 million
occurred, reflecting modification to the previously anticipated
level of support among certain brands, and also from the
strategic plan projecting net sales of certain brands to decline
at a faster rate than was assumed in the prior-year strategic
plan. These impairment charges were based on the excess of
certain brands carrying values over their fair values,
determined with the assistance of an independent appraisal firm,
using the present value of estimated future cash flows assuming
a discount rate of 11.0% in each of 2005 and 2004. The discount
rate was determined by adjusting the RJR Tobacco enterprise
discount rate by an appropriate risk premium to reflect an asset
group risk. These impairment charges are reflected as decreases
in the carrying value of the trademarks in the consolidated
balance sheets, as goodwill and trademark impairment charges in
the consolidated income statements and had no impact on cash
flows.
Interest and debt expense was $113 million for the
year ended December 31, 2005, an increase of
$28 million from 2004. This increase is primarily due to
higher average debt balances, resulting from the June 2005
private offering, in addition to higher interest rates impacting
interest rate swaps.
Interest income was $85 million for the year ended
December 31, 2005, an increase of $55 million from
2004. This increase is primarily due to higher interest rates
and, to a lesser extent, higher average cash balances.
Other (income) expense, net was $15 million expense
in 2005 compared with $2 million income in 2004. The change
was primarily due to $7 million of net costs related to the
extinguishment of the 2006 notes and unfavorable foreign
exchange revaluation.
Provision for income taxes was a provision of
$431 million, or an effective rate of 30.4%, for the year
ended December 31, 2005, compared with a provision of
$202 million, or an effective rate of 24.4%, in 2004. The
2005 provision was impacted mainly by the resolution of certain
prior years tax matters that resulted in a reduction of
income tax expense of $78 million and $14 million
deduction as a result of the American Jobs Creation Act of 2004,
offset in part by state taxes and certain nondeductible items.
In the fourth quarter of 2005, RAI recorded an adjustment of
$13 million as a decrease in income tax expense and a
corresponding decrease in deferred tax liabilities. This
adjustment resulted from differences between the deferred tax
liabilities recorded in prior periods and the underlying
cumulative timing differences supporting them.
The 2004 provision was impacted by the resolution of certain
prior years tax matters of $126 million, offset in
part by state taxes and certain nondeductible items.
Discontinued operations reflect transactions related to
the 1999 sale of the international tobacco business to JTI.
During 2005 and 2004, these transactions included
$2 million and $12 million, respectively, of after-tax
reversals of indemnification accruals. Including these
adjustments, the net after-tax gain on the sale of the
international tobacco business was $2.5 billion.
85
Extraordinary items included a gain of $55 million
and $49 million in 2005 and 2004, respectively, related to
the 2000 acquisition of RJRs former parent, NGH, primarily
from settlement of tax matters. Including these adjustments, the
net after-tax gain on the acquisition was $1.7 billion.
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 RAI and 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
RAI and RJR that, when combined with RAIs and RJRs
cash balances, will enable RAI and RJR to make their required
debt-service payments, and enable RAI 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.
Contractual obligations as of December 31, 2006 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less than 1
|
|
|
1-3 Years
|
|
|
4-5 Years
|
|
|
|
|
|
|
Total
|
|
|
Year-2007
|
|
|
2008-2009
|
|
|
2010-2011
|
|
|
Thereafter
|
|
|
Long-term notes, exclusive of
interest(1)
|
|
$
|
3,191
|
|
|
$
|
329
|
|
|
$
|
199
|
|
|
$
|
299
|
|
|
$
|
2,364
|
|
RAI Credit Facilities(1)
|
|
|
1,542
|
|
|
|
15
|
|
|
|
31
|
|
|
|
31
|
|
|
|
1,465
|
|
Interest payments related to
long-term notes and RAI Credit Facilities(1)
|
|
|
2,125
|
|
|
|
331
|
|
|
|
618
|
|
|
|
580
|
|
|
|
596
|
|
Operating leases(2)
|
|
|
79
|
|
|
|
21
|
|
|
|
29
|
|
|
|
16
|
|
|
|
13
|
|
Non-qualified pension
obligations(3)
|
|
|
66
|
|
|
|
6
|
|
|
|
13
|
|
|
|
13
|
|
|
|
34
|
|
Postretirement benefit
obligations(3)
|
|
|
741
|
|
|
|
75
|
|
|
|
149
|
|
|
|
150
|
|
|
|
367
|
|
Qualified pension funding(3)
|
|
|
294
|
|
|
|
294
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase obligations(4)
|
|
|
1,897
|
|
|
|
379
|
|
|
|
505
|
|
|
|
336
|
|
|
|
677
|
|
Other noncurrent liabilities(5)
|
|
|
109
|
|
|
|
N/A
|
|
|
|
67
|
|
|
|
5
|
|
|
|
37
|
|
MSA and other state settlement
obligations(6)
|
|
|
14,040
|
|
|
|
2,600
|
|
|
|
5,660
|
|
|
|
5,780
|
|
|
|
|
|
Federal tobacco buyout
obligations(7)
|
|
|
2,125
|
|
|
|
265
|
|
|
|
535
|
|
|
|
555
|
|
|
|
770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash obligations
|
|
$
|
26,209
|
|
|
$
|
4,315
|
|
|
$
|
7,806
|
|
|
$
|
7,765
|
|
|
$
|
6,323
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
For more information about RAIs long-term notes and credit
facilities, see Debt below and
notes 11 and 12 to consolidated financial statements. |
|
(2) |
|
Operating lease obligations represent estimated lease payments
primarily related to office space, automobiles, warehouse space
and computer equipment. See note 20 to consolidated
financial statements for additional information. |
|
(3) |
|
For more information about RAIs pension plans and
postretirement benefits, see note 17 to consolidated
financial statements. Non-qualified pension and postretirement
benefit obligations captioned under Thereafter
include obligations during the next five years only. These
obligations are not reasonably estimable beyond ten years.
Qualified pension plan funding is based on Pension Benefit
Guaranty Corporation requirements, Pension Protection Act and
tax deductibility and is not reasonably estimable beyond one
year. |
86
|
|
|
(4) |
|
Purchase obligations include commitments to acquire tobacco
leaf, leaf processing, media services, capital expenditures and
software maintenance. The major component of the purchase
obligations, although not believed to be incremental to
previously anticipated leaf purchase needs, is the estimated
value of the commitment to purchase leaf as a part of the
settlement agreement reached in the DeLoach antitrust
case. See note 14 to consolidated financial statements for
additional information on the DeLoach case. |
|
(5) |
|
Other noncurrent liabilities include primarily restructuring and
bonus compensation. Certain other noncurrent liabilities are
excluded from the table above, including RJRs liabilities
recorded in 1999 related to certain indemnification claims, for
which timing of payments are not estimable. For more information
about RJRs indemnification obligations, see note 14
to consolidated financial statements. |
|
(6) |
|
MSA and other state settlement obligation amounts in the
aggregate beyond five years are not meaningful as these are
obligations into perpetuity. For more information about the MSA
and other state settlement, see note 14 to consolidated
financial statements. |
|
(7) |
|
For more information about the tobacco buyout legislation, see
Governmental Activity below and
note 14 to consolidated financial statements. |
Commitments as of December 31, 2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitment Expiration Period
|
|
|
|
|
|
|
Less than
|
|
|
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
Standby letters of credit backed
by revolving credit facility
|
|
$
|
25
|
|
|
$
|
24
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commitments
|
|
$
|
25
|
|
|
$
|
24
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
Flows
2006
Compared with 2005
Net cash flows from operating activities were $1.5 billion
in 2006, compared with $1.3 billion in 2005. This increase
is primarily due to an increase in net income of
$98 million, excluding non-cash charges and the receipt of
an IRS tax refund in 2006, partially offset by higher pension
funding and higher income taxes paid in 2006. Net cash flows for
2006 were also favorably impacted by the $178 million
classification of certain book overdrafts as accounts payable
compared with the 2005 classification in cash and cash
equivalents, resulting from changes in certain banking
relationships.
Net cash flows used in investing activities were
$3.5 billion in 2006, compared with $989 million in
2005. This change is primarily due to the acquisition of Conwood
for $3.5 billion, offset in part by lower net purchases of
short-term investments of $981 million.
Net cash flows from financing activities were $2.2 billion
in 2006, compared with net cash flows used in financing
activities of $450 million in 2005. This change is
primarily due to $3.2 billion in proceeds from RAIs
debt issuances to fund the Conwood acquisition and lower debt
repayment, offset in part by higher dividends paid per share of
common stock.
2005
Compared with 2004
Net cash flows from operating activities of $1.3 billion in
2005 increased $537 million from 2004. This change is
primarily due to higher net income, lower restructuring and
income tax payments, favorable related party movements and
favorable inventory movements due to lower leaf costs, changes
in leaf durations and lower finished goods. 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
$989 million in 2005 compared with net cash flows from
investing activities of $260 million in 2004. This change
is primarily due to the 2005 net purchases of short-term
investments of $898 million compared with the 2004 net
proceeds from the sales of short-term investments of
$188 million. Also, the 2005 net cash flows used in
investing activities include $45 million related to the
purchase of the U.S. duty-free and U.S. military
overseas businesses relating to certain brands from JTI compared
with
87
$204 million in net cash proceeds acquired in the B&W
business combination. For 2005, cash flows from investing
activities also includes $48 million related to the sale of
RJR Tobaccos packaging operations.
Net cash flows used in financing activities were
$450 million in 2005 compared with $467 million in
2004. This change is primarily due to the $499 million debt
issuance proceeds in June 2005 less $360 million for
repayments of long-term debt related to the tender offer for the
2006 notes. This decrease was offset in part by higher dividends
paid reflecting primarily the outstanding shares of common stock
issued in consideration of the business combination and, to a
lesser extent, the increased dividend rate in 2005.
Stock
Repurchases
RAI repurchases and cancels shares of its common stock forfeited
with respect to the tax liability associated with certain option
exercises and vesting of restricted stock grants under the RAI
Long-Term Incentive Plan. Accordingly, during 2006, RAI
repurchased and cancelled 207 shares of its common stock.
On February 6, 2007, the board of directors of RAI
authorized the repurchase by RAI of up to $75 million of
its outstanding shares of common stock to offset dilution from
restricted stock grants under employee incentive programs and
the exercise of previously granted options.
Dividends
On February 6, 2007, RAIs board of directors declared
a quarterly cash dividend of $0.75 per common share. The
dividend will be paid on April 2, 2007 to shareholders of
record as of March 15, 2007. On an annualized basis, the
dividend rate is $3.00 per common share. The current
dividend reflects RAIs 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 recorded capital
expenditures of $133 million, $110 million and
$92 million in 2006, 2005 and 2004, respectively. Of the
2006 amount, $116 million related to RJR Tobacco and
$4 million related to Conwood. RJR Tobacco plans to spend
$140 million to $150 million for capital expenditures
during 2007, and Conwood plans to spend $40 million to
$50 million. Conwoods increase in capital
expenditures in 2007 is primarily related to the expansion of
manufacturing facilities. Capital expenditures are funded
primarily by cash flows from operations. 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 December 31, 2006.
Debt
Credit
Facilities
On May 31, 2006, RAI entered into new $2.1 billion
senior, secured credit facilities, consisting of a six-year
$1.55 billion secured term loan and a five-year,
$550 million secured revolving credit facility, together
referred to as RAI Credit Facilities. The credit agreement
related to the RAI Credit Facilities is an amendment and
restatement of the agreement related to RJRs prior
revolving credit facility, which the RAI revolving credit
facility replaced. RAIs proceeds from the term loan were
used, together with the net proceeds of a private debt offering
and available cash, to finance the Conwood acquisition.
RAIs term loan requires quarterly, mandatory repayments of
approximately $4 million, which began on September 30,
2006. An additional mandatory repayment is due 110 days
after the last day of each year, commencing December 31,
2007, equal to excess cash flow as defined in the credit
agreement, including reductions for, among other things, capital
expenditures, cash dividends, debt principal payments and
pension funding.
RAI is able to use the RAI revolving credit facility for
borrowings and issuances of letters of credit, at its option.
Also, at the request of RAI and the discretion of the lenders,
RAI is able to increase the borrowing limit under the revolving
credit facility by $250 million. At December 31, 2006,
RAI had $25 million in letters of credit
88
outstanding under its revolving credit facility. No borrowings
were outstanding, and the remaining $525 million of the
revolving credit facility was available for borrowing.
Under the terms of the RAI Credit Facilities, RAI is not
required to maintain compensating balances; however, RAI is
required to pay a commitment fee ranging from 0.75% to
1.50% per annum on the unused portion of the revolving
credit facility. Borrowings under the RAI Credit Facilities bear
interest, at the option of RAI, at a rate equal to an applicable
margin plus: the reference rate, which is the higher of the
federal funds effective rate plus 0.5% and the prime rate; or
the Eurodollar rate, which is the rate at which Eurodollar
deposits for one, two, three or six months are offered in the
interbank Eurodollar market. The term loans applicable
margin is subject to adjustment based upon RAIs
consolidated leverage ratio. At December 31, 2006, RAI had
the following term loan amounts outstanding: $850 million
bearing interest at the November 30, 2006, six-month LIBOR
rate plus 1.750%; $650 million bearing interest at the
September 5, 2006, six-month LIBOR rate plus 1.750%; and
$42 million at the December 29, 2006, three-month
LIBOR rate plus 1.750%.
The RAI Credit Facilities have restrictive covenants that limit
RAIs and its subsidiaries ability to pay dividends
and repurchase stock, make investments, prepay certain
indebtedness, 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 revolving credit facility, RAIs cumulative dividends
generally may not exceed the sum of $625 million plus 75%
of cumulative adjusted net income (as defined in the credit
agreement).
RAIs material domestic subsidiaries, including RJR, RJR
Tobacco, Santa Fe, Lane, GPI and Conwood, guarantee RAIs
obligations under the RAI Credit Facilities. These guarantors
also have pledged substantially all of their assets to secure
these obligations, including indebtedness and other obligations
held by or owing to such guarantor of a subsidiary. RAI has
pledged substantially all of its assets, including the stock of
its direct subsidiaries to secure such obligations. RJR has
pledged its interest in RJR Tobacco common stock as collateral
for the RAI Credit Facilities. Under the terms of the RAI Credit
Facilities, the collateral will be released automatically in
certain circumstances, including at such time, if any, as the
term loan is paid in full and RAI obtains an investment grade
corporate credit rating by each of Moodys and S&P.
Long-term
Debt
On May 19, 2006, RAI commenced, in a private offering, an
offer to exchange up to $1.45 billion of RJRs
outstanding guaranteed, secured notes for like principal amounts
of new RAI guaranteed, secured notes. The offer was made to
certain institutional holders of the RJR notes. Each new series
of RAI notes has identical terms as the corresponding series of
RJR notes with respect to interest rates, redemption terms and
interest payment and maturity dates. In conjunction with the
exchange offer, consents were solicited from the RJR noteholders
to eliminate substantially all of the restrictive covenants and
to eliminate an event of default from the RJR indentures
governing the series of RJR notes subject to the exchange offer.
The requisite number of consents were received, and, as a
result, the remaining RJR notes are now unsecured.
At the closing of the exchange offer on June 20, 2006,
approximately 89% of the RJR notes were validly tendered for
exchange and were accepted by RAI. The tendered RJR notes were
cancelled. The $161 million aggregate principal amount of
RJR notes that are still outstanding under the amended RJR
indentures are now unsecured, but remain guaranteed by certain
of RJRs subsidiaries, including RJR Tobacco, and
RJRs parent, RAI. On September 30, 2006, GPI and RJR
Packaging, LLC were added as guarantors of RJRs long-term
unsecured notes. RJR also has $89 million of other non-bank
debt that is neither secured nor guaranteed.
On October 25, 2006, RAI filed a registration statement
with the SEC, which became effective November 7, 2006,
pursuant to which RAI offered to exchange the $161 million
of remaining RJR unsecured notes for RAI registered secured
notes. At the expiration of the exchange offer on
February 15, 2007, 29% of the RJR notes had been validly
tendered for exchange and were accepted by RAI.
On May 31, 2006, RAI completed a private offering of
$1.65 billion in aggregate principal amount of senior,
secured notes, consisting of $625 million of
7.25% senior secured notes due June 1, 2013,
$775 million of 7.625% senior secured notes due
June 1, 2016 and $250 million of 7.75% senior
secured notes due June 1, 2018.
89
RAIs net proceeds from the private offering, together with
the proceeds from the term loan and available cash, were used to
finance the Conwood acquisition.
On October 3, 2006, RAI filed a registration statement with
the SEC, which became effective November 7, 2006, pursuant
to which RAI offered to exchange $2.939 billion of RAI
privately placed secured notes for RAI registered secured notes.
The notes subject to such exchange offer represented the notes
that had been issued in the May 19 and May 31, 2006,
private offerings of RAI. This exchange offer was made in
satisfaction of RAIs obligations under registration rights
agreements that had been entered into in connection with
RAIs prior private offerings. At the expiration of the
exchange offer on December 8, 2006, 99% of the privately
placed secured notes had been validly tendered for exchange and
were accepted by RAI.
In conjunction with their obligations under the RAI Credit
Facilities, RAIs material domestic subsidiaries, including
RJR, RJR Tobacco, Santa Fe, Lane, GPI and Conwood,
guarantee RAIs long-term secured notes. RJR has pledged
its interest in RJR Tobacco common stock as collateral for
RAIs long-term secured notes. Also, RJR Tobaccos and
Conwoods material subsidiaries have pledged their
principal properties to secure these obligations. These assets
constitute a portion of the security for the obligations of RAI
and the guarantors under the RAI Credit Facilities. The
collateral securing RAIs long-term senior secured notes
will be released automatically in certain circumstances. If
these assets are no longer pledged as security for the
obligations of RAI and the guarantors under the RAI Credit
Facilities, or any other indebtedness of RAI, they will be
released automatically as security for RAIs senior secured
notes and the related guarantees. Generally, the terms of
RAIs guaranteed senior secured notes restrict the pledge
of collateral, sale/leaseback transactions and the transfer of
all or substantially all of the assets of certain of RAIs
subsidiaries.
On March 14, 2006, RJR filed a shelf registration statement
with the SEC, immediately effective upon filing, for an
indeterminate amount of debt securities. Pursuant to this shelf
registration statement, RJR may issue debt securities guaranteed
by its parent, RAI, and certain of RJRs subsidiaries,
including RJR Tobacco. As of the date of this filing, no debt
securities have been issued thereunder.
As of December 31, 2006, Moodys corporate credit
rating of RAI was Ba2, positive outlook, and S&Ps
rating was BB+, stable outlook. On February 12, 2007,
Moodys corporate credit rating of RAI was changed to Ba1,
positive outlook. Concerns about, or lowering of, RAIs
corporate ratings by S&P or Moodys could have an
adverse impact on RAIs ability to access the debt markets
and could increase borrowing costs. However, given the cash
balances and operating performance 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 December 31, 2006, long-term debt consisted of the
following:
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
RJR 8.5% 9.25%
unsecured notes, due 2007 to 2013
|
|
$
|
89
|
|
RJR 6.5% 7.875%
guaranteed, unsecured notes, due 2007 to 2015
|
|
|
163
|
|
|
|
|
|
|
Total RJR debt
|
|
|
252
|
|
RAI 6.5% 7.875%
guaranteed, secured notes, due 2007 to 2015(1)
|
|
|
1,298
|
|
RAI 7.25% 7.75%
guaranteed, secured notes, due 2013 to 2018(2)
|
|
|
1,641
|
|
RAI floating rate, guaranteed,
secured, term loan, due 2012
|
|
|
1,542
|
|
|
|
|
|
|
Total RAI debt
|
|
|
4,481
|
|
|
|
|
|
|
Total debt
|
|
|
4,733
|
|
Current maturities of long-term
debt
|
|
|
(344
|
)
|
|
|
|
|
|
|
|
$
|
4,389
|
|
|
|
|
|
|
|
|
|
(1) |
|
RAI debt arising from the RJR exchanged notes; see above for
additional information. |
|
(2) |
|
RAI newly issued long-term debt; see above for additional
information. |
90
At its option, RAI and RJR, as applicable, may redeem any or all
of their outstanding notes, in whole or in part at any time,
subject to the payment of a make-whole premium.
RAI and RJR use interest rate swaps to manage interest rate risk
on a portion of their debt obligations. Under certain
conditions, any fair value that results in a liability position
of the interest rate swaps may require full collateralization
with cash or securities.
RAI, RJR and their affiliates were in compliance with all
covenants and restrictions imposed by their indebtedness at
December 31, 2006.
Litigation
and Settlements
Various legal claims, including litigation claiming that 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,
Conwood and their affiliates, including RAI, or indemnitees. For
further discussion of the litigation and legal proceedings
pending against RAI or its affiliates or indemnitees, see
note 14 to consolidated financial statements.
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 or indemnitees, or
the loss of any particular claim concerning the use of smokeless
tobacco against Conwood, when viewed on an individual basis, is
not probable, the possibility of material losses related to
tobacco 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,
Conwood or their affiliates or indemnitees, 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. As described in note 14 to
consolidated financial statements, 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 state settlement agreements, see
Litigation Affecting the Cigarette
Industry Governmental Health-Care Cost Recovery
Cases MSA and Other State Settlement
Agreements in note 14 to consolidated financial
statements. 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 condition 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 value categories, RJR Tobaccos
share of the domestic premium and value cigarette categories,
and the effect of any resulting cost advantage of manufacturers
not subject to the MSA and other state settlement agreements.
The MSA includes an adjustment, referred to as an NPM
Adjustment, that potentially reduces RJR Tobaccos and
other participating manufacturers annual payment
obligations. Certain requirements must be satisfied before the
NPM Adjustment, which relates to a specified market year, is
available. In April 2006, RJR Tobacco placed $647 million
of its MSA payment into a disputed payments account, in
accordance with a procedure established by the MSA. That amount
represented RJR Tobaccos share of the 2003 NPM Adjustment
as calculated by an independent auditor designated under the MSA.
During 2006, proceedings were initiated and prosecuted with
respect to an NPM Adjustment for 2004. The independent auditor
determined that the participating manufacturers again suffered a
market share loss sufficient to trigger an NPM Adjustment for
2004. On April 17, 2006, RJR Tobacco and the other
cigarette manufacturers initiated the significant
factor proceedings called for under the MSA. On
February 12, 2007, the independent economic consulting firm
retained by the settling states and the cigarette manufacturers
issued a final, non-
91
appealable determination that the disadvantages of the MSA were
a significant factor contributing to the 2004 market
share loss. RJR Tobacco is evaluating what action to take in
light of this determination.
The settling states contend that RJR Tobacco and other
participating manufacturers are not entitled to the 2003 NPM
Adjustment. As of February 2, 2007, of the settling states,
37 had filed legal proceedings seeking orders compelling RJR
Tobacco and the other participating manufacturers that placed
money in the disputed payments account to pay such disputed
amounts to the settling states. RJR Tobacco intends to defend
these proceedings vigorously by, among other things, moving to
compel arbitration as provided in the MSA. As of
February 2, 2007, 35 courts had addressed whether disputes
concerning the 2003 NPM Adjustment are arbitrable, and 34 had
ruled that arbitration is required under the MSA. See
note 14 to consolidated financial statements for additional
information regarding these proceedings.
Governmental
Activity
The marketing, sale, taxation and use of tobacco products 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:
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significantly increase their taxes on tobacco products;
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restrict displays, advertising and sampling of tobacco products;
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establish ignition propensity standards for cigarettes;
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raise the minimum age to possess or purchase tobacco products;
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restrict or ban the use of certain flavorings in tobacco
products;
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require the disclosure of ingredients used in the manufacture of
tobacco products;
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require the disclosure of nicotine yield information for
cigarettes based on a machine test method different from that
required by the U.S. Federal Trade Commission;
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impose restrictions on smoking in public and private
areas; and
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restrict the sale of tobacco products directly to consumers or
other unlicensed recipients, including over the Internet.
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In addition, during 2007, the U.S. Congress will consider
regulation of the manufacture and sale of tobacco products by
the FDA, and also may consider legislation regarding:
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further increases in the federal excise tax on cigarettes and
other tobacco products;
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regulation of environmental tobacco smoke;
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additional warnings on tobacco packaging and advertising;
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reduction or elimination of the tax deductibility of advertising
expenses;
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implementation of a national standard for fire-safe
cigarettes;
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regulation of the retail sale of tobacco products over the
Internet and in other
non-face-to-face
retail transactions, such as by mail order and
telephone; and
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banning of the delivery of tobacco products by the
U.S. Postal Service.
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In February 2007, proposed legislation was introduced in the
U.S. House of Representatives and the U.S. Senate that
would give the FDA broad regulatory authority over tobacco
products. The proposals would grant the FDA authority to impose
product standards (including standards relating to, among other
things, nicotine yields and smoke constituents) and would
reinstate the FDAs 1996 proposed legislation that would
have restricted marketing. The proposed legislation also would
govern modified risk products and would impose new and larger
warning labels on tobacco products.
92
Together with manufacturers price increases in recent
years and substantial increases in state and federal taxes on
tobacco products, these developments have had and will likely
continue to have an adverse effect on the sale of tobacco
products.
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 $2.575 per pack in New Jersey. On
December 31, 2006, the weighted average state cigarette
excise tax per pack, calculated on a
12-month
rolling average basis, was approximately $0.799. Four states
passed excise tax per pack increases in 2006: Texas ($0.41 to
$1.41, effective January 1, 2007); New Jersey ($2.40 to
$2.575, effective July 15, 2006); Vermont ($1.19 to $1.79
on July 1, 2006, and $1.79 to $1.99 on July 1, 2008);
and Hawaii ($1.40 to $2.60 over six years, in six annual
increments of $0.20, commencing October 1, 2006).
Additionally, 2006 ballot initiatives to increase the cigarette
excise tax in Arizona by $0.82 per pack and in South Dakota
by $1.00 per pack were approved. Certain city and county
governments, such as New York and Chicago, also impose
substantial excise taxes on cigarettes sold in those
jurisdictions.
A federal excise tax was first imposed on smokeless tobacco
products in 1986 and currently is $0.195 per pound for
chewing tobacco, and $0.585 per pound for snuff. The
federal tax on small cigars, defined as those weighing three
pounds or less per thousand, is $1.828 per thousand. Large
cigars are taxed at a rate of 20.719% of the manufacturers
price, with a cap of $48.75 per thousand.
Forty-nine states also subject smokeless tobacco to excise
taxes. As of December 31, 2006, 40 states taxed
smokeless tobacco on an ad valorem basis at rates that range
from 3% in North Carolina to 90% in Massachusetts. California,
which adjusts its rate annually in an effort to equalize
smokeless tobacco and cigarette taxes, currently imposes a rate
of 46.76%. In 2006, Texas passed legislation that raises its ad
valorem excise tax rate to 40% effective January 1, 2007.
Alabama, Arizona, Connecticut, Montana and North Dakota tax
moist snuff (and in Alabama, Arizona and North Dakota chewing
tobacco as well) on the bases of weight at rates ranging from
$0.01 for snuff units weighing less than 5/8 of an ounce in
Alabama to $0.85 per ounce of snuff in Montana, and $0.015
per ounce for chewing tobacco in Alabama to $0.16 per ounce
in North Dakota. Kentucky has a unit tax of $0.095 per unit
on moist snuff. Three states changed the method of taxing moist
snuff from an ad valorem basis to a weight-based tax during
2006: Vermont ($1.49 per ounce), Rhode Island
($1.00 per ounce) and New Jersey ($0.75 per ounce).
Cigars are generally taxed on an ad valorem basis, ranging from
3% in North Carolina to 75% in Alaska and Washington. Alabama,
Arizona, Oklahoma and Texas have unit-based tax schemes for
cigars, while California, Connecticut, Florida, Iowa, Tennessee
and Vermont tax little cigars the same as cigarettes. The
Commonwealth of Pennsylvania levies no tax on other tobacco
products.
On October 25, 2006, the Alcohol and Tobacco Tax and Trade
Bureau of the U.S. Department of Treasury, referred to as
the TTB, issued a Notice of Proposed Rulemaking, proposing
changes to the regulations that govern the classification and
labeling of cigars and cigarettes for federal excise tax
purposes. The proposed regulatory changes address concerns
regarding the adequacy of current regulatory standards for
distinguishing between cigars and cigarettes, with particular
reference to the distinction between little cigars and
cigarettes. The distinction between cigars and cigarettes is
important for federal tax purposes because the rate of tax
varies from one product class to another. For example, the rate
of tax on little cigars (weighing not more than three pounds per
thousand) is $1.828 per thousand, compared to the rate of
tax on cigarettes (weighing not more than three pounds per
thousand) which is $19.50 per thousand.
It is estimated that at least three-fourths of all recognized
and established little cigar brands in the United States would
be re-classified as cigarettes under criteria
established under the proposed regulations. Although the CAPTAIN
BLACK and WINCHESTER little cigar brands manufactured by Lane
have been classified and sold as little cigars for
more than 16 years and 35 years, respectively, both
brands would be re-classified as cigarettes under
these proposed regulations. Although it is not possible to fully
assess and quantify the negative impact of the proposed
regulations on the little cigar products of Lane, the immediate
impact would be to increase the federal excise tax on such
products by more than tenfold. The deadline for submitting
written comments to TTB regarding the proposed regulations is
March 26, 2007.
In 1964, the Report of the Advisory Committee to the Surgeon
General of the U.S. Public Health Service concluded that
cigarette smoking was a health hazard of sufficient importance
to warrant appropriate remedial
93
action. Since 1966, federal law has required a warning statement
on cigarette packaging. Since 1971, television and radio
advertising of cigarettes has been prohibited in the United
States. Cigarette advertising in other media in the United
States is required to include information with respect to the
tar and nicotine yield of cigarettes, as well as a
warning statement.
During the past four decades, various laws affecting the
cigarette industry have been enacted. In 1964, Congress enacted
the Comprehensive Smoking Education Act. Among other things,
this act:
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establishes an interagency committee on smoking and health that
is charged with carrying out a program to inform the public of
any dangers to human health presented by cigarette smoking;
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requires a series of four health warnings to be printed on
cigarette packages and advertising on a rotating basis;
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increases type size and area of the warning required in
cigarette advertisements; and
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requires that cigarette manufacturers provide annually, on a
confidential basis, a list of ingredients added to tobacco in
the manufacture of cigarettes to the Secretary of Health and
Human Services.
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The warnings currently required on cigarette packages and
advertisements are:
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SURGEON GENERALS WARNING: Smoking Causes Lung
Cancer, Heart Disease, Emphysema, And May Complicate
Pregnancy;
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SURGEON GENERALS WARNING: Quitting Smoking Now
Greatly Reduces Serious Risks to Your Health;
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SURGEON GENERALS WARNING: Smoking By Pregnant Women
May Result in Fetal Injury, Premature Birth, And Low Birth
Weight; and
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SURGEON GENERALS WARNING: Cigarette Smoke Contains
Carbon Monoxide.
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Since the initial report in 1964, the Secretary of Health,
Education and Welfare (now the Secretary of Health and Human
Services) and the Surgeon General have issued a number of other
reports which purport to find the nicotine in cigarettes
addictive and to link cigarette smoking and exposure to
cigarette smoke with certain health hazards, including various
types of cancer, coronary heart disease and chronic obstructive
lung disease. These reports have recommended various
governmental measures to reduce the incidence of smoking. In
1992, the federal Alcohol, Drug Abuse and Mental Health Act was
signed into law. This act required states to adopt a minimum age
of 18 for purchase of tobacco products and to establish a system
to monitor, report and reduce the illegal sale of tobacco
products to minors in order to continue receiving federal
funding for mental health and drug abuse programs. In January
1996, the U.S. Department of Health and Human Services
announced regulations implementing this legislation. And in June
2006, the Surgeon General released a report entitled The
Health Consequences of Involuntary Exposure to Tobacco
Smoke. Among its conclusions, the report found the
following: exposure of adults to secondhand smoke causes
coronary heart disease and lung cancer, exposure of children to
secondhand smoke results in an increased risk of sudden infant
death syndrome, acute respiratory infections, ear problems and
more severe asthma; and that there is no risk-free level of
exposure to secondhand smoke.
In 1986, Congress enacted the Comprehensive Smokeless Tobacco
Health Education Act of 1986, which, among other things,
required health warning notices on smokeless tobacco packages
and advertising and prohibited the advertising of smokeless
tobacco products on any medium of electronic communications
subject to the jurisdiction of the Federal Communications
Commission. The warnings currently required on smokeless tobacco
packages and advertising, which appear on a rotating basis, are:
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WARNING: THIS PRODUCT MAY CAUSE MOUTH CANCER;
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WARNING: THIS PRODUCT MAY CAUSE GUM DISEASE AND TOOTH
LOSS; and
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WARNING: THIS PRODUCT IS NOT A SAFE ALTERNATIVE TO
CIGARETTES.
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94
In June 2000, the seven largest U.S. cigar companies,
including Lane, entered into agreements with the
U.S. Federal Trade Commission to clearly and conspicuously
display on virtually every cigar package and advertisement one
of the following warnings, which appear on a rotating basis:
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SURGEON GENERAL WARNING: Cigar Smoking Can Cause
Cancers Of The Mouth And Throat, Even If You Do Not Inhale;
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SURGEON GENERAL WARNING: Cigar Smoking Can Cause
Lung Cancer And Heart Disease;
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SURGEON GENERAL WARNING: Tobacco Use Increases The
Risk Of Infertility, Stillbirth And Low Birth Weight;
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SURGEON GENERAL WARNING: Cigars Are Not A Safe
Alternative To Cigarettes; and
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SURGEON GENERAL WARNING: Tobacco Smoke Increases
The Risk Of Lung Cancer And Heart Disease, Even In
Nonsmokers.
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Legislation imposing various restrictions on public smoking also
has been enacted in 49 states and many local jurisdictions,
and many employers have initiated programs restricting or
eliminating smoking in the workplace. A number of states have
enacted legislation designating a portion of increased cigarette
excise taxes to fund either anti-smoking programs, health-care
programs or cancer research. In addition, educational and
research programs addressing health-care issues related to
smoking are being funded from industry payments made or to be
made under settlements with state attorneys general. Federal law
prohibits smoking in scheduled passenger aircraft, and the
U.S. Interstate Commerce Commission has banned smoking on
buses transporting passengers interstate. Certain common
carriers have imposed additional restrictions on passenger
smoking.
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. On January 26, 2006, the Air Resources Board
identified environmental tobacco smoke as a Toxic Air
Contaminant, following a three-year administrative process. The
Air Resources Board is now 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.
On December 31, 2003, the New York Office of Fire
Prevention and Control 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, California and Vermont, and in 2006, Illinois,
Massachusetts and New Hampshire, each enacted fire-safe
legislation of its own, adopting the same testing standard set
forth in the OFPC regulations described above. This requirement
took effect in Vermont on May 1, 2006, and will take effect
in California on January 1, 2007, in New Hampshire on
October 1, 2007, and in Illinois and Massachusetts on
January 1, 2008. 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.
On August 29, 2006, The Massachusetts Department of Public
Health released a report entitled, Change in Nicotine
Yields
1998-2004,
based on data submitted by RJR Tobacco as well as other
cigarette manufacturers pursuant to Massachusetts law. Under
this law, cigarette manufactures are required to provide
nicotine yield data generated under a machine test method
different from that required by the FTC for all styles of a
cigarette brand family that has a national market share of 3% or
more as well as other brand styles selected by the MDPH. Other
than Texas in 2000, no other state has passed similar
regulations. However, Massachusetts recent report has
generated interest from at least one other state for this type
of information.
A price differential exists between cigarettes manufactured for
sale abroad and cigarettes manufactured for U.S. sale.
Consequently, a domestic gray market has developed in cigarettes
manufactured for sale abroad, but instead diverted for domestic
sales that compete with cigarettes that RJR Tobacco manufactures
for domestic sale. The U.S. federal government and all
states, except Massachusetts, have enacted legislation
prohibiting the sale and distribution of gray market cigarettes.
In addition, RJR Tobacco has taken legal action against certain
distributors and retailers who engage in such practices.
95
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
U.S. District Court for the Southern District of New York
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-five states by statute or court rule have limited, and
several additional states are considering 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 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. In February 2006, the
first session of the Conference of the Parties, referred to as
the COP, occurred in Geneva, Switzerland. The COP, among other
actions taken, established a permanent secretariat, adopted a
budget, and created working groups to begin to develop protocols
on cross-border advertising and illegal trade and guidelines on
establishing smoke-free places and regulating tobacco products.
Although the U.S. delegate to the World Health Organization
voted for the treaty in 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. Similarly, it is not possible to determine
what additional federal, state or local legislation or
regulations relating to smokeless tobacco products will be
enacted or to predict the effect of new regulation on Conwood or
smokeless tobacco products in general, but any new legislation
or regulations could have an adverse effect on Conwood or
smokeless tobacco products in general.
Tobacco
Buyout Legislation
On October 22, 2004, the President signed the Fair and
Equitable Tobacco Reform Act of 2004, referred to as FETRA,
eliminating the U.S. governments tobacco production
controls and price support program. The buyout of
96
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
$9.9 billion, including approximately $9.6 billion
payable to quota tobacco holders and growers through industry
assessments over ten years and approximately $290 million
for the liquidation of quota tobacco stock. As a result of the
tobacco buyout legislation, the MSA Phase II obligations
established in 1999 will be continued as scheduled through the
end of 2010, 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 $230 million
to $280 million. RAIs operating subsidiaries incurred
$81 million in 2005 related to assessments from quota
tobacco stock liquidation. In the first quarter of 2006, a
$9 million favorable adjustment was recorded relating to
the tobacco stock liquidation assessment. Remaining contingent
liabilities for liquidation of quota tobacco stock, if any, will
be recorded when an assessment is made. See note 1 to
consolidated financial statements for additional information
related to federal tobacco buyout expenses.
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. In addition, future market
pricing could impact the carrying value of inventory, and
adversely affect RJR Tobaccos financial condition and
results of operations.
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 with third parties under the
Comprehensive Environmental Response, Compensation and Liability
Act 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 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.
Other
Contingencies and Guarantees
For information relating to other contingencies and guarantees
of RAI, RJR and RJR Tobacco, see Other
Contingencies and Guarantees in note 14 to
consolidated financial statements.
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
tobacco products;
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various legal actions, proceedings and claims relating to the
sale, distribution, manufacture, development, advertising,
marketing and claimed health effects of tobacco products 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 the MSA and other
state settlement agreements;
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the continuing decline in volume in the domestic cigarette
industry;
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concentration of a material amount of sales with a single
customer or distributor;
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competition from other manufacturers, including any new entrants
in the marketplace;
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increased promotional activities by competitors, including
deep-discount cigarette 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, marketing strategies and promotional programs;
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the failure to realize the anticipated benefits arising from the
Conwood acquisition;
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the ability to achieve efficiencies in manufacturing and
distribution operations without negatively affecting sales;
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the cost 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;
|
|
|
|
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;
|
|
|
|
the rating of RAIs securities;
|
|
|
|
any restrictive covenants imposed under RAIs debt
agreements;
|
|
|
|
the possibility of fire, violent weather and other disasters
that may adversely affect manufacturing and other facilities;
|
|
|
|
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
|
|
|
|
the potential existence of significant deficiencies or material
weaknesses in internal control 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.
|
|
Item 7A.
|
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, British Pounds and Swiss Francs. RAI and
its subsidiaries have established policies and procedures to
manage their exposure to market risks and use major creditworthy
institutions as counterparties to minimize their investment and
credit risk. Frequently, these institutions are also
98
members of the bank group that provide RAI credit and management
believes this further minimizes the risk of nonperformance.
Derivative financial instruments are not used for trading or
speculative purposes.
The table below provides information about RAIs financial
instruments, as of December 31, 2006, that are sensitive to
changes in interest rates. The table presents notional amounts
and weighted average interest rates by contractual maturity
dates for the years ending December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
|
|
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
Thereafter
|
|
|
Total
|
|
|
Value(1)
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Rate
|
|
$
|
405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
405
|
|
|
$
|
405
|
|
Average Interest Rate
|
|
|
5.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.5
|
%
|
|
|
|
|
Variable Rate
|
|
$
|
2,321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,321
|
|
|
$
|
2,321
|
|
Average Interest Rate
|
|
|
5.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.3
|
%
|
|
|
|
|
Debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Rate
|
|
$
|
329
|
|
|
|
|
|
|
$
|
200
|
|
|
$
|
300
|
|
|
|
|
|
|
$
|
2,360
|
|
|
$
|
3,189
|
|
|
$
|
3,319
|
|
Average Interest Rate(2)
|
|
|
6.7
|
%
|
|
|
|
|
|
|
7.9
|
%
|
|
|
6.5
|
%
|
|
|
|
|
|
|
7.5
|
%
|
|
|
7.3
|
%
|
|
|
|
|
Variable Rate
|
|
$
|
15
|
|
|
$
|
15
|
|
|
$
|
15
|
|
|
$
|
15
|
|
|
$
|
15
|
|
|
$
|
1,467
|
|
|
$
|
1,542
|
|
|
$
|
1,554
|
|
Average Interest Rate(2)
|
|
|
6.9
|
%
|
|
|
6.8
|
%
|
|
|
6.8
|
%
|
|
|
6.9
|
%
|
|
|
6.9
|
%
|
|
|
7.0
|
%
|
|
|
7.0
|
%
|
|
|
|
|
Swaps:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount(3)
|
|
$
|
300
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
450
|
|
|
$
|
750
|
|
|
$
|
15
|
|
Average Variable Interest Pay
Rate(2)
|
|
|
6.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.6
|
%
|
|
|
6.6
|
%
|
|
|
|
|
Average Fixed Interest Receive
Rate(2)
|
|
|
6.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7.3
|
%
|
|
|
7.0
|
%
|
|
|
|
|
|
|
|
(1) |
|
Fair values are based on current market rates available or on
rates available for instruments with similar terms and
maturities and quoted market values. |
|
(2) |
|
Based upon contractual interest rates for fixed rate
indebtedness or current market rates for LIBOR plus negotiated
spreads for variable rate indebtedness. |
|
(3) |
|
RAI has swapped $750 million of fixed rate debt to variable
rate debt. |
RAIs exposure to foreign currency transactions was not
material to results of operations for the year ended
December 31, 2006, but may be in future periods in relation
to activity associated with RAIs international operations.
RAI currently has no hedges for its exposure to foreign
currency. See Liquidity and Financial
Condition in Item 7 for additional information.
99
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
Report of
Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Reynolds American Inc.:
We have audited the accompanying consolidated balance sheets of
Reynolds American Inc. and subsidiaries as of December 31,
2006 and 2005, and the related consolidated statements of
income, shareholders equity and comprehensive income, and
cash flows for each of the years in the three-year period ended
December 31, 2006. These consolidated financial statements
are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Reynolds American Inc. and subsidiaries as of
December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the years in the
three-year period ended December 31, 2006, in conformity
with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial
statements, effective January 1, 2006, Reynolds American
Inc. and subsidiaries adopted the provisions of Statement of
Financial Accounting Standards No. 123(R),
Share-Based Payment, and effective December 31,
2006, Reynolds American Inc. and subsidiaries adopted the
provisions of Statement of Financial Accounting Standards
No. 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plans.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Reynolds American Inc.s internal control
over financial reporting as of December 31, 2006, based on
the criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report
dated February 27, 2007, expressed an unqualified opinion
on managements assessment of, and the effective operation
of, internal control over financial reporting.
/s/ KPMG LLP
Greensboro, North Carolina
February 27, 2007
100
Managements
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term
is defined in
Rule 13a-15(f)
of the Securities Exchange Act of 1934. Internal control over
financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements in accordance with
generally accepted accounting principles and includes those
policies and procedures that:
(i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of RAI,
(ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of RAI are being
made only in accordance with authorizations of management and
directors of RAI, and
(iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or
disposition of RAIs assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements and
even when determined to be effective, can only provide
reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any
evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies
and procedures may deteriorate.
Management conducted an evaluation of the effectiveness of
RAIs internal control over financial reporting based on
the framework in Internal Control Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this
evaluation, management concluded that RAIs system of
internal control over financial reporting was effective as of
December 31, 2006. Internal control over financial
reporting related to the net assets and operations of the
Conwood companies acquired by RAI on May 31, 2006, were
excluded from the assessment of the effectiveness of RAIs
internal control over financial reporting as of
December 31, 2006. These operations reported
$4.3 billion of total assets and $291 million in net
sales as of and for the seven months ended December 31,
2006, which are included in RAIs consolidated financial
statements.
KPMG LLP, RAIs independent registered public accounting
firm, has issued an attestation report on managements
assessment of the effectiveness of RAIs internal control
over financial reporting. Such report is included in
Item 8 Financial Statements and Supplementary
Data.
Dated: February 27, 2007
101
Report of
Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Reynolds American Inc.:
We have audited managements assessment, included in the
accompanying Managements Report on Internal Control over
Financial Reporting, that Reynolds American Inc. maintained
effective internal control over financial reporting as of
December 31, 2006, based on criteria established in
Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Reynolds American Inc.s management is responsible
for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is
to express an opinion on managements assessment and an
opinion on the effectiveness of the Companys internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Reynolds
American Inc. maintained effective internal control over
financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on criteria established
in Internal Control Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Also, in our opinion, Reynolds American Inc.
maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2006, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO).
Internal control over financial reporting related to the net
assets and operations of the Conwood companies acquired by
Reynolds American Inc. on May 31, 2006, were excluded from
the assessment of the effectiveness of Reynolds American
Inc.s internal control over financial reporting as of
December 31, 2006. These operations reported
$4.3 billion of total assets and $291 million in net
sales as of and for the seven months ended December 31,
2006, which are included in Reynolds American Inc.s
consolidated financial statements. Our audit of internal control
over financial reporting of Reynolds American Inc. also excluded
an evaluation of the internal control over financial reporting
of the Conwood companies.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Reynolds American Inc. and
subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of income, shareholders
equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2006, and
our report dated February 27, 2007 expressed an unqualified
opinion on those consolidated financial statements.
/s/ KPMG LLP
Greensboro, North Carolina
February 27, 2007
102
REYNOLDS
AMERICAN INC.
CONSOLIDATED
STATEMENTS OF INCOME
(Dollars
in Millions, Except Per Share Amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net sales(1)
|
|
$
|
8,010
|
|
|
$
|
7,779
|
|
|
$
|
6,196
|
|
Net sales, related party
|
|
|
500
|
|
|
|
477
|
|
|
|
241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,510
|
|
|
|
8,256
|
|
|
|
6,437
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold(1),(2)
|
|
|
4,803
|
|
|
|
4,919
|
|
|
|
3,872
|
|
Selling, general and
administrative expenses
|
|
|
1,658
|
|
|
|
1,611
|
|
|
|
1,455
|
|
Loss on sale of assets
|
|
|
|
|
|
|
24
|
|
|
|
|
|
Amortization expense
|
|
|
28
|
|
|
|
41
|
|
|
|
24
|
|
Restructuring and asset impairment
charges
|
|
|
1
|
|
|
|
2
|
|
|
|
5
|
|
Goodwill and trademark impairment
charges
|
|
|
90
|
|
|
|
200
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
1,930
|
|
|
|
1,459
|
|
|
|
882
|
|
Interest and debt expense
|
|
|
270
|
|
|
|
113
|
|
|
|
85
|
|
Interest income
|
|
|
(136
|
)
|
|
|
(85
|
)
|
|
|
(30
|
)
|
Other (income) expense, net
|
|
|
(13
|
)
|
|
|
15
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations before income taxes
|
|
|
1,809
|
|
|
|
1,416
|
|
|
|
829
|
|
Provision for income taxes
|
|
|
673
|
|
|
|
431
|
|
|
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
|
1,136
|
|
|
|
985
|
|
|
|
627
|
|
Discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on sale of discontinued
businesses, net of income taxes (2005 $1;
2004 $6)
|
|
|
|
|
|
|
2
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
1,136
|
|
|
|
987
|
|
|
|
639
|
|
Extraordinary item
gain on acquisition
|
|
|
74
|
|
|
|
55
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,210
|
|
|
$
|
1,042
|
|
|
$
|
688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income per
share(3):
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
3.85
|
|
|
$
|
3.34
|
|
|
$
|
2.83
|
|
Gain on sale of discontinued
businesses
|
|
|
|
|
|
|
0.01
|
|
|
|
0.06
|
|
Extraordinary item
|
|
|
0.25
|
|
|
|
0.18
|
|
|
|
0.22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
4.10
|
|
|
$
|
3.53
|
|
|
$
|
3.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted income per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
3.85
|
|
|
$
|
3.34
|
|
|
$
|
2.81
|
|
Gain on sale of discontinued
businesses
|
|
|
|
|
|
|
0.01
|
|
|
|
0.06
|
|
Extraordinary item
|
|
|
0.25
|
|
|
|
0.18
|
|
|
|
0.22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
4.10
|
|
|
$
|
3.53
|
|
|
$
|
3.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends declared per
share
|
|
$
|
2.75
|
|
|
$
|
2.10
|
|
|
$
|
1.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Excludes excise taxes of $2,124 million,
$2,175 million and $1,850 million during 2006, 2005
and 2004, respectively. |
|
(2) |
|
See Master Settlement Agreement and Federal Tobacco Buyout
Expenses in note 1. |
|
(3) |
|
All per share amounts have been retroactively adjusted to
reflect the August 14, 2006,
two-for-one
stock split. See note 1 for additional information. |
See Notes to Consolidated Financial Statements
103
REYNOLDS
AMERICAN INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Dollars
in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Cash flows from (used in)
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,210
|
|
|
$
|
1,042
|
|
|
$
|
688
|
|
Less income from discontinued
operations
|
|
|
|
|
|
|
(2
|
)
|
|
|
(12
|
)
|
Adjustments to reconcile to net
cash flows from (used in) continuing operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
162
|
|
|
|
195
|
|
|
|
153
|
|
Restructuring and asset impairment
charges, net of cash payments
|
|
|
(14
|
)
|
|
|
(62
|
)
|
|
|
(151
|
)
|
Acquisition restructuring charges,
net of cash payments
|
|
|
(81
|
)
|
|
|
(59
|
)
|
|
|
(86
|
)
|
Goodwill and trademark impairment
charges
|
|
|
90
|
|
|
|
200
|
|
|
|
199
|
|
Deferred income tax expense
(benefit)
|
|
|
105
|
|
|
|
32
|
|
|
|
(142
|
)
|
Extraordinary item
|
|
|
(74
|
)
|
|
|
(55
|
)
|
|
|
(49
|
)
|
Other changes, net of acquisition
effects, that provided (used) cash:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
151
|
|
|
|
(101
|
)
|
|
|
2
|
|
Inventories
|
|
|
58
|
|
|
|
200
|
|
|
|
(61
|
)
|
Related party, net
|
|
|
(24
|
)
|
|
|
113
|
|
|
|
(74
|
)
|
Accounts payable
|
|
|
226
|
|
|
|
(25
|
)
|
|
|
(4
|
)
|
Accrued liabilities including
income taxes and other working capital
|
|
|
(124
|
)
|
|
|
59
|
|
|
|
86
|
|
Litigation bonds
|
|
|
24
|
|
|
|
16
|
|
|
|
10
|
|
Tobacco settlement and related
expenses
|
|
|
(20
|
)
|
|
|
(131
|
)
|
|
|
137
|
|
Pension and postretirement
|
|
|
(265
|
)
|
|
|
(211
|
)
|
|
|
(56
|
)
|
Other, net
|
|
|
33
|
|
|
|
62
|
|
|
|
96
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from operating
activities
|
|
|
1,457
|
|
|
|
1,273
|
|
|
|
736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
(7,677
|
)
|
|
|
(10,883
|
)
|
|
|
(4,569
|
)
|
Proceeds from sale of short-term
investments
|
|
|
7,760
|
|
|
|
9,985
|
|
|
|
4,757
|
|
Purchases of long-term investments
|
|
|
|
|
|
|
(5
|
)
|
|
|
(10
|
)
|
Proceeds from sale of long-term
investments
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Capital expenditures
|
|
|
(136
|
)
|
|
|
(105
|
)
|
|
|
(92
|
)
|
Distributions from equity investees
|
|
|
18
|
|
|
|
12
|
|
|
|
5
|
|
Acquisitions, net of cash acquired
|
|
|
(3,519
|
)
|
|
|
(45
|
)
|
|
|
165
|
|
Net proceeds from the sale of
businesses
|
|
|
3
|
|
|
|
48
|
|
|
|
|
|
Net proceeds from the sale of fixed
assets
|
|
|
24
|
|
|
|
4
|
|
|
|
3
|
|
Other
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows (used in) from
investing activities
|
|
|
(3,531
|
)
|
|
|
(989
|
)
|
|
|
260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock
|
|
|
(775
|
)
|
|
|
(575
|
)
|
|
|
(383
|
)
|
Proceeds from exercise of stock
options
|
|
|
4
|
|
|
|
3
|
|
|
|
43
|
|
Excess tax benefit from stock-based
compensation
|
|
|
4
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock
|
|
|
|
|
|
|
(3
|
)
|
|
|
(71
|
)
|
Repayments of long-term debt
|
|
|
(190
|
)
|
|
|
(360
|
)
|
|
|
(56
|
)
|
Repayments of term loan credit
facility
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
Proceeds from issuance of long-term
debt
|
|
|
1,641
|
|
|
|
499
|
|
|
|
|
|
Principal borrowings under term
loan credit facility
|
|
|
1,550
|
|
|
|
|
|
|
|
|
|
Deferred debt issuance costs
|
|
|
(52
|
)
|
|
|
(7
|
)
|
|
|
|
|
Debt retirement costs
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
financing activities
|
|
|
2,174
|
|
|
|
(450
|
)
|
|
|
(467
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
100
|
|
|
|
(166
|
)
|
|
|
529
|
|
Cash and cash equivalents at
beginning of year
|
|
|
1,333
|
|
|
|
1,499
|
|
|
|
970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
1,433
|
|
|
$
|
1,333
|
|
|
$
|
1,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes paid, net of refunds
|
|
$
|
573
|
|
|
$
|
306
|
|
|
$
|
360
|
|
Interest paid
|
|
$
|
238
|
|
|
$
|
92
|
|
|
$
|
74
|
|
See Notes to Consolidated Financial Statements
104
REYNOLDS
AMERICAN INC.
CONSOLIDATED
BALANCE SHEETS
(Dollars
in Millions)
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Assets
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,433
|
|
|
$
|
1,333
|
|
Short-term investments
|
|
|
1,293
|
|
|
|
1,373
|
|
Accounts receivable, net of
allowance (2006 $4; 2005 $7)
|
|
|
100
|
|
|
|
99
|
|
Accounts receivable, related party
|
|
|
62
|
|
|
|
67
|
|
Income tax receivable
|
|
|
7
|
|
|
|
159
|
|
Inventories
|
|
|
1,155
|
|
|
|
1,066
|
|
Deferred income taxes, net
|
|
|
793
|
|
|
|
865
|
|
Prepaid expenses
|
|
|
92
|
|
|
|
98
|
|
Assets held for sale
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
4,935
|
|
|
|
5,065
|
|
Property, plant and equipment, at
cost:
|
|
|
|
|
|
|
|
|
Land and land improvements
|
|
|
97
|
|
|
|
100
|
|
Buildings and leasehold
improvements
|
|
|
675
|
|
|
|
677
|
|
Machinery and equipment
|
|
|
1,689
|
|
|
|
1,649
|
|
Construction-in-process
|
|
|
50
|
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
Total property, plant and equipment
|
|
|
2,511
|
|
|
|
2,479
|
|
Less accumulated depreciation
|
|
|
1,449
|
|
|
|
1,426
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net
|
|
|
1,062
|
|
|
|
1,053
|
|
Trademarks, net of accumulated
amortization (2006 $517; 2005 $504)
|
|
|
3,479
|
|
|
|
2,188
|
|
Goodwill
|
|
|
8,175
|
|
|
|
5,672
|
|
Other intangibles, net of
accumulated amortization (2006 $57; 2005
$42)
|
|
|
215
|
|
|
|
226
|
|
Other assets and deferred charges
|
|
|
312
|
|
|
|
315
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
18,178
|
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
shareholders equity
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
275
|
|
|
$
|
45
|
|
Tobacco settlement and related
accruals
|
|
|
2,237
|
|
|
|
2,254
|
|
Due to related party
|
|
|
9
|
|
|
|
31
|
|
Deferred revenue, related party
|
|
|
62
|
|
|
|
69
|
|
Current maturities of long-term
debt
|
|
|
344
|
|
|
|
190
|
|
Other current liabilities
|
|
|
1,165
|
|
|
|
1,560
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
4,092
|
|
|
|
4,149
|
|
Long-term debt (less current
maturities)
|
|
|
4,389
|
|
|
|
1,558
|
|
Deferred income taxes, net
|
|
|
1,167
|
|
|
|
639
|
|
Long-term retirement benefits
(less current portion)
|
|
|
1,227
|
|
|
|
1,374
|
|
Other noncurrent liabilities
|
|
|
260
|
|
|
|
246
|
|
Commitments and contingencies:
|
|
|
|
|
|
|
|
|
Shareholders equity:
|
|
|
|
|
|
|
|
|
Common stock (shares issued:
2006 295,624,741; 2005 294,865,890)
|
|
|
|
|
|
|
|
|
Paid-in capital
|
|
|
8,702
|
|
|
|
8,694
|
|
Accumulated deficit
|
|
|
(1,241
|
)
|
|
|
(1,638
|
)
|
Accumulated other comprehensive
loss (Defined benefit pension and post-retirement
plans: 2006 $418, net of tax. Cumulative minimum
pension liability: 2005 $502, net of tax)
|
|
|
(418
|
)
|
|
|
(503
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
7,043
|
|
|
|
6,553
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
18,178
|
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
See Notes to Consolidated Financial Statements
105
REYNOLDS
AMERICAN INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND
COMPREHENSIVE INCOME
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
|
|
|
Other
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
Common
|
|
|
Paid-In
|
|
|
(Accumulated
|
|
|
Comprehensive
|
|
|
Unamortized
|
|
|
Treasury
|
|
|
Shareholders
|
|
|
Comprehensive
|
|
|
|
Stock
|
|
|
Capital
|
|
|
Deficit)
|
|
|
Income (Loss)
|
|
|
Restricted Stock
|
|
|
Stock
|
|
|
Equity
|
|
|
Income
|
|
|
Balance at December 31, 2003
|
|
$
|
1
|
|
|
$
|
7,377
|
|
|
$
|
(2,469
|
)
|
|
$
|
(462
|
)
|
|
$
|
(23
|
)
|
|
$
|
(1,367
|
)
|
|
$
|
3,057
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
688
|
|
|
$
|
688
|
|
Minimum pension liability, net of
$10 million tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
705
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends- $1.90 per share
|
|
|
|
|
|
|
(162
|
)
|
|
|
(280
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(442
|
)
|
|
|
|
|
Stock options exercised
|
|
|
|
|
|
|
43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
|
|
|
Tax benefit on equity awards
|
|
|
|
|
|
|
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
|
|
|
|
|
|
Restricted stock awarded
|
|
|
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock amortization
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
Restricted stock forfeited
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
Common stock repurchased
|
|
|
|
|
|
|
(43
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(28
|
)
|
|
|
(71
|
)
|
|
|
|
|
B&W business combination
|
|
|
(1
|
)
|
|
|
1,443
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,401
|
|
|
|
2,843
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2004
|
|
|
|
|
|
|
8,682
|
|
|
|
(2,061
|
)
|
|
|
(445
|
)
|
|
|
|
|
|
|
|
|
|
|
6,176
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
1,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,042
|
|
|
$
|
1,042
|
|
Minimum pension liability, net of
$87 million tax benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(56
|
)
|
|
|
|
|
|
|
|
|
|
|
(56
|
)
|
|
|
(56
|
)
|
Cumulative translation adjustment
and other, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends $2.10 per
share
|
|
|
|
|
|
|
|
|
|
|
(619
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(619
|
)
|
|
|
|
|
Stock options exercised
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
Tax benefit on equity awards
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
Common stock repurchased
|
|
|
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2005
|
|
|
|
|
|
|
8,694
|
|
|
|
(1,638
|
)
|
|
|
(503
|
)
|
|
|
|
|
|
|
|
|
|
|
6,553
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
1,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,210
|
|
|
$
|
1,210
|
|
Minimum pension liability, net of
$317 million tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
491
|
|
|
|
|
|
|
|
|
|
|
|
491
|
|
|
|
491
|
|
Cumulative translation adjustment
and other, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,702
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Implementation of SFAS 158,
net of $257 million tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(407
|
)
|
|
|
|
|
|
|
|
|
|
|
(407
|
)
|
|
|
|
|
Dividends $2.75 per
share
|
|
|
|
|
|
|
|
|
|
|
(813
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(813
|
)
|
|
|
|
|
Stock options exercised
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
Tax benefit on equity awards
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
2006
|
|
$
|
|
|
|
$
|
8,702
|
|
|
$
|
(1,241
|
)
|
|
$
|
(418
|
)
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to Consolidated Financial Statements
106
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Summary
of Significant Accounting Policies
Overview
The consolidated financial statements 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. In addition,
RAIs operating subsidiaries include the companies acquired
on May 31, 2006, by RAIs newly formed subsidiary,
Conwood Holdings, Inc., described in note 2. The acquired
companies are collectively referred to as Conwood.
RAI was incorporated as a holding company in the state of North
Carolina on January 5, 2004, and its common stock is listed
on the NYSE under the symbol RAI. RAI was created to facilitate
the transactions on July 30, 2004, to combine the
U.S. assets, liabilities and operations of Brown &
Williamson Holdings, Inc., formerly known as Brown &
Williamson Tobacco Company and 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. These July 30, 2004,
transactions generally are referred to as the B&W business
combination.
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, a North Carolina corporation and an
indirect, wholly owned operating subsidiary of RAI. The
consolidated financial statements of RAI include the results of
RJR through July 30, 2004, and of RAI and the acquired
operations of B&W and Lane subsequent to July 30, 2004,
and Conwood subsequent to May 31, 2006.
Basis of
Presentation
The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires estimates and assumptions to
be made that affect the reported amounts in the consolidated
financial statements and accompanying notes. Actual results
could differ from those estimates. Certain reclassifications
were made to conform prior years financial statements to
the current presentation.
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.
All dollar amounts, other than per share amounts, are presented
in millions unless otherwise noted.
Stock
Split
On July 19, 2006, RAI announced that its board of directors
had declared a
two-for-one
stock split, to be effected in the form of a 100% stock dividend
of its common stock, to shareholders of record on July 31,
2006. The stock dividend was distributed to RAIs
shareholders on August 14, 2006. All current and prior
period share and per share amounts have been adjusted to reflect
this stock split.
107
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Master
Settlement Agreement and Federal Tobacco Buyout
Expenses
Cost of products sold includes the following components for the
Master Settlement Agreement and other state settlement
agreements, referred to as the MSA, and federal tobacco buyout
expenses for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Settlement
|
|
$
|
2,611
|
|
|
$
|
2,641
|
|
|
$
|
2,252
|
|
Phase II growers
liability offset
|
|
|
|
|
|
|
(79
|
)
|
|
|
(69
|
)
|
Phase II growers expense
|
|
|
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total settlement expense
|
|
$
|
2,611
|
|
|
$
|
2,600
|
|
|
$
|
2,183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout
|
|
$
|
265
|
|
|
$
|
264
|
|
|
$
|
70
|
|
Federal quota tobacco stock
liquidation assessment
|
|
|
(9
|
)
|
|
|
81
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense
|
|
$
|
256
|
|
|
$
|
345
|
|
|
$
|
70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For additional information, see Governmental
Health-Care Cost Recovery Cases MSA and Other State
Settlement Agreements and Tobacco Buyout
Legislation in note 14.
Cash,
Cash Equivalents and Short-Term Investments
Cash balances are recorded net of book overdrafts when a bank
right-of-offset
exists. All other book overdrafts are recorded in accounts
payable. Cash equivalents include money market funds, commercial
paper and time deposits in major institutions with high credit
ratings to minimize investment risk. As short-term, highly
liquid investments readily convertible to known amounts of cash,
with remaining maturities of three months or less at the time of
purchase, cash equivalents have carrying values that approximate
fair values. Debt securities included in cash equivalents are
classified and accounted for as
held-to-maturity.
The appropriate classification of cash equivalents and
short-term investments is determined at the time of purchase and
the classification is reassessed at each reporting date.
Short-term investments include investment pools and auction rate
notes that are classified and accounted for as
available-for-sale
securities.
Investment securities classified as
available-for-sale
are reported at fair value based on current market quotes with
unrealized gains and losses, net of any tax effect, recorded as
a separate component of accumulated other comprehensive income
in shareholders equity until realized. Interest income and
amortization of premiums and discounts are included in interest
income. Gains and losses on investment securities sold are
determined based on the specific identification method and are
included in other (income) expense, net. Unrealized losses that
are other than temporary are recognized in net income. No
securities are held for speculative or trading purposes.
108
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Accounts
Receivable
Accounts receivable are reported net of allowance for doubtful
accounts. A summary of activity in the allowance for doubtful
accounts is as follows:
|
|
|
|
|
Balance at December 31, 2003
|
|
$
|
3
|
|
Bad debt expense
|
|
|
1
|
|
Allowance for doubtful accounts
acquired
|
|
|
4
|
|
Write-off of bad debt
|
|
|
(1
|
)
|
|
|
|
|
|
Balance at December 31,
2004
|
|
|
7
|
|
Bad debt expense
|
|
|
1
|
|
Write-off of bad debt
|
|
|
(1
|
)
|
|
|
|
|
|
Balance at December 31,
2005
|
|
|
7
|
|
Bad debt expense
|
|
|
1
|
|
Bad debt recoveries
|
|
|
(2
|
)
|
Write-off of bad debt
|
|
|
(2
|
)
|
|
|
|
|
|
Balance at December 31,
2006
|
|
$
|
4
|
|
|
|
|
|
|
Inventories
Inventories are stated at the lower of cost or market. The cost
of tobacco inventories is determined principally under the
last-in,
first-out, or LIFO, method and is calculated at the end of each
year. The cost of work in process and finished goods includes
materials, direct labor, and variable costs and overhead and
full absorption of fixed manufacturing overhead. Stocks of
tobacco, which have an operating cycle that exceeds
12 months due to curing requirements, are classified as
current assets, consistent with recognized industry practice.
Long-lived
Assets
Long-lived assets, such as property, plant and equipment,
trademarks and other intangible assets with definite lives, are
reviewed for impairment whenever events or changes in
circumstances indicate that the book value of the asset may not
be recoverable. The carrying value of long-lived assets would be
impaired if the best estimate of future undiscounted cash flows
expected to be generated by the asset is less than the carrying
value. If an asset is impaired, the loss is measured as the
difference between estimated fair value and carrying value.
Property,
Plant and Equipment
Property, plant and equipment are recorded at cost and
depreciated using the straight-line method over the estimated
useful lives of the assets. Useful lives range from 20 to
50 years for buildings and improvements and from 3 to
30 years for machinery and equipment. The cost and related
accumulated depreciation of assets sold or retired are removed
from the accounts and the gain or loss on disposition is
recognized in income.
Intangible
Assets
Intangibles include goodwill, trademarks and other intangibles.
Trademarks and other intangibles are capitalized when acquired.
See note 2 for additional information related to the
intangible assets acquired as part of the Conwood acquisition in
2006.
Trademarks and other intangible assets with indefinite lives and
goodwill are not amortized, but are tested annually, during the
fourth quarter, for impairment or more frequently if events and
circumstances indicate that the asset might be impaired. An
impairment loss is recognized to the extent that the carrying
amount exceeds the assets fair value.
109
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The changes in the carrying amount of goodwill during the years
ended December 31, 2005 and 2006, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco
|
|
|
Santa Fe
|
|
|
Lane
|
|
|
Conwood
|
|
|
Consolidated
|
|
|
Balance as of January 1, 2005
|
|
$
|
5,321
|
|
|
$
|
224
|
|
|
$
|
140
|
|
|
$
|
|
|
|
$
|
5,685
|
|
Adjustment to 2004 acquisition
restructuring reserve, net of tax
|
|
|
(9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9
|
)
|
Impairment included in operating
income
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
(2
|
)
|
Adjustment to deferred tax
|
|
|
(3
|
)
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2005
|
|
|
5,309
|
|
|
|
224
|
|
|
|
139
|
|
|
|
|
|
|
|
5,672
|
|
Adjustment to 2004 acquisition
restructuring reserve, net of tax
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
Goodwill acquired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,509
|
|
|
|
2,509
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2006
|
|
$
|
5,303
|
|
|
$
|
224
|
|
|
$
|
139
|
|
|
$
|
2,509
|
|
|
$
|
8,175
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the carrying amount of trademarks during the
years ended December 31, 2005 and 2006, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
|
Santa Fe
|
|
|
Lane
|
|
|
Conwood
|
|
|
|
|
|
|
Indefinite
|
|
|
Finite
|
|
|
Indefinite
|
|
|
Indefinite
|
|
|
Indefinite
|
|
|
Finite
|
|
|
|
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Consolidated
|
|
|
Balance as of January 1, 2005
|
|
$
|
2,144
|
|
|
$
|
79
|
|
|
$
|
155
|
|
|
$
|
25
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,403
|
|
Impairment included in operating
income
|
|
|
(197
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(198
|
)
|
Amortization expense
|
|
|
|
|
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2005
|
|
|
1,947
|
|
|
|
61
|
|
|
|
155
|
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
2,188
|
|
Trademarks acquired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,390
|
|
|
|
4
|
|
|
|
1,394
|
|
Impairment included in operating
income
|
|
|
(88
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(90
|
)
|
Amortization expense
|
|
|
|
|
|
|
(12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
(13
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2006
|
|
$
|
1,859
|
|
|
$
|
47
|
|
|
$
|
155
|
|
|
$
|
25
|
|
|
$
|
1,390
|
|
|
$
|
3
|
|
|
$
|
3,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the carrying amount of other intangibles during
the years ended December 31, 2005 and 2006, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
|
Lane
|
|
|
GPI
|
|
|
|
|
|
|
Indefinite
|
|
|
Finite
|
|
|
Indefinite
|
|
|
Indefinite
|
|
|
|
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Life
|
|
|
Consolidated
|
|
|
Balance as of January 1, 2005
|
|
$
|
16
|
|
|
$
|
155
|
|
|
$
|
35
|
|
|
$
|
|
|
|
$
|
206
|
|
Intangibles acquired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
44
|
|
|
|
44
|
|
Amortization expense
|
|
|
|
|
|
|
(24
|
)
|
|
|
|
|
|
|
|
|
|
|
(24
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2005
|
|
|
16
|
|
|
|
131
|
|
|
|
35
|
|
|
|
44
|
|
|
|
226
|
|
Intangibles acquired
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Amortization expense
|
|
|
|
|
|
|
(15
|
)
|
|
|
|
|
|
|
|
|
|
|
(15
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2006
|
|
$
|
20
|
|
|
$
|
116
|
|
|
$
|
35
|
|
|
$
|
44
|
|
|
$
|
215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In December 2005, GPI acquired from Japan Tobacco Inc., referred
to as JTI, its U.S. duty-free and U.S. overseas
military businesses relating to certain brands for
$45 million. The acquisition was accounted for
110
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
as a purchase, and the purchase price was allocated on the basis
of the estimated fair market value of the inventory and
intangible assets acquired, determined with the assistance of an
independent appraisal firm. The related rights were previously
sold to JTI in 1999 as a part of the sale of RJRs
international tobacco business.
Details of finite-lived intangible assets as of
December 31, 2006, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Gross
|
|
|
Amortization
|
|
|
Net
|
|
|
Consumer database
|
|
$
|
3
|
|
|
$
|
3
|
|
|
$
|
|
|
Customer contracts
|
|
|
16
|
|
|
|
16
|
|
|
|
|
|
Contract manufacturing
|
|
|
151
|
|
|
|
37
|
|
|
|
114
|
|
Technology-based
|
|
|
3
|
|
|
|
1
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangibles
|
|
|
173
|
|
|
|
57
|
|
|
|
116
|
|
Trademarks
|
|
|
86
|
|
|
|
36
|
|
|
|
50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
259
|
|
|
$
|
93
|
|
|
$
|
166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006, the estimated remaining
amortization expense associated with finite-lived intangible
assets in each of the next five years and thereafter was as
follows:
|
|
|
|
|
Year
|
|
Amount
|
|
|
2007
|
|
$
|
23
|
|
2008
|
|
|
21
|
|
2009
|
|
|
20
|
|
2010
|
|
|
19
|
|
2011
|
|
|
19
|
|
Thereafter
|
|
|
64
|
|
|
|
|
|
|
|
|
$
|
166
|
|
|
|
|
|
|
In connection with the annual impairment testing of goodwill and
indefinite-lived intangible assets in the fourth quarter of
2004, impairment occurred on certain of RJR Tobaccos
non-growth brands, primarily WINSTON, SALEM and DORAL. The
impairment primarily reflected RJR Tobaccos decision in
the fourth quarter of 2004 to implement brand strategies
resulting from the B&W business combination, and to limit
investment in these brands in an effort to optimize
profitability. The annual impairment testing of goodwill and
certain intangible assets in the fourth quarters of 2005 and
2006, included modification to the previously anticipated level
of support among certain brands, and an increased rate of
decline in projected net sales of certain brands, compared with
that assumed in the prior year strategic plan.
As a result of impairment testing, RJR Tobacco recorded
impairment charges of $90 million, $198 million and
$199 million, during 2006, 2005 and 2004, respectively.
These charges are based on the excess of certain brands
carrying values over their fair values, determined with the
assistance of an independent appraisal firm, using the present
value of estimated future cash flows assuming a discount rate of
10.75% in 2006 and 11.0% in each of 2005 and 2004. The discount
rate was determined by adjusting the RJR Tobacco enterprise
discount rate by an appropriate risk premium to reflect an asset
group risk. These impairment charges are reflected as decreases
in the carrying value of the trademarks in the consolidated
balance sheets as of December 31, 2006 and 2005, as
goodwill and trademark impairment charges in the consolidated
income statements for the years ended December 31, 2006,
2005 and 2004 and had no impact on cash flows. In addition,
during the 2004 annual valuation, the extent of the sales
decline projected for certain brands that would no longer
receive marketing support indicated that a definite life was
probable. As a result, these brands are being amortized over
their remaining lives, which range from 5 to 15 years,
consistent with the pattern of economic benefits estimated to be
received.
111
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Additionally, during the fourth quarter of 2005, Lanes
goodwill was impaired $2 million relating to the excess of
book value over fair value of assets reclassified to
held-for-sale
concerning its pipe manufacturing business.
Accounting
for Derivative Instruments and Hedging Activities
Statement of Financial Accounting Standard No. 133,
Accounting for Derivative Instruments and Hedging
Activities, requires RAI to measure every derivative
instrument, including certain derivative instruments embedded in
other contracts, at fair value and record them in the balance
sheet as either an asset or liability. Changes in fair value of
derivatives are recorded currently in earnings unless special
hedge accounting criteria are met. For derivatives designated as
fair value hedges, the changes in fair value of both the
derivative instrument and the hedged item are recorded in
earnings. For derivatives designated as cash flow hedges, the
effective portions of changes in the fair value of the
derivative are reported in other comprehensive income. The
ineffective portions of hedges are recognized in earnings in the
current period.
RAI formally assesses both at inception of the hedge and on an
ongoing basis, whether each derivative is highly effective in
offsetting changes in fair values or cash flows of the hedged
item. If it is determined that a derivative is not highly
effective as a hedge or if a derivative ceases to be a highly
effective hedge, RAI will discontinue hedge accounting
prospectively.
Software
Costs
Computer software and software development costs incurred in
connection with developing or obtaining computer software for
internal use that has a useful life of greater than three years
are capitalized. These costs are amortized over five years or
less. During 2006 and 2005, costs of $41 million and
$22 million, respectively, were capitalized or included in
construction in process. At December 31, 2006, and
December 31, 2005, the unamortized balance was
$67 million and $47 million, respectively. Related
amortization expense was $21 million, $20 million and
$32 million for the years ended December 31, 2006,
2005 and 2004, respectively. Amortization on a portion of
acquired software assets as a part of the B&W business
combination was accelerated in 2004 as its useful life was
limited due to the business integration.
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 are generally met when title and
risk of loss pass to the customer. Certain sales of leaf,
considered as
bill-and-hold
for accounting purposes, are recorded as deferred revenue when
all of the above revenue recognition criteria are met except
delivery, postponed by the customers request. Revenue is
subsequently recognized upon delivery. Shipping and handling
costs are classified as cost of products sold. Certain sales
incentives, including coupons, buydowns and slotting allowances,
are classified as reductions of net sales.
Advertising
and Research and Development
Advertising costs, which are expensed as incurred, were
$93 million, $96 million and $143 million in the
years ended December 31, 2006, 2005 and 2004, respectively.
Research and development costs, which are expensed as incurred,
were $58 million, $53 million and $48 million in
the years ended December 31, 2006, 2005 and 2004,
respectively.
Income
Taxes
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss
and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect
112
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the
enactment date. Income taxes for RAI and its subsidiaries are
calculated on a separate return basis.
Stock-Based
Compensation
In the first quarter of 2006, RAI adopted
SFAS No. 123(R), Share-Based Payment,
issued by the Financial Accounting Standards Board, referred to
as FASB, in December 2004. This statement is a revision of
SFAS No. 123 and supersedes Accounting Principles
Board, referred to as 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. RAIs adoption of
SFAS No. 123(R) did not have a material impact on its
financial condition, results of operations or cash flows
primarily because all of RAIs outstanding stock options
are fully vested. See note 16 for additional disclosures
related to stock-based compensation as required by
SFAS No. 123(R).
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 APB Opinion No. 25. Compensation costs
related to grants or modifications of existing grants subsequent
to January 1, 2003, are recognized under the fair value
method of SFAS No. 123. 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
B&W business combination on July 30, 2004. Therefore,
there is no pro forma stock-based employee compensation
disclosure for 2006 or 2005.
The following table illustrates the effect on net income and
income per share as if RAI had applied the fair value
recognition provisions of SFAS No. 123 for the year
ended December 31:
|
|
|
|
|
|
|
2004
|
|
|
Net income, as reported
|
|
$
|
688
|
|
Add: Stock-based employee
compensation expense included in reported net income, net of tax
|
|
|
22
|
|
Deduct: Stock-based employee
compensation expense determined under fair value based method
for all awards, net of tax
|
|
|
20
|
|
|
|
|
|
|
Pro forma net income
|
|
$
|
690
|
|
|
|
|
|
|
Income per share:
|
|
|
|
|
Basic as reported
|
|
$
|
3.11
|
|
Basic pro forma
|
|
|
3.12
|
|
Diluted as reported
|
|
|
3.09
|
|
Diluted pro forma
|
|
|
3.10
|
|
Pension
and Postretirement
In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and
Other Postretirement Plans-an amendment of FASB Statements
No. 87, 88, 106, and 132(R). SFAS No. 158
requires balance sheet recognition of the net asset or liability
for the overfunded or underfunded status of defined benefit
pension and other postretirement benefit plans, on a plan by
plan basis, and recognition of changes in the funded status in
the year in which the changes occur. These changes are reported
in other comprehensive loss, as a separate component of
shareholders equity as of December 31, 2006. See
note 17 for additional information relating to the adoption
of SFAS No. 158.
Gains or losses are annual 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,
113
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
was included in pension expense, and as described in
SFAS No. 106, Employers Accounting for
Postretirement Benefits other than Pensions was included
in the postretirement benefit cost. 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. For further information and
detailed disclosure in accordance with
SFAS No. 132(R), Employers Disclosures
about Pensions and Other Postretirement Benefits, see
note 17.
Tobacco-Related
Litigation Contingencies
In accordance with SFAS No. 5, Accounting for
Contingencies, RAI and its operating subsidiaries will
record any loss related to tobacco litigation at such time that
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 would be recorded. RAI
discloses information concerning tobacco-related litigation for
which an unfavorable outcome is more than remote. RAI and its
operating subsidiaries record their legal expenses and other
litigation costs and related administrative costs as selling,
general and administrative expenses as those costs are incurred.
See note 14 for additional information on tobacco-related
litigation.
Recently
Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurement. SFAS No. 157 does
not require any new fair value measurements but provides a
definition of fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value
measurements. SFAS No. 157 is effective for RAI as of
January 1, 2008. RAI has not yet determined the impact of
the adoption of SFAS No. 157 on its financial
position, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, referred
to as FIN No. 48. FIN No. 48 clarifies
SFAS No. 109, Accounting for Income Taxes,
by providing specific guidance for consistent reporting of
uncertain income taxes recognized in a companys financial
statements, including classification, interest and penalties and
disclosures. FIN No. 48 is effective for RAI as of
January 1, 2007. Based on preliminary analysis, RAI does
not expect the implementation of FIN 48, during the first
quarter of 2007, to have a material impact on its financial
position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities. SFAS No. 159 permits all entities
to choose to elect to measure eligible financial instruments at
fair value. SFAS No. 159 is effective for RAI as of
January 1, 2008. RAI has not yet determined the impact of
the adoption of SFAS No. 159 on its financial
position, results of operations or cash flows.
Note 2
Conwood Acquisition
On May 31, 2006, RAI, through its newly formed subsidiary,
Conwood Holdings, Inc., completed a $3.5 billion
acquisition of 100% of the capital stock of a newly formed
holding company owning Conwood Company, L.P., Conwood Sales Co.,
L.P., Rosswil LLC, Scott Tobacco LLC, Conwood LLC, Conwood-1 LLC
and Conwood-2 LLC. Conwood LLC, Conwood-1 LLC and Conwood-2 LLC
were merged into Conwood Holdings, Inc. in the third quarter of
2006. Also in the third quarter of 2006, Conwood Company, L.P.
and Conwood Sales Co., L.P. were converted into limited
liability companies and renamed Conwood Company, LLC and Conwood
Sales Co., LLC, respectively. Conwood is engaged in the business
of developing, manufacturing and marketing smokeless tobacco
products. Conwoods headquarters and primary manufacturing
facility are located in Memphis, Tennessee. Other facilities are
located in Winston-Salem, North Carolina; Bowling Green,
Kentucky; Sanford, North Carolina; Springfield, Tennessee; and
Clarksville, Tennessee. The Conwood acquisition was funded by
RAI borrowings, new RAI debt securities and available cash and
was treated as a purchase of the Conwood net assets by RAI for
financial accounting purposes. See notes 11 and 12 for
additional information relating to borrowing arrangements and
long-term debt. RAI believes the Conwood acquisition will
enhance shareholder value and will continue to be accretive
114
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
to operating earnings. The consolidated financial statements of
RAI include the results of the Conwood operations subsequent to
May 31, 2006.
The following unaudited pro forma results of operations of RAI
for the years ended 2006 and 2005, assume that the Conwood
acquisition occurred at the beginning of each year presented.
The pro forma amounts include certain adjustments, including
interest expense and taxes. These unaudited pro forma results
are not necessarily indicative of the actual results of
operations that would have been achieved nor are they
necessarily indicative of future results of operations.
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Net sales
|
|
$
|
8,707
|
|
|
$
|
8,696
|
|
Net income before extraordinary
item
|
|
|
1,140
|
|
|
|
978
|
|
Net income
|
|
|
1,214
|
|
|
|
1,033
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
Net income before extraordinary
item
|
|
$
|
3.86
|
|
|
$
|
3.32
|
|
Net income
|
|
$
|
4.11
|
|
|
$
|
3.50
|
|
Diluted:
|
|
|
|
|
|
|
|
|
Net income before extraordinary
item
|
|
$
|
3.86
|
|
|
$
|
3.31
|
|
Net income
|
|
$
|
4.11
|
|
|
$
|
3.50
|
|
The fair values of assets acquired and liabilities assumed at
the date of acquisition were as follows:
|
|
|
|
|
Current assets
|
|
$
|
148
|
|
Property, plant and equipment
|
|
|
48
|
|
Trademarks
|
|
|
1,394
|
|
Goodwill
|
|
|
2,509
|
|
Other assets
|
|
|
1
|
|
|
|
|
|
|
Total assets acquired
|
|
|
4,100
|
|
Current liabilities
|
|
|
30
|
|
Long-term retirement benefits
|
|
|
46
|
|
Deferred income taxes, net
|
|
|
503
|
|
Other noncurrent liabilities
|
|
|
2
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
581
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
3,519
|
|
|
|
|
|
|
The goodwill resulting from the allocation of excess purchase
price will be non-deductible for tax purposes, and was assigned
to the acquired companies. Conwoods trademark values
include $1.39 billion of indefinite-lived trademarks and
$4 million of finite-lived trademarks with a
weighted-average amortization period of 8.5 years. For
2006, total amortization expense relating to the acquired
intangibles was $1 million.
Note 3
B&W Business Combination and Other Acquisitions
RAI facilitated the July 30, 2004, transactions to combine
the U.S. assets, liabilities and operations of B&W with
RJR Tobacco. 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, RAI
acquired from an indirect subsidiary of BAT the capital stock of
Cigarette Manufacturers Supplies Inc., referred to as CMSI,
which then owned all of the capital stock of Lane, and
115
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
RJR became a wholly owned subsidiary of RAI. In 2006, CMSI was
merged with and into Lane, and Lane became a direct, wholly
owned subsidiary of RAI.
In December 2005, GPI acquired from JTI, its U.S. duty-free
and U.S. overseas military businesses relating to certain
brands. The acquisition was accounted for as a purchase, with
its cost of $45 million allocated on the basis of the fair
market value of the inventory and intangible assets acquired.
The related rights were previously sold to JTI in 1999 as a part
of the sale of RJRs international tobacco business.
Note 4
Restructuring and Impairment Charges
2004
B&W Business Combination Restructuring Costs
The components of the B&W business combination restructuring
costs accrued and utilized were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
(40
|
)
|
|
|
(28
|
)
|
|
|
(68
|
)
|
Adjusted in 2005
|
|
|
|
|
|
|
9
|
|
|
|
9
|
|
Adjustment to goodwill
|
|
|
1
|
|
|
|
(16
|
)
|
|
|
(15
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2005
|
|
|
72
|
|
|
|
40
|
|
|
|
112
|
|
Utilized in 2006
|
|
|
(69
|
)
|
|
|
(12
|
)
|
|
|
(81
|
)
|
Adjustment to goodwill
|
|
|
(2
|
)
|
|
|
(8
|
)
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2006
|
|
$
|
1
|
|
|
$
|
20
|
|
|
$
|
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In connection with the allocation of the cost of the B&W
business combination 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, which was significantly completed
by midyear 2006. Other accruals include the cost to relocate
former B&W employees retained and transferred from
facilities that were to be 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 warehouse and
certain leased sales offices, net of expected
sub-lease
income.
During 2005, RJR Tobacco determined that, under the B&W
business combination restructuring plan, the employment of
approximately 15 additional former B&W employees would be
terminated, which resulted in an accrual of $1 million. The
2005 reduction in relocation/exit costs of $16 million was
primarily due to
lower-than-expected
losses on home sales. Also, in 2005, $9 million was
expensed in selling, general and administrative, primarily
relating to
lower-than-expected
sub-lease
income on closed facilities.
During 2006, RJR Tobacco recorded an $8 million reduction
to the reserve primarily due to
lower-than-expected
losses on home sales and a $2 million reduction to the
reserve due to
lower-than-expected
costs for severance and related benefits.
As of December 31, 2006, $235 million of the accrued
amount had been paid. In the consolidated balance sheet as of
December 31, 2006, $9 million is included in other
current liabilities and $12 million is included in other
noncurrent liabilities.
As part of the integration of operations acquired through the
B&W business combination, RJR Tobacco transitioned
production from the former B&W manufacturing facility in
Macon, Georgia to RJR Tobaccos Winston-Salem, North
Carolina facilities. The Macon facility had been placed in an
active marketing program, and
116
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
during the third quarter of 2006, was put in a condition
available for immediate sale. The associated assets were
remeasured at the lower of their carrying value or fair value
less cost to sell, and, as a result, an impairment of
$8 million was recognized and included in selling, general
and administrative expenses in the third quarter of 2006. The
facility was sold in the fourth quarter of 2006 for
$8 million.
2003
Restructuring and Asset Impairment Charges
The components of the 2003 restructuring and asset impairment
charges, recorded and utilized were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
|
|
|
Contract
|
|
|
|
|
|
|
Severance
|
|
|
Asset
|
|
|
Termination/
|
|
|
|
|
|
|
and 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
|
|
|
(58
|
)
|
|
|
|
|
|
|
|
|
|
|
(58
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2005
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
17
|
|
Incurred in 2006
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Utilized in 2006
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2006
|
|
$
|
4
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 substantially was completed during the fourth quarter
of 2004. The remaining accrual represents severance that
substantially will be paid by December 31, 2007. In the
fourth quarter of 2006, a $1 million restructuring charge
was incurred for additional employee severance and benefits.
The cash portion of the restructuring and asset impairment
charges to date is approximately $226 million, of which
$172 million relates to employee severance costs and
$54 million relates to exit costs. As of December 31,
2006, $222 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 consolidated balance sheet
as of December 31, 2006, $3 million is included in
other current liabilities and $1 million is included in
other noncurrent liabilities. No significant additional charges
are expected to be incurred in connection with the 2003
restructuring plan.
117
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2002
Restructuring and Asset Impairment Charges
The components of the 2002 restructuring and asset impairment
charges, recorded and utilized were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
|
|
|
|
|
|
|
Employee
|
|
|
|
|
|
Termination/
|
|
|
|
|
|
|
Severance
|
|
|
Asset
|
|
|
Exit
|
|
|
|
|
|
|
and Benefits
|
|
|
Impairment
|
|
|
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
|
|
Incurred in 2005
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
3
|
|
Utilized in 2005
|
|
|
(3
|
)
|
|
|
(3
|
)
|
|
|
|
|
|
|
(6
|
)
|
Adjusted in 2005
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2005
|
|
|
1
|
|
|
|
|
|
|
|
1
|
|
|
|
2
|
|
Utilized in 2006
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2006
|
|
$
|
|
|
|
$
|
|
|
|
$
|
1
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2002, RJR Tobacco recorded a pre-tax restructuring charge of
$222 million, $135 million after tax, in response to
changing competitive practices within the tobacco industry. The
remaining $2 million was incurred by RJR.
During 2003, $5 million of the charge was reversed,
reflecting
less-than-expected
workforce reductions and exit costs of field sales offices, and
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 substantially were completed as of
December 31, 2004. During 2005, $1 million of the
charge was reversed relating to the sale of the packaging
operations.
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.
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 operations resulted in additional
impairment of $40 million in the fourth quarter of 2004.
During 2005, the remaining assets relating to the additional
non-tobacco business were revalued and resulted in additional
impairment of $3 million.
In 2005, RJR Tobacco completed the sale of its packaging
operations to a consortium of five packaging companies for
$48 million. In connection with this sale transaction, RJR
Tobacco recorded a net loss on sale of assets of
$25 million in the second quarter of 2005. In the fourth
quarter of 2005, the net loss was reduced by $1 million to
$24 million, due to lower estimated severance and related
benefits.
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 $27 million for
118
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
severance and related benefits to be paid by RJR Tobacco to
approximately 170 employees. 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 completed
by mid-year 2007. With the termination of the packaging
employees, RJR Tobacco incurred a 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 buyers
and RJR Tobacco, RJR Tobacco will continue to obtain its
packaging materials from certain of the buyers. Also, as a
result of certain transitional supply pricing, which is above
current market prices, $14 million was accrued as part of
the loss. Of the charges incurred during the second quarter of
2005 related to the sale of the packaging operations,
$16 million of these accruals were included in other
current liabilities in the consolidated balance sheet as of
December 31, 2006.
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 December 31, 2006,
$54 million of this amount had been paid. The
$204 million non-cash portion included $44 million
related to employee benefits, $158 million related to asset
impairments and $2 million related to the write-off of
prepaid promotional rights that were terminated. In the
consolidated balance sheet as of December 31, 2006,
$1 million is included in other current liabilities.
Note 5
Discontinued Operations
Discontinued operations reflect transactions related to the 1999
sale of the international tobacco business to JTI. During 2005
and 2004, these transactions included $2 million and
$12 million, respectively, of after-tax reversals of
indemnification accruals. Including these adjustments, the net
after-tax gain on the sale of the international tobacco business
was $2.5 billion.
Note 6
Income Per Share
The components of the calculation of income per share were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Income from continuing operations
|
|
$
|
1,136
|
|
|
$
|
985
|
|
|
$
|
627
|
|
Income from discontinued operations
|
|
|
|
|
|
|
2
|
|
|
|
12
|
|
Extraordinary item
gain on acquisition
|
|
|
74
|
|
|
|
55
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,210
|
|
|
$
|
1,042
|
|
|
$
|
688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares, in
thousands(1)
|
|
|
295,033
|
|
|
|
294,790
|
|
|
|
221,556
|
|
Effect of dilutive potential
shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
58
|
|
|
|
382
|
|
|
|
913
|
|
Restricted stock
|
|
|
293
|
|
|
|
|
|
|
|
404
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares,
in thousands
|
|
|
295,384
|
|
|
|
295,172
|
|
|
|
222,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Outstanding contingently issuable restricted stock of
0.5 million shares and 0.4 million shares were
excluded from the basic share calculation for the years ended
December 31, 2006, and 2004, respectively, as the related
vesting provisions had not been met. |
119
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Note 7
Short-Term Investments
Short-term investments classified as
available-for-sale
as of December 31 were as follows:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Auction rate notes
|
|
$
|
659
|
|
|
$
|
1,083
|
|
Commercial paper and
asset/mortgage-backed securities
|
|
|
116
|
|
|
|
54
|
|
Federal agency securities and
treasury bills and notes
|
|
|
79
|
|
|
|
55
|
|
Fixed income funds
|
|
|
416
|
|
|
|
179
|
|
Other investments
|
|
|
23
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
Total short-term investments
|
|
$
|
1,293
|
|
|
$
|
1,373
|
|
|
|
|
|
|
|
|
|
|
The investments in auction rate notes are instruments with
long-term contractual maturities, but are highly liquid, as they
reprice at intervals ranging from 7 to 49 days, and
therefore the fair values approximate carrying values. The
individual securities are generally held 30 to 45 days
depending upon cash needs for operations. The contractual
maturities of securities, other than auction rate notes,
averaged less than one year. Realized and unrealized gains and
losses on
available-for-sale
securities for the years ended December 31, 2006 and 2005,
were not significant, and accordingly, the amortized cost of
these securities approximated fair value.
Note 8
Inventories
The major components of inventories at December 31 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Leaf tobacco
|
|
$
|
930
|
|
|
$
|
853
|
|
Raw materials
|
|
|
44
|
|
|
|
32
|
|
Work in process
|
|
|
54
|
|
|
|
57
|
|
Finished products
|
|
|
164
|
|
|
|
156
|
|
Other
|
|
|
26
|
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,218
|
|
|
|
1,129
|
|
Less LIFO allowance
|
|
|
63
|
|
|
|
63
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,155
|
|
|
$
|
1,066
|
|
|
|
|
|
|
|
|
|
|
Inventories valued under the LIFO method were approximately
$888 million and $947 million at December 31,
2006 and 2005, respectively, net of the LIFO allowance. The LIFO
allowance reflects the excess of the current cost of LIFO
inventories at December 31, 2006 and 2005, over the amount
at which these inventories were carried on the consolidated
balance sheets. RAI recorded $2 million and $7 million
of expense from LIFO inventory liquidations during 2006 and
2005, respectively. There was no impact on net income from LIFO
inventory liquidations during 2004.
120
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Note 9
Other Current Liabilities
Other current liabilities at December 31 included the
following:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Payroll and employee benefits
|
|
$
|
189
|
|
|
$
|
175
|
|
Pension and other post-retirement
benefits
|
|
|
72
|
|
|
|
307
|
|
Marketing and advertising
|
|
|
263
|
|
|
|
232
|
|
Declared dividends
|
|
|
222
|
|
|
|
184
|
|
Accrued restructuring charges
|
|
|
13
|
|
|
|
100
|
|
Other
|
|
|
406
|
|
|
|
562
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,165
|
|
|
$
|
1,560
|
|
|
|
|
|
|
|
|
|
|
Note 10
Income Taxes
The components of the provision for income taxes from continuing
operations were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
501
|
|
|
$
|
328
|
|
|
$
|
289
|
|
State and other
|
|
|
67
|
|
|
|
71
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
568
|
|
|
|
399
|
|
|
|
344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
50
|
|
|
|
6
|
|
|
|
(140
|
)
|
State and other
|
|
|
55
|
|
|
|
26
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
105
|
|
|
|
32
|
|
|
|
(142
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
673
|
|
|
$
|
431
|
|
|
$
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The current deferred income tax asset shown on the consolidated
balance sheets at December 31 included the following:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets (liabilities):
|
|
|
|
|
|
|
|
|
LIFO inventories
|
|
$
|
(227
|
)
|
|
$
|
(240
|
)
|
Pension and other postretirement
liabilities
|
|
|
72
|
|
|
|
115
|
|
Tobacco settlement related accruals
|
|
|
885
|
|
|
|
894
|
|
Other accrued liabilities
|
|
|
63
|
|
|
|
96
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
793
|
|
|
$
|
865
|
|
|
|
|
|
|
|
|
|
|
121
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The non-current deferred income tax liability shown on the
consolidated balance sheets at December 31 included the
following:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Pension and other postretirement
liabilities
|
|
$
|
490
|
|
|
$
|
545
|
|
Other non-current liabilities
|
|
|
56
|
|
|
|
88
|
|
|
|
|
|
|
|
|
|
|
|
|
|
546
|
|
|
|
633
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(261
|
)
|
|
|
(254
|
)
|
Trademarks
|
|
|
(1,342
|
)
|
|
|
(862
|
)
|
Other
|
|
|
(110
|
)
|
|
|
(156
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,713
|
)
|
|
|
(1,272
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,167
|
)
|
|
$
|
(639
|
)
|
|
|
|
|
|
|
|
|
|
The total deferred tax assets were $1,566 million and
$1,738 million as of December 31, 2006 and 2005,
respectively. The total deferred tax liabilities were
$1,940 million and $1,512 million as of
December 31, 2006 and 2005, respectively.
There were total net deferred tax liabilities of
$374 million as of December 31, 2006, and net deferred
tax assets of $226 million as of December 31, 2005. No
valuation allowance has been provided on the deferred tax assets
as of December 31, 2006, or as of December 31, 2005,
as RAI believes it is more likely than not that all of the
deferred tax assets will be realized.
Pre-tax income for domestic and foreign operations consisted of
the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Domestic (includes
U.S. exports)
|
|
$
|
1,768
|
|
|
$
|
1,373
|
|
|
$
|
794
|
|
Foreign
|
|
|
41
|
|
|
|
43
|
|
|
|
35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,809
|
|
|
$
|
1,416
|
|
|
$
|
829
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The differences between the provision for income taxes from
continuing operations and income taxes computed at statutory
U.S. federal income tax rates were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Income taxes computed at statutory
U.S. federal income tax rates
|
|
$
|
633
|
|
|
$
|
496
|
|
|
$
|
290
|
|
State and local income taxes, net
of federal tax benefits
|
|
|
58
|
|
|
|
59
|
|
|
|
33
|
|
Favorable resolution of tax matters
|
|
|
(17
|
)
|
|
|
(78
|
)
|
|
|
(126
|
)
|
Other items, net
|
|
|
(1
|
)
|
|
|
(46
|
)
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes from
continuing operations
|
|
$
|
673
|
|
|
$
|
431
|
|
|
$
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
37.2
|
%
|
|
|
30.4
|
%
|
|
|
24.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2005, RAI received a $76 million cash distribution from
a foreign subsidiary under the provisions of the American Jobs
Creation Act. The provisions of the Act provide for a one-time
repatriation of foreign earnings of an affiliate at a net 5.25%
tax rate if the earnings are repatriated under a Qualified
Domestic Reinvestment Plan. The earnings were repatriated under
a QDRP, resulting in a net tax of 5.25% on the cash distribution.
122
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
As of December 31, 2006, there was $52 million of
accumulated and undistributed income of foreign subsidiaries.
RAI plans to reinvest these earnings abroad indefinitely.
Accordingly, no applicable deferred income taxes have been
provided.
In 2006, 2005 and 2004, the resolution of prior years tax
matters resulted in a reduction of income tax expense of
$17 million, $78 million and $126 million,
respectively. The 2006 adjustment finalizes the Internal Revenue
Services audit of tax returns for the years 1986 through
2001. In 2005 and 2004, RAI recorded an adjustment to tax
expense included in discontinued operations of $1 million
and $6 million, respectively, related to the gain on the
1999 sale of RJRs international tobacco business.
In 2006, 2005 and 2004, RAI recorded an adjustment of
$74 million, $55 million and $49 million,
respectively, to the gain related to the acquisition of
RJRs former parent, NGH, which occurred in 2000, primarily
reflecting the favorable resolution of associated tax matters.
Including this adjustment, the net after-tax gain on the
acquisition of NGH was $1.8 billion.
Note 11
Borrowing Arrangements
On May 31, 2006, RAI entered into new $2.1 billion
senior, secured credit facilities, consisting of a six-year
$1.55 billion secured term loan and a five-year
$550 million secured revolving credit facility, together
referred to as the RAI Credit Facilities. The credit agreement
related to the RAI Credit Facilities is an amendment and
restatement of the agreement related to RJRs prior
revolving credit facility, which the RAI revolving credit
facility replaced. RAIs proceeds from the term loan were
used, together with the net proceeds of a private debt offering
and available cash, to finance the Conwood acquisition. See
notes 2 and 12 for additional information relating to the
Conwood acquisition and long-term debt security issuances,
respectively.
RAIs term loan requires quarterly, mandatory repayments of
approximately $4 million, which began on September 30,
2006. An additional mandatory repayment is due 110 days
after the last day of each year, commencing December 31,
2007, equal to excess cash flow as defined in the credit
agreement, including reductions for, among other things, capital
expenditures, cash dividends, debt principal payments and
pension funding.
RAI is able to use the RAI revolving credit facility for
borrowings and issuances of letters of credit, at its option.
Also, at the request of RAI and the discretion of the lenders,
RAI is able to increase the borrowing limit under the revolving
credit facility by $250 million. At December 31, 2006,
RAI had $25 million in letters of credit outstanding under
its revolving credit facility. No borrowings were outstanding,
and the remaining $525 million of the revolving credit
facility was available for borrowing.
Under the terms of the RAI Credit Facilities, RAI is not
required to maintain compensating balances; however, RAI is
required to pay a commitment fee ranging from 0.75% to
1.50% per annum on the unused portion of the revolving
credit facility. Borrowings under the RAI Credit Facilities bear
interest, at the option of RAI, at a rate equal to an applicable
margin plus: the reference rate, which is the higher of the
federal funds effective rate plus 0.5% and the prime rate; or
the Eurodollar rate, which is the rate at which Eurodollar
deposits for one, two, three or six months are offered in the
interbank Eurodollar market. The term loans applicable
margin is subject to adjustment based upon RAIs
consolidated leverage ratio. At December 31, 2006, RAI had
the following term loan amounts outstanding: $850 million
bearing interest at the November 30, 2006, six-month LIBOR
rate plus 1.750%; $650 million bearing interest at the
September 5, 2006, six-month LIBOR rate plus 1.750%; and
$42 million at the December 29, 2006, three-month
LIBOR rate plus 1.750%.
The RAI Credit Facilities have restrictive covenants that limit
RAIs and its subsidiaries ability to pay dividends
and repurchase stock, make investments, prepay certain
indebtedness, 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 revolving credit facility, RAIs cumulative dividends
generally may not exceed the sum of $625 million plus 75%
of cumulative adjusted net income, as defined in the credit
agreement.
123
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
RAIs material domestic subsidiaries, including RJR, RJR
Tobacco, Santa Fe, Lane, GPI, and Conwood, guarantee RAIs
obligations under the RAI Credit Facilities. These guarantors
also have pledged substantially all of their assets to secure
these obligations, including indebtedness and other obligations
held by or owing to such guarantor of a subsidiary. RAI has
pledged substantially all of its assets, including the stock of
its direct subsidiaries, to secure such obligations. RJR has
pledged its interest in RJR Tobacco common stock as collateral
for the RAI Credit Facilities. Under the terms of the RAI Credit
Facilities, the collateral will be released automatically in
certain circumstances, including at such time, if any, as the
term loan is paid in full and RAI obtains an investment grade
corporate credit rating by each of Moodys and S&P.
As of December 31, 2006, Moodys corporate credit
rating of RAI was Ba2, positive outlook, and S&Ps
rating was BB+, stable outlook. Concerns about, or lowering of,
RAIs corporate ratings by S&P or Moodys could
have an adverse impact on RAIs ability to access the debt
markets and could increase borrowing costs. However, given the
cash balances and operating performance 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.
Note 12
Long-Term Debt
Long-term debt as of December 31 consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
RJR 8.5% 9.25%
unsecured notes, due 2007 to 2013
|
|
$
|
89
|
|
|
$
|
89
|
|
RJR 6.5% 7.875%
guaranteed, unsecured notes, due 2007 to 2015
|
|
|
163
|
|
|
|
|
|
RJR 7.75% guaranteed, unsecured
notes, due May 15, 2006
|
|
|
|
|
|
|
190
|
|
RJR 6.5% 7.875%
guaranteed, secured notes, due 2007 to 2015
|
|
|
|
|
|
|
1,469
|
|
|
|
|
|
|
|
|
|
|
Total RJR debt
|
|
|
252
|
|
|
|
1,748
|
|
RAI 6.5% 7.875%
guaranteed, secured notes, due 2007 to 2015(1)
|
|
|
1,298
|
|
|
|
|
|
RAI 7.25% 7.75%
guaranteed, secured notes, due 2013 to 2018(2)
|
|
|
1,641
|
|
|
|
|
|
RAI floating rate, guaranteed,
secured term loan, due 2012
|
|
|
1,542
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total RAI debt
|
|
|
4,481
|
|
|
|
|
|
Total debt
|
|
|
4,733
|
|
|
|
1,748
|
|
Current maturities of long-term
debt
|
|
|
(344
|
)
|
|
|
(190
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,389
|
|
|
$
|
1,558
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
RAI debt arising from the RJR exchanged notes; see below for
additional information. |
|
(2) |
|
RAI newly issued long-term debt; see below for additional
information. |
As of December 31, 2006, the maturities of RAIs and
RJRs notes, net of discount and excluding fair value
adjustments associated with interest rate swaps of
$15 million, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
|
|
RAI
|
|
|
RJR
|
|
|
Total
|
|
|
2007
|
|
$
|
237
|
|
|
$
|
92
|
|
|
$
|
329
|
|
2009
|
|
|
185
|
|
|
|
14
|
|
|
|
199
|
|
2010
|
|
|
298
|
|
|
|
1
|
|
|
|
299
|
|
Thereafter
|
|
|
2,206
|
|
|
|
143
|
|
|
|
2,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,926
|
|
|
$
|
250
|
|
|
$
|
3,176
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On May 19, 2006, RAI commenced, in a private offering, an
offer to exchange up to $1.45 billion of RJRs
outstanding guaranteed, secured notes for like principal amounts
of new RAI guaranteed, secured notes. The offer was made to
certain institutional holders of the RJR notes. Each new series
of RAI notes has identical terms as the
124
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
corresponding series of RJR notes with respect to interest
rates, redemption terms and interest payment and maturity dates.
In conjunction with the exchange offer, consents were solicited
from the RJR noteholders to eliminate substantially all of the
restrictive covenants and to eliminate an event of default from
the RJR indentures governing the series of RJR notes subject to
the exchange offer. The requisite number of consents were
received, and, as a result, the remaining RJR notes are now
unsecured.
At the closing of the exchange offer on June 20, 2006,
approximately 89% of the RJR notes were validly tendered for
exchange and were accepted by RAI. The tendered RJR notes were
cancelled. The portion exchanged of each original RJR note was
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exchanged
|
|
|
Remaining
|
|
|
|
|
|
|
for RAI
|
|
|
RJR
|
|
|
|
|
|
|
Guaranteed,
|
|
|
Guaranteed,
|
|
|
|
Principal
|
|
|
Secured
|
|
|
Unsecured
|
|
|
|
Amount
|
|
|
Notes
|
|
|
Notes
|
|
|
6.500% notes, due
June 1, 2007
|
|
$
|
300
|
|
|
$
|
237
|
|
|
$
|
63
|
|
7.875% notes, due
May 15, 2009
|
|
|
200
|
|
|
|
186
|
|
|
|
14
|
|
6.500% notes, due
July 15, 2010
|
|
|
300
|
|
|
|
299
|
|
|
|
1
|
|
7.250% notes, due
June 1, 2012
|
|
|
450
|
|
|
|
368
|
|
|
|
82
|
|
7.300% notes, due
July 15, 2015
|
|
|
200
|
|
|
|
199
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,450
|
|
|
$
|
1,289
|
|
|
$
|
161
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The $161 million aggregate principal amount of RJR notes
outstanding as of December 31, 2006, under the amended RJR
indentures are now unsecured, but remain guaranteed by certain
of RJRs subsidiaries, including RJR Tobacco, and
RJRs parent, RAI. On October 25, 2006, RAI filed a
registration statement with the SEC, which became effective
November 7, 2006, pursuant to which RAI offered to exchange
$161 million of remaining RJR unsecured notes for RAI
registered secured notes. For additional information on
subsequent events relating to this exchange offer, see
note 24. RJR also has $89 million of other non-bank
debt that is neither secured nor guaranteed.
On May 31, 2006, RAI completed a private offering of
$1.65 billion in aggregate principal amount of senior,
secured notes, consisting of $625 million of
7.25% senior secured notes due June 1, 2013,
$775 million of 7.625% senior secured notes due
June 1, 2016, and $250 million of 7.75% senior
secured notes due June 1, 2018. RAIs net proceeds
from the private offering, together with the proceeds from the
term loan and available cash, were used to finance the Conwood
acquisition. See notes 1 and 11 for additional information
relating to the Conwood acquisition and the RAI Credit
Facilities, respectively.
On October 3, 2006, RAI filed a registration statement with
the SEC, which became effective November 7, 2006, pursuant
to which RAI offered to exchange $2.939 billion of RAI
privately placed secured notes for RAI registered secured notes.
The notes subject to such exchange offer represented the notes
that had been issued in the May 19 and May 31, 2006,
private offerings of RAI. This exchange offer was made in
satisfaction of RAIs obligations under registration rights
agreements that had been entered into in connection with
RAIs prior private offerings. At the expiration of the
exchange offer on December 8, 2006, 99% of the privately
placed secured notes had been validly tendered for exchange and
were accepted by RAI.
In conjunction with their obligations under the RAI Credit
Facilities, RAIs material domestic subsidiaries, including
RJR, RJR Tobacco, Santa Fe, Lane, GPI and Conwood,
guarantee RAIs long-term secured notes. RJR has pledged
its interest in RJR Tobacco common stock as collateral for
RAIs long-term secured notes. Also, RJR Tobaccos and
Conwoods material subsidiaries have pledged their
principal properties to secure these obligations. These assets
constitute a portion of the security for the obligations of RAI
and the guarantors under the RAI Credit Facilities. The
collateral securing RAIs long-term senior secured notes
will be released automatically in certain circumstances. If
these assets are no longer pledged as security for the
obligations of RAI and the guarantors under the RAI Credit
Facilities, or any other indebtedness of RAI, they will be
released automatically as security for RAIs senior secured
notes and the related guarantees. Generally, the terms of
RAIs guaranteed senior secured notes restrict the pledge
of collateral, sale/leaseback transactions and the transfer of
all or substantially all of the assets of
125
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
certain of RAIs subsidiaries. The audited financial
statements of RJR Tobacco are included as Exhibit 99.1 to
this
Form 10-K,
pursuant to
Rule 3-16
of
Regulation S-X
of SEC regulations, relating to RJRs pledge of its
interest in RJR Tobacco common stock.
The estimated fair value of RAIs and RJRs
outstanding long-term notes, net of current portion, was
$3.0 billion and $1.6 billion, with an effective
average rate of 7.24% and 6.77%, as of December 31, 2006
and 2005, respectively. The estimated fair value of RAIs
outstanding term loan was $1.6 billion as of
December 31, 2006. The fair values are based on available
market quotes and discounted cash flows, as appropriate. At its
option, RAI or RJR, as applicable, 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.
RAI, RJR and their affiliates were in compliance with all
covenants and restrictions imposed by their indebtedness at
December 31, 2006.
Note 13
Financial Instruments
Interest
Rate Arrangements
RAI and RJR use interest rate swaps to manage interest rate risk
on a portion of their respective 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 of debt, with fixed rates of 6.5% to 7.75%,
due in 2006 to 2012, so that the interest payable effectively
becomes variable. During 2005, swaps were settled related to the
$310 million of notes due in 2006 that were purchased in
response to RJRs tender offer. The remaining
$190 million of notes due in 2006 were paid on May 15,
2006, with all related swaps settled. Of the remaining
$750 million RJR publicly registered notes with swap
agreements, $605 million were exchanged for RAI privately
held notes in the second quarter of 2006, and the associated
swaps were assigned to RAI. See note 12 for additional
information.
As of December 31, 2006, the average interest rate on
RAIs consolidated $4.7 billion long-term debt was
7.24% after the effect of the swaps. The interest rate
swaps notional amounts and termination dates match those
of the corresponding outstanding notes. As of December 31,
2006, 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 $15 million and $24 million at
December 31, 2006, and 2005, respectively, included in
other assets and deferred charges and is equal to the increase
in the fair value of the hedged long-term debt.
Under certain conditions, any fair value that results in a
liability position of the interest rate swaps may require full
collateralization with cash or securities.
See notes 7 and 12 for additional disclosures of fair value
for short-term investments and long-term debt.
Credit
Risk
RAI and its subsidiaries minimize counterparty credit risk
related to their financial instruments by using major
institutions with high credit ratings.
Note 14
Commitments and Contingencies
Tobacco
Litigation General
Introduction
Various legal proceedings, including litigation claiming that
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, Conwood or their affiliates, including RAI
and RJR, or indemnitees, including B&W. (As described in
greater detail below, RJR Tobacco has agreed to indemnify
B&W and its affiliates against certain litigation
liabilities.) These legal proceedings include claims relating to
cigarette products manufactured by
126
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
RJR Tobacco or certain of its affiliates and indemnitees, as
well as claims relating to smokeless tobacco products
manufactured by Conwood. A discussion of the legal proceedings
relating to cigarette products is set forth below under the
heading Litigation Affecting the Cigarette
Industry. All of the references under that heading to
tobacco-related litigation, smoking and health litigation and
other similar references are references to legal proceedings
relating to cigarette products and are not references to legal
proceedings involving smokeless tobacco products, and case
numbers under that heading include only cases involving
cigarette products and not cases involving smokeless tobacco
products. The legal proceedings relating to the smokeless
tobacco products manufactured by Conwood are discussed
separately under the heading Smokeless Tobacco
Litigation below.
Certain
Terms and Phrases
Certain terms and phrases used in this disclosure may require
some explanation. The terms judgment or final
judgment refer 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. In most cases,
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 below
under Accounting for Tobacco-Related
Litigation Contingencies.
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 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 alleged
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, Conwood and their 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, or by
the Comprehensive Smokeless Tobacco Health Education Act, the
lack of any defect in the product, assumption of the risk,
contributory or comparative fault, lack of proximate cause,
remoteness, lack of
127
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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.
Accounting
for Tobacco-Related Litigation Contingencies
In accordance with generally accepted accounting principles, RAI
and its subsidiaries, including RJR Tobacco and Conwood, as
applicable, 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, or the loss of any
particular claim concerning the use of smokeless tobacco against
Conwood, 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.
RJR Tobacco recorded less than $1 million related to the
judgment in the Thompson v. B&W individual case
in the fourth quarter of 2006, to be paid in 2007. No other
liability for pending smoking and health tobacco litigation was
recorded in RAIs consolidated balance sheet as of
December 31, 2006. RJR has liabilities totaling
$94 million that were recorded in 1999 in connection with
certain indemnification claims asserted by Japan Tobacco Inc.,
referred to as 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 Litigation Affecting the
Cigarette Industry Other Litigation and
Developments and Other Contingencies and
Guarantees below.
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 Litigation Affecting the Cigarette
Industry
Class-Action
Suits.
|
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
128
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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 Litigation Affecting
the Cigarette Industry 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 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.
The U.S. Department of Justice case brought against various
industry members, including RJR Tobacco and B&W, discussed
below under Litigation Affecting the Cigarette
Industry Governmental Health-Care Cost Recovery
Cases, also can be distinguished from the circumstances
surrounding the MSA and the other state settlement agreements.
Under its Medical Care Recovery Act and Medicare Secondary Payer
Act 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 claim remaining in the
case involved alleged violations of civil provisions 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
U.S. Court of Appeals for the District of Columbia held
that disgorgement is not an available remedy. Trial of the case
concluded on June 9, 2005. On August 17, 2006, the
court found certain defendants liable for the RICO claims and
issued an order for injunctive and other relief, but did not
impose any direct financial penalties. Certain defendants,
including RJR Tobacco, have appealed to the U.S. Court of
Appeals for the District of Columbia. The government also has
appealed. A comprehensive discussion of this case is set forth
below under Litigation Affecting the Cigarette
Industry Governmental Health-Care Cost Recovery
Cases.
Similarly, the other cases settled by RJR Tobacco can be
distinguished from existing cases pending against RJR Tobacco
and its affiliates and indemnitees, including B&W. The
original Broin case, discussed below under
Litigation Affecting the Cigarette
Industry
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
Litigation Affecting the Cigarette
Industry Antitrust Cases, was 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 Litigation
Affecting the Cigarette
Industry MSA Enforcement 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 the merits and should not be affected by the
settlement of prior MSA enforcement cases.
129
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Conwood also believes that it has a number of valid defenses to
the smokeless tobacco litigation against it. Conwood has
asserted and will continue to assert some or all of these
defenses in each case at the time and in the manner deemed
appropriate by Conwood and its counsel. No verdict or judgment
has been returned or entered against Conwood on any claim for
personal injuries allegedly resulting from the use of smokeless
tobacco. Conwood intends to defend vigorously all smokeless
tobacco litigation claims asserted against it. No liability for
pending smokeless tobacco litigation currently is recorded in
RAIs consolidated balance sheet as of December 31,
2006.
Cautionary
Statement
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, or the loss of any particular case concerning the
use of smokeless tobacco against Conwood, 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, Conwood or their affiliates or indemnitees,
or to reasonably estimate the amount or range of any possible
loss.
Although RJR Tobacco believes that it has valid bases for
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 or its affiliates or indemnities, 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 against RJR Tobacco or its affiliates
or indemnitees.
Similarly, smokeless tobacco litigation is subject to many
uncertainties. Notwithstanding the quality of defenses available
to Conwood, 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 against Conwood.
Litigation
Affecting the Cigarette Industry
Overview
Introduction. 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, certain 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.
During the fourth quarter of 2006, 21 tobacco-related cases were
served against RJR Tobacco or its affiliates or indemnitees,
including B&W. On December 31, 2006, there were 1,237
cases (including 942 individual smoker
130
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
cases pending in West Virginia state court as a consolidated
action) pending in the United States against RJR Tobacco or its
affiliates or indemnitees, including B&W, as compared with
1,270 on December 31, 2005, and 1,333 on December 31,
2004, pending against RJR Tobacco or its affiliates or
indemnitees, including B&W.
As of February 2, 2007, 1,271 tobacco-related cases were
pending against RJR Tobacco or its affiliates or indemnitees:
1,263 in the United States; four in Puerto Rico; three in Canada
and one in Israel. Of the 1,263 total U.S. cases, 34 cases
are pending against B&W that are not also pending against
RJR Tobacco. The U.S. case number does not include the
2,624 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 February 2, 2007,
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
February 2, 2007:
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|
Number of
|
|
State
|
|
U.S. Cases
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West Virginia
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947
|
*
|
Florida
|
|
|
100
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|
Missouri
|
|
|
27
|
|
New York
|
|
|
26
|
|
Maryland
|
|
|
23
|
|
Louisiana
|
|
|
20
|
|
Mississippi
|
|
|
19
|
|
California
|
|
|
13
|
|
Illinois
|
|
|
9
|
|
Alabama
|
|
|
5
|
|
Pennsylvania
|
|
|
4
|
|
Tennessee
|
|
|
4
|
|
Delaware
|
|
|
4
|
|
New Jersey
|
|
|
4
|
|
District of Columbia
|
|
|
3
|
|
Georgia
|
|
|
3
|
|
Connecticut
|
|
|
3
|
|
Minnesota
|
|
|
2
|
|
Michigan
|
|
|
2
|
|
Ohio
|
|
|
2
|
|
North Carolina
|
|
|
2
|
|
South Dakota
|
|
|
2
|
|
Vermont
|
|
|
2
|
|
Massachusetts
|
|
|
2
|
|
Kentucky
|
|
|
2
|
|
Oregon
|
|
|
2
|
|
Kansas
|
|
|
2
|
|
Indiana
|
|
|
2
|
|
New Mexico
|
|
|
2
|
|
Washington
|
|
|
2
|
|
South Carolina
|
|
|
2
|
|
Arizona
|
|
|
2
|
|
Texas
|
|
|
1
|
|
Arkansas
|
|
|
1
|
|
Colorado
|
|
|
1
|
|
Hawaii
|
|
|
1
|
|
Iowa
|
|
|
1
|
|
Idaho
|
|
|
1
|
|
Montana
|
|
|
1
|
|
North Dakota
|
|
|
1
|
|
Nebraska
|
|
|
1
|
|
New Hampshire
|
|
|
1
|
|
Nevada
|
|
|
1
|
|
Utah
|
|
|
1
|
|
Virginia
|
|
|
1
|
|
Mariana Islands
|
|
|
1
|
|
Alaska
|
|
|
1
|
|
Maine
|
|
|
1
|
|
Rhode Island
|
|
|
1
|
|
Wisconsin
|
|
|
1
|
|
Wyoming
|
|
|
1
|
|
|
|
|
|
|
Total
|
|
|
1,263
|
|
|
|
|
|
|
|
|
|
* |
|
942 of the 947 cases are pending as a consolidated action. |
Of the 1,263 pending U.S. cases, 49 are pending in federal
court, 1,213 in state court and one in tribal court.
The following table lists the categories of the
U.S. tobacco-related cases pending against RJR Tobacco or
its affiliates or indemnitees as of February 2, 2007,
compared with the number of cases pending against RJR Tobacco,
its affiliates or indemnitees as of October 13, 2006, as
reported in RAIs Quarterly Report on
Form 10-Q
for the
131
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
fiscal quarter ended September 30, 2006, filed with the SEC
on November 7, 2006, and a cross-reference to the
discussion of each case type.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in
|
|
|
|
|
|
|
RJR Tobaccos
|
|
|
Number of
|
|
|
|
|
|
|
Case Numbers as
|
|
|
Cases Since
|
|
|
|
|
|
|
of February 2,
|
|
|
October 13,
|
|
|
Page
|
|
Case Type
|
|
2007
|
|
|
2006
|
|
|
Reference
|
|
|
Individual Smoking and Health
|
|
|
1,169
|
|
|
|
−184
|
|
|
|
138
|
|
Flight Attendant ETS
(Broin II)
|
|
|
2,624
|
|
|
|
−2
|
|
|
|
140
|
|
Class-Action
|
|
|
23
|
|
|
|
+3
|
|
|
|
141
|
|
Governmental Health-Care Cost
Recovery
|
|
|
3
|
|
|
|
No Change
|
|
|
|
150
|
|
Other Health-Care Cost Recovery
and Aggregated Claims
|
|
|
3
|
|
|
|
No Change
|
|
|
|
154
|
|
Master Settlement
Agreement-Enforcement And Validity
|
|
|
49
|
|
|
|
+12
|
|
|
|
155
|
|
Asbestos Contribution
|
|
|
0
|
|
|
|
No Change
|
|
|
|
157
|
|
Antitrust
|
|
|
6
|
|
|
|
+1
|
|
|
|
158
|
|
Other Litigation
|
|
|
10
|
|
|
|
+1
|
|
|
|
160
|
|
Three pending cases against RJR Tobacco and B&W that have
attracted significant media attention are the Florida state
court
class-action
case Engle v. R. J. Reynolds Tobacco Co., the
federal RICO case brought by the U.S. Department of
Justice, and the federal lights class action, Schwab
[McLaughlin] v. Philip Morris USA, Inc.
In 2000, a jury in Engle rendered a punitive damages
verdict in favor of the Florida class of
approximately $145 billion against all defendants. On
July 6, 2006, the Florida Supreme Court, among other
things, affirmed an appellate courts dismissal of the
punitive damages award, decertified the class going forward,
preserved several
class-wide
findings from the trial, including that nicotine is addictive
and cigarettes are defectively designed, and authorized class
members to avail themselves of these findings in individual
lawsuits under certain conditions. On December 21, 2006,
the Florida Supreme Court, in response to motions from both
sides issued a revised opinion in which it set aside the
jurys finding of a conspiracy to misrepresent. The court
also clarified that the future plaintiffs could rely on the
Engle jurys findings on express warranty. The
Supreme Court mandate was issued on January 11, 2007, thus
beginning a one-year period in which class members may file
individual lawsuits.
In the U.S. Department of Justice case, brought in 1999 in
the U.S. District Court for the District of Columbia, the
government sought, among other forms of relief, the disgorgement
of profits pursuant to the civil provisions of RICO. The
U.S. Court of Appeals for the District of Columbia ruled in
2005 that disgorgement is not an available remedy in the case.
The bench trial ended in June 2005, and the court, in August
2006, issued its ruling, among other things, finding the
defendants liable for the RICO claims, imposing no direct
financial penalties on the defendants, but ordering the
defendants to make certain corrective communications
in a variety of media and enjoining the defendants from using
certain brand descriptors. Both sides have appealed to the
U.S. Court of Appeals for the District of Columbia, and the
trial courts order has been stayed pending the appeal.
In September 2006, the U.S. District Court for the Eastern
District of New York in Schwab certified a nationwide
class of lights smokers and set a trial date of
January 22, 2007. On November 16, 2006, the Second
Circuit granted the defendants motions to stay the
district court proceedings and for review of the class
certification ruling. Briefing is complete. Oral argument has
not been scheduled.
For a detailed description of these cases, see
Class Action Suits Engle
Case, Governmental Health-Care Cost
Recovery Cases Department of Justice Case and
Class Action Suits
Lights Cases below.
In November 1998, the major U.S. cigarette manufacturers,
including RJR Tobacco and B&W, entered into the MSA with 46
U.S. states and certain U.S. territories and
possessions. These cigarette manufacturers previously
132
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
settled four other cases, brought on behalf of Mississippi,
Florida, Texas and Minnesota, by separate agreements with each
state. The MSA and other state settlement agreements:
|
|
|
|
|
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 $2.6 billion,
$2.7 billion and $2.0 billion in 2006, 2005 and 2004,
respectively. RJR Tobacco estimates its payments will be
approximately $2.6 billion in 2007 and will be
approximately $2.8 billion thereafter. These payments are
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.
Scheduled Trials. Trial schedules are subject
to change, and many cases are dismissed before trial. Compared
to prior years, however, it is possible that there will be an
increased number of tobacco-related trials against RJR Tobacco
or its affiliates and indemnitees, during 2007. The following
table lists the trial schedule, as of February 2, 2007, for
RJR Tobacco or its affiliates and indemnitees, including
B&W, through December 31, 2007.
|
|
|
|
|
|
|
Trial Date
|
|
Case Name/Type
|
|
Defendant(s)
|
|
Jurisdiction
|
|
January 22, 2007 [ONGOING]
|
|
Whiteley v. R.J. Reynolds
Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
Superior Court San Francisco
County (San Francisco, CA)
|
April 18, 2007
|
|
Falconer v. R.J. Reynolds
Tobacco Co. [Individual]
|
|
RJR Tobacco
|
|
Circuit Court Jackson County
(Kansas City, MO)
|
September 17, 2007
|
|
Hausrath v. Philip Morris
USA, Inc.
[Individual]
|
|
B&W
|
|
NY Supreme Court Erie County
(Buffalo, NY)
|
October 29, 2007
|
|
Williams v.
Brown & Williamson Tobacco
Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court City of
St. Louis (St. Louis, MO)
|
November 20, 2007
|
|
Ryan v. Philip Morris USA,
Inc.
[Individual]
|
|
RJR Tobacco, B&W
|
|
U.S. District Court Northern
District Fort Wayne Division (Indianapolis, IN)
|
Trial Results. From January 1, 1999
through February 2, 2007, 52 smoking and health and
health-care cost recovery cases in which RJR Tobacco or B&W
were defendants were tried. Verdicts in favor of RJR Tobacco,
B&W and, in some cases, RJR Tobacco, B&W and other
defendants, were returned in 36 cases (including four mistrials)
tried in Florida (10), New York (4), Missouri (4), Tennessee
(3), Mississippi (2), California (2), West Virginia (2),
Ohio (2), Connecticut (1), Louisiana (1), New Jersey (1),
Pennsylvania (1), South Carolina (1), Texas (1) and
Washington (1).
Additionally, from January 1, 1999 through February 2,
2007, verdicts were returned in 20 smoking and health cases in
which RJR Tobacco, B&W, or their respective affiliates were
not defendants. Verdicts were returned in
133
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
favor of the defendants in 11 cases four 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, two in each of Florida and Oregon and one in
Illinois. The defendants appeals or post-trial motions are
pending in these cases.
There were no cases in which RJR Tobacco or B&W was a
defendant tried in the third or fourth quarters of 2006.
One case was tried in the second quarter of 2006 in which RJR
Tobacco was a defendant. In Kimball v. R.J. Reynolds
Tobacco Co., an individual smoker case, a Washington state
court jury returned a verdict in favor of RJR Tobacco on
May 15, 2006. On June 20, 2006, the plaintiff waived
his right to appeal or to pursue the case further and RJR
Tobacco agreed to reduce the amount of costs taxed against the
plaintiff.
One case was tried in the first quarter of 2006 in which RJR
Tobacco and B&W were defendants. In VanDenBurg v.
Brown & Williamson Tobacco Corp., an individual
smoker case, a Missouri state court jury returned a verdict in
favor of the defendants, including RJR Tobacco and B&W, on
February 22, 2006. The plaintiffs motion for a new
trial was denied on June 19, 2006. The plaintiffs
deadline for seeking an appeal has passed.
134
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following chart reflects the verdicts and post-trial
developments in the smoking and health cases that have been
tried since January 1, 1999 and remain pending as of
February 2, 2007, in which verdicts have been returned in
favor of the plaintiffs and against RJR Tobacco or B&W, or
both.
|
|
|
|
|
|
|
|
|
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. The Florida Supreme Court
on July 6, 2006 affirmed the dismissal of the punitive damages
award and decertified, on a going-forward basis, the class. The
court preserved a number of classwide findings from Phase I of
the Engle trial, and authorized class members to avail
themselves of those findings in individual lawsuits, provided
they commence those lawsuits within one year of the date the
courts decision becomes final. In addition, the court
reinstated compensatory damage verdicts in favor of two
plaintiffs in the amounts of $2.85 million and $4.023 million,
respectively. On December 21, 2006, the Florida Supreme Court,
in response to motions from both sides issued a revised opinion
in which it set aside the jurys finding of a conspiracy to
misrepresent and clarified that the future plaintiffs could rely
on the Engle jurys findings on express warranty.
The Supreme Court mandate issued on January 11, 2007. On
January 12, 2007, the defendants asked Floridas Third
District Court of Appeals to review issues that had been raised
but not addressed by either appellate court. The Third District
Court of Appeals denied the motion on February 21, 2007.
|
135
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
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 non-economic 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. On August 2, 2006, the plaintiffs filed a motion for
entry of partial judgment and notice of jury trial on punitive
damages. The court granted the defendants motion to
strike as premature the plaintiffs motion. On January 2,
2007, the defendants moved to set aside the June 11, 2002,
verdict to dismiss the plaintiffs punitive damages claim.
On January 3, 2007, the plaintiffs filed a motion for entry of
judgment. A hearing on the motion is scheduled for
March 15, 2007.
|
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.
|
|
On August 22, 2006, the Court of
Appeals for the Western District of Missouri affirmed the
judgment. The Missouri Supreme Court refused to hear the case.
On January 3, 2007, RJR Tobacco, due to its obligation to
indemnify B&W, paid the plaintiff approximately $268,100
(judgment plus interest).
|
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. The defendants motion to stay entry and
enforcement of the final judgment pending further appeals was
granted on January 5, 2007. The defendants filed a notice of
appeal on January 25, 2007.
|
136
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
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,
jointly and severally, for a smoking cessation program.
|
|
On September 29, 2004, the
defendants posted a $50 million bond and noticed their appeal to
the Louisiana Court of Appeal. RJR Tobacco posted $25 million
toward the bond. On February 7, 2007, the Louisiana Court
of Appeal found that any class member who started smoking or
whose right to participate in the program accrued after
September 1, 1988, is not entitled to recovery. The court also
rejected the award of pre-judgment interest and most of the
specific components of the smoking cessation program. However,
the court upheld the class certification and found the
defendants responsible for funding smoking cessation for
eligible class members. On February 21, 2007, the
defendants filed a motion for rehearing.
|
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 June 1, 2005, B&W filed its
notice of appeal. Oral argument occurred on October 5, 2006. A
decision is pending.
|
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.
|
|
On August 18, 2005, B&W filed
its notice of appeal. Pursuant to its agreement to indemnify
B&W, RJR Tobacco posted a supersedeas bond in the amount of
$2.058 million on February 7, 2006. Oral argument occurred on
December 12, 2006. A decision is pending.
|
137
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict
|
|
Case Name/Type
|
|
Jurisdiction
|
|
Verdict
|
|
Post-Trial Status
|
|
August 17, 2006
|
|
United States v. Philip Morris
USA, Inc. [Governmental
Health-Care Cost Recovery]
|
|
U.S. District Court, District of
Columbia (Washington, DC)
|
|
RJR Tobacco and B&W were found
liable for civil RICO claims; were enjoined from using certain
brand descriptors and from making certain misrepresentations;
and were ordered to make corrective communications on five
subjects, including smoking and health and addiction, required
to reimburse the U.S. Department of Justice appropriate costs
associated with the lawsuit, and maintain document web sites.
|
|
On September 11, 2006, RJR Tobacco
and B&W filed their notices of appeal. On October 16, 2006,
the government filed its notice of appeal. In addition, the
government has requested the defendants pay a total of
approximately $1.9 million in costs. The court of appeals
granted the defendants motion to stay the district
courts order on October 31, 2006. On November 28, 2006,
the court of appeals stayed the appeals pending the
defendants motion for clarification of the trial
courts ruling on the order.
|
Individual
Smoking and Health Cases
As of February 2, 2007, 1,169 individual cases, including
942 individual smoker cases in West Virginia state court in a
consolidated action, were pending in the U.S. 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 1,163 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, 2006.
On March 20, 2000, in Whiteley v.
Raybestos-Manhattan, Inc. (a case filed in April 1999, and
pending in Superior Court, San Francisco County,
California), a jury awarded the plaintiffs $1.72 million in
compensatory damages and $20 million in punitive damages.
RJR Tobacco and Philip Morris were each assigned
$10 million of the punitive damages award. The defendants
appealed the final judgment to the California Court of Appeals.
On April 7, 2004, the court of appeals reversed the
judgment and remanded the case for a new trial. On
April 28, 2006, the plaintiffs filed a consolidated amended
complaint for survival/loss of consortium/wrongful death. The
plaintiffs allege that use of the defendants products,
along with exposure to asbestos, caused Mrs. Whiteley to
develop lung cancer and ultimately die. With the filing of the
consolidated complaint, the case name became Whiteley v.
R. J. Reynolds Tobacco Co. Jury selection began on
January 22, 2007. Opening statements occurred on
February 26, 2007.
On October 12, 2000, in Jones v. Brown &
Williamson Tobacco Corp. (a case filed in July 1997, and
pending in Circuit Court, Hillsborough County, Florida), a jury
found against RJR Tobacco and awarded approximately $200,000 in
compensatory damages only. The action was brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, seeking to recover an amount in excess of $150,000.
The plaintiff was also allowed to make a claim for punitive
damages. The plaintiff alleged that Mrs. Joness use
of the defendants products caused her to develop lung
cancer, emphysema, heart disease, chronic obstructive pulmonary
disease, referred to as COPD, and ultimately caused her death.
The judge granted RJR Tobacco a new trial on December 28,
2000, and the new trial decision was affirmed by the Second
District Court of Appeal of Florida on August 30, 2002. On
April 27, 2005, the Florida Supreme Court dismissed the
plaintiffs notice of appeal without prejudice. The
plaintiff dismissed all claims against RJR Tobacco on
April 19, 2006.
On December 21, 2001, in Kenyon v. R. J. Reynolds
Tobacco Co. (a case filed in July 2000 in Circuit Court,
Hillsborough County, Florida), a jury awarded the plaintiff
$165,000 in compensatory damages only in an action brought by
Florence Kenyon against RJR Tobacco seeking to recover
compensatory damages and costs. The
138
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
plaintiff alleged that Mr. Kenyons use of the
defendants products caused his development of lung cancer
and/or other
illnesses. On May 30, 2003, the Second District Court of
Appeal of Florida affirmed per curiam (that is, without writing
an opinion) the trial courts final judgment. After
exhausting its state court appeals, RJR Tobacco paid the
plaintiff approximately $196,000 (judgment plus interest) in
2003. In 2005, RJR Tobacco also paid approximately
$1.3 million in attorneys fees to the
plaintiffs counsel.
On August 15, 2003, a jury returned a verdict in favor of
B&W in Eiser v. Brown & Williamson Tobacco
Corp. (a case filed in March 1999, and pending in
the Court of Common Pleas, Philadelphia County, Pennsylvania).
The plaintiff, Lois Eiser, sought compensatory and punitive
damages in an amount in excess of $50,000, together with
interest, costs of suit and attorneys fees in this
wrongful death action against B&W. The plaintiff contends
the decedents injury and death were directly related to
the actions of the defendants. On January 19, 2006, the
Superior Court of Pennsylvania affirmed the verdict. On
September 22, 2006, the Pennsylvania Supreme Court granted
the plaintiffs petition to appeal. Oral argument is
scheduled for April 16, 2007.
On November 4, 2003, in Thompson v. Brown &
Williamson Tobacco Corp. (a case filed in August 2000 in
Circuit Court, Jackson County, Missouri), a jury awarded
$2.1 million in compensatory damages against B&W and
Philip Morris in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking an unspecified amount of compensatory and
punitive damages. The plaintiffs, Michael Thompson and Christi
Thompson, alleged that the defendants manufactured, sold and
placed in the stream of commerce cigarettes that caused
Mr. Thompsons throat cancer. 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 Missouri Court of Appeals affirmed the judgment on
August 22, 2006 and denied the defendants motion to
transfer the case to the Missouri Supreme Court. The
defendants application for transfer in the Missouri
Supreme Court was denied on December 19, 2006. On
January 3, 2007, RJR Tobacco, due to its obligation to
indemnify B&W, paid the plaintiff approximately $268,100
(judgment plus interest) in satisfaction of the judgment.
On December 18, 2003, in Frankson v. Brown &
Williamson Tobacco Corp. (a case filed in August 2000, and
pending in Supreme Court, Kings County, New York), a 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, in an action brought against
the major U.S. cigarette manufacturers, including RJR
Tobacco and B&W, seeking $270 million in compensatory
damages, unspecified punitive damages, attorneys fees,
costs and disbursements. The plaintiff, Gladys Frankson, alleged
that Mr. Frankson became physically and psychologically
addicted to nicotine, was unable to cease smoking, developed
lung cancer and subsequently died as a result. 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 July 5, 2006, the Appellate Division denied the
defendants appeal of the trial courts decision
denying the defendants post-trial motions. The
defendants motion for rehearing, or in the alternative,
for leave to appeal to the New York Court of Appeals was denied
on October 5, 2006. On November 20, 2006, the
plaintiff filed a motion to enter judgment in the sums of
$175,000 in compensatory damages (the original jury award
reduced by 50%) and $5 million in punitive damages (the
amount the plaintiff stipulated to). The motion was granted on
December 8, 2006, and the defendants filed a notice of
appeal on January 25, 2007. The defendants motion to
stay entry and enforcement of the final judgment pending further
appeals was granted on January 5, 2007. The stay is in
effect for 15 days after the plaintiff serves notice of
entry of judgment in order to allow the defendants to post a
supersedeas bond. Once the plaintiff serves the notice of entry
of judgment, the defendants will file a notice of appeal within
15 days.
139
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On February 1, 2005, a jury returned a split verdict in
Smith v. Brown & Williamson Tobacco Corp.
(a case filed in May 2003, and pending in Circuit Court, Jackson
County, Missouri), finding in favor of B&W on two counts,
fraudulent concealment and conspiracy, and finding in favor of
the plaintiff on the negligence count (which incorporates
failure to warn and product defect claims). The plaintiff,
Lincoln Smith, claimed that the defendants tobacco
products caused Mrs. Smiths death from lung cancer
and sought an unspecified amount of compensatory and punitive
damages. The plaintiff was 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
aggravating circumstances, which provided an entitlement to
punitive damages. On February 2, 2005, the jury awarded the
plaintiff $20 million in punitive damages. On June 1,
2005, B&W filed its notice of appeal with the Missouri Court
of Appeals. Oral argument occurred on October 5, 2006. A
decision is pending. Pursuant to its agreement to indemnify
B&W, RJR Tobacco will post a supersedeas bond in the amount
of $24.3 million if necessary.
On March 18, 2005, in Rose v. Brown &
Williamson Tobacco Corp. (a case filed in December 1996, and
pending in New York Supreme Court, County of New York), a 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. The action was brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking to recover $15 million in compensatory
damages and $35 million in punitive damages. The
plaintiffs, Norma Rose and Leonard Rose, allege that their use
of the defendants products caused them to become addicted
to nicotine and develop lung cancer, COPD and other smoking
related conditions
and/or
diseases. Oral argument on B&Ws appeal occurred on
December 12, 2006. A decision is pending. Pursuant to its
agreement to indemnify B&W, RJR Tobacco posted a supersedeas
bond in the amount of $2.058 million on February 7,
2006.
On February 22, 2006, in VanDenBurg v.
Brown & Williamson Tobacco Corp. (a case filed
in January 2003, and pending in Circuit Court, Jackson County,
Missouri), a jury returned a verdict in favor of the defendants,
including RJR Tobacco and B&W in an action brought against
the major U.S. cigarette manufacturers seeking an
unspecified amount of compensatory and punitive damages. This
individual case was part of a multi-plaintiff action and was
served on the defendants in June and July of 2003. The group of
plaintiffs alleged that their use of the defendants
tobacco products caused each to be inflicted with various types
of cancer. The plaintiffs motion for new trial requesting
an evidentiary hearing was denied on June 19, 2006. The
plaintiffs deadline for seeking an appeal has passed.
On May 15, 2006, in Kimball v. R. J. Reynolds Tobacco
Co. (a case filed in January 2003, and pending in Superior
Court, Whatcom County, Washington), a jury returned a verdict in
favor of the only defendant, RJR Tobacco, in an action seeking
in excess of $75,000 in compensatory and punitive damages. The
plaintiff, Philip Kimball, alleged that Mrs. Kimball
sustained personal injury as a result of using the
defendants products causing damages, including medical
expenses, pain and suffering, anxiety and severe emotional
distress. On June 20, 2006, the plaintiff agreed to waive
his right to appeal or to pursue the case further and RJR
Tobacco agreed to reduce the amount of costs taxed against the
plaintiff.
Broin II
Cases
As of February 2, 2007, there were 2,624 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. Punitive damages are not available in these cases.
On October 5, 2000, the Broin court 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
140
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STATEMENTS (Continued)
elements, and the plaintiffs bear the burden of proving that
their alleged adverse health effects actually were caused by
exposure to ETS. Below is a description of the Broin II
cases against RJR Tobacco and B&W that went to trial,
were decided, remained on appeal or were otherwise pending,
since January 1, 2006.
In Janoff v. Philip Morris, Inc. (a case filed in
February 2000 in Circuit Court, Dade County, Florida), a jury
found in favor of the defendants, including RJR Tobacco and
B&W, on September 5, 2002, in an action brought against
the major U.S. cigarette manufacturers seeking to recover
compensatory damages pursuant to the Broin settlement.
The plaintiff, Suzette Janoff, alleged that as a result of
exposure to ETS in airline cabins, she suffered from, among
other illnesses, chronic sinusitis, chronic bronchitis and other
respiratory and pulmonary problems. The judge granted the
plaintiffs motion for a new trial 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. On November 1, 2005, the Florida
Supreme Court refused to hear the case. At this time, the
plaintiff has not indicated whether the case will be retried.
In Swaty v. Philip Morris, Inc. (a case filed in
September 2000 in Circuit Court, Dade County, Florida), a jury
found in favor of the defendants, including RJR Tobacco and
B&W, on May 3, 2005, in an action brought against the
major U.S. cigarette manufacturers seeking to recover an
unspecified amount of compensatory damages pursuant to the
Broin settlement. The plaintiff, Lorraine Swaty, alleged
that as a result of exposure to ETS in airline cabins, she
suffered from chronic sinusitis and asthma. On November 8,
2006, the Third District Court of Appeal affirmed the verdict.
The plaintiffs motion for rehearing and motion for
clarification was denied on January 11, 2007. The mandate
issued on January 29, 2007.
Class-Action
Suits
Overview. As of February 2, 2007, 23
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
nation-wide 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
nation-wide, 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, West Virginia and the District of Columbia.
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 12 cases alleging that the use of the term
lights constitutes unfair and deceptive trade
practices under state law or violates the federal RICO statute.
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, certain 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. Eighteen federal courts, including two courts of
appeals, and most state courts that have considered the issue
have rejected class certification in such cases. Apart from the
Castano case discussed above, only two federal district
courts have certified a smoker class action In re
Simon (II) Litigation (in which the class was
ultimately decertified) and Schwab [McLaughlin] v.
Philip Morris USA, Inc., discussed below under
Lights Cases, both of
which were filed in the U.S. District Court for the Eastern
District of New York.
In Simon (II) (a case filed in September 2000, and
pending in U.S. District Court, Eastern District, New
York), on September 19, 2002, the court certified a
nationwide mandatory, non-opt-out punitive damages class in an
action brought against the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, and parent
companies of U.S. cigarette manufacturers seeking an
unspecified amount in punitive damages. The class sought to
represent
141
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STATEMENTS (Continued)
persons who suffered from or have died from diseases allegedly
caused by smoking of cigarettes designed, manufactured, marketed
and sold by the defendant cigarette companies. The plaintiffs
alleged that the cigarette companies designed, manufactured,
marketed and sold cigarettes in a defective condition, that they
fraudulently and deceptively denied and concealed that they were
defective and posed significant health risks to those who used
them. On May 6, 2005, the Second Circuit, in a unanimous
opinion, decertified the class. On August 8, 2005, the
Second Circuit denied plaintiffs petition for rehearing
and remanded the case to the District Court for further
proceedings. On March 20, 2006, the court entered final
judgment dismissing the case. The class did not appeal.
On February 10, 2003, in Simms v. Philip Morris,
Inc. (a case filed in May 2001, and pending in the
U.S. District Court, District of Columbia), the court
denied certification of a proposed nation-wide class of smokers
who purchased cigarettes while underage in an action brought
against the major U.S. cigarette manufacturers, including
RJR Tobacco and B&W, seeking: treble damages; disgorgement
of unjust enrichment; to enjoin defendants from engaging in
marketing or advertising campaigns that target
and/or
encourage under-age youth to purchase cigarettes, and from
making false, misleading or deceptive statements concerning the
health effects and addictive natures of cigarettes; to require
the defendants to make corrective statements; and the recovery
of attorneys fees, expert fees and costs. The action was brought
to recover the purchase price paid by the plaintiffs and class
members for defendants products while they were underage,
or in the alternative, to recover the unjust enrichment obtained
by the defendants from the plaintiffs and class members while
they were underage through the use of fraud, deception,
misrepresentation, and other activities constituting
racketeering, in violation of federal law. On December 21,
2006, the court denied the plaintiffs motions for
reconsideration and reversal of the order that denied class
certification.
Medical
Monitoring and Smoking Cessation Cases
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 case filed in May 1996, and pending in District
Court, Orleans Parish, Louisiana), an 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, in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking to recover an unspecified amount of
compensatory and punitive damages. The plaintiffs allege that
their use of the defendants products caused them to become
addicted to nicotine. Opening statements occurred on
January 21, 2003. On July 28, 2003, the jury returned
a verdict in favor of the defendants on the plaintiffs
claim for medical monitoring and found that cigarettes were not
defectively designed. However, the jury also made certain
findings against the defendants on claims relating to fraud,
conspiracy, marketing to minors and smoking cessation.
Notwithstanding 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 pay for a program to help people stop
smoking. On March 31, 2004, phase two of the trial began to
address only 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 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. The Louisiana Court of
Appeal issued its opinion on February 7, 2007. The court
found that any class member who started smoking or whose right
to participate in the program accrued after September 1,
1988, is not entitled to any recovery under Louisiana law. The
court also rejected the award of pre-judgment interest and most
of the specific components of the smoking cessation program.
However, the court upheld the class certification and found the
defendants responsible for funding smoking cessation for
eligible class members. On February 21, 2007, the
defendants filed a motion for rehearing.
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 on May 6,
2004. In Lowe v. Philip Morris, Inc. (a case filed
in November 2001, and
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
pending in Circuit Court, Multnomah County, Oregon), a judge
dismissed the complaint on November 4, 2003, for failure to
state a claim in an action against the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, seeking
creation of a court-supervised program of medical monitoring,
smoking cessation and education, and recovery of attorneys
fees. The plaintiffs appealed, and on September 6, 2006,
the Court of Appeals affirmed the trial courts dismissal
of the plaintiffs complaint. On December 27, 2006,
the plaintiffs filed a petition for review with the Oregon
Supreme Court. Briefing is underway.
Engle
Case
Trial began in July 1998 in Engle v. R. J. Reynolds Tobacco
Co. (a case filed in May 1994, and pending in Circuit Court,
Dade County, Florida), in which a class consisting of Florida
residents, or their survivors, alleges diseases or medical
conditions caused by their alleged addiction to
cigarettes. The action was brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking actual damages and punitive damages in excess
of $100 billion each and the creation of a medical fund to
compensate individuals for future health care costs. The
plaintiffs alleged that their use of the defendants
products caused their development of various illnesses and their
addiction. 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 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 November 6, 2000, the trial judge denied all 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-Dade County Circuit Court with instructions to
decertify the class. The class appealed, and the Florida Supreme
Court accepted the case on May 12, 2004.
On July 6, 2006, the court issued its decision. The court
affirmed the dismissal of the punitive damages award and
decertified the class, on a going-forward basis. The court
preserved a number of
class-wide
findings from Phase I of the trial, including that
cigarettes can cause certain diseases, that nicotine is
addictive and that defendants placed defective and unreasonably
dangerous cigarettes on the market, and authorized class members
to avail themselves of those findings in individual lawsuits,
provided they commence those lawsuits within one year of the
date the courts decision becomes final. The court
specified that the class is confined to those Florida residents
who developed smoking-related illnesses that
manifested themselves on or before November 21,
1996. In addition, the court reinstated the compensatory damages
awards of $2.85 million to Mary Farnan and
$4.023 million to Angie Della Vecchia, but ruled that the
claims of Frank Amodeo were barred by the statute of
limitations. Finally, the court reversed the Third District
Court of Appeals 2003 ruling that class counsels
improper statements during trial required reversal.
On August 7, 2006, RJR Tobacco and the other defendants
filed a rehearing motion arguing, among other things, that the
findings from the Engle trial are not sufficiently
specific to serve as the basis for further proceedings and that
the Florida Supreme Courts application of the
class-action
rule denies defendants due process. On the same day, the
plaintiffs also filed a rehearing motion arguing that some
smokers who became sick after November 21, 1996, and who
are therefore not class members, should nevertheless have the
statute of limitations tolled since they may have refrained from
filing suit earlier in the mistaken belief that they were
Engle class
143
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
members. On December 21, 2006, the Florida Supreme Court
withdrew its July 6, 2006, decision and issued a revised
opinion on December 21, 2006, in which it set aside the
jurys findings of a conspiracy to misrepresent and
clarified that the future plaintiffs could rely on the Engle
jurys findings on express warranty. The court issued
its mandate on January 11, 2007, which begins the one-year
period for individual class members to file lawsuits.
On January 12, 2007, the defendants asked the Third
District Court of Appeal to rule on certain outstanding issues
that were raised by the parties, but not addressed by the court
in its prior rulings. That motion was denied on
February 21, 2007. RAI anticipates individual case filings
in Florida will increase as a result of the Engle
decision.
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,
Lukacs v. Philip Morris, Inc. (a case filed in
February 2001, and pending in Circuit Court, Dade County,
Florida), was tried against Philip Morris, Liggett and B&W,
and resulted in a verdict for the plaintiffs on June 11,
2002, in a personal injury action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking to recover an unspecified amount in
compensatory and punitive damages. The plaintiff alleged that
his use of the defendants brands caused his development of
bladder, throat, oral cavity and tongue cancer. RJR Tobacco was
voluntarily dismissed on May 1, 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. On August 2, 2006, the
plaintiff filed a motion for entry of partial judgment and
notice of jury trial on punitive damages. Trial was scheduled to
begin on November 27, 2006; however, on September 27,
2006, the trial court granted the defendants motion to
strike as premature the plaintiffs motions and removed the
case from the trial calendar. On January 2, 2007, the
defendants asked the court to set aside the jurys
June 11, 2002, verdict for the plaintiffs and to dismiss
the plaintiffs punitive damages claim. On January 3,
2007, the plaintiffs filed a motion for entry of judgment. A
hearing on the motion is scheduled for March 15, 2007.
California
Business and Professions Code Cases
On November 30, 2000, in Daniels v. Philip Morris Cos.,
Inc. (a case filed in April 1998, and pending in Superior
Court, San Diego County, California), a judge, 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 action had
been brought against the major U.S. cigarette
manufacturers, including RJR Tobacco and B&W, seeking to
recover an unspecified amount of compensatory and punitive
damages, restitution to each member of the class and to the
general public, and an injunction prohibiting the defendants
from engaging in further violation of California
Business & Professions Code §17200 and
§17500. The plaintiffs allege that due to the deceptive
practices of the defendants, they became addicted to cigarettes
as teenagers. 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 affirmed
the trial court. On February 16, 2005, the California
Supreme Court granted the plaintiffs petition for review.
Briefing is complete. Oral argument has not been scheduled.
On April 11, 2001, in Brown v. American Tobacco Co.,
Inc. (a case filed in June 1997, and pending in Superior
Court, San Diego County, California), the same judge in
Daniels granted in part the plaintiffs motion for
certification of a class 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. The action was brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, seeking to recover restitution, disgorgement of
profits and other equitable relief under California Business and
Professions Code §17200 et seq. and §17500 et seq.
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 and on the plaintiffs common
law claims. 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,
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2005, the court granted the defendants motion. The
plaintiffs filed a notice of appeal on May 19, 2005. On
September 5, 2006, the California Court of Appeal affirmed
the judges order decertifying the class. On
October 13, 2006, the plaintiffs filed a petition for
review with the California Supreme Court. The petition for
review was granted on November 1, 2006. Briefing is
underway.
Lights
Cases
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 (2),
Washington (1) and New York (1). The class in these cases
generally seek to recover $50,000 to $75,000 per class
member for compensatory and punitive damages, attorneys
fees and costs from RJR Tobacco
and/or
B&W, unless otherwise noted.
On November 14, 2001, in Turner v. R. J. Reynolds
Tobacco Co. (a case filed in February 2000, and pending in
Circuit Court, Madison County, Illinois), a judge 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.... The plaintiffs
claim that the defendants sold and packaged light
cigarettes as having lowered tar and nicotine delivery
when in reality they were designed to deliver higher levels of
tar and nicotine. On June 6, 2003, RJR Tobacco filed a
motion to stay the case pending Philip Morris appeal of
the Price v. Philip Morris Inc. case, which is
discussed below. RJR Tobacco filed an emergency stay/supremacy
order request 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.
On December 18, 2001, in Howard v. Brown &
Williamson Tobacco Corp. (another case filed in February
2000, and pending in Circuit Court, Madison County, Illinois), a
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. The plaintiffs allege that the
defendants violated the Illinois Consumer Fraud and Deceptive
Business Practices Act by not fully disclosing the true nature
of light cigarettes and carried out false and
deceptive advertising concerning light cigarettes.
On June 6, 2003, the trial judge issued an order staying
all proceedings pending resolution of the Price v.
Philip Morris, Inc. case, discussed below. The plaintiffs
appealed this stay order to the Illinois Fifth District Court of
Appeals, which 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. The
case was filed on February 10, 2000, in the Circuit Court
for the Third Judicial Circuit, Madison County, Illinois. The
class members claim that the defendants sold and packaged
light cigarettes as having lowered tar and nicotine
delivery when in reality they were designed to deliver higher
levels of tar and nicotine. 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 the 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. On December 15, 2005, the Illinois Supreme
Court reversed the lower state courts decision and sent
the case back to the lower court with instructions to dismiss
the case. On May 8, 2006, the plaintiffs filed a motion to
stay mandate until final disposition of their petition for
certiorari to the U.S. Supreme Court. The motion was
granted on May 19, 2006. The plaintiffs petition for
writ of certiorari was denied on November 27, 2006. On
December 15, 2006, the Illinois Supreme Court
145
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
reversed the Circuit Courts judgment and remanded the case
with instructions to dismiss. On December 18, 2006, the
defendants filed a motion to dismiss and for entry of final
judgment, which was granted by the court. Judgment was entered
dismissing the case with prejudice on the same day. The
plaintiffs filed a motion to vacate
and/or
withhold judgment in the Circuit Court on January 17, 2007.
In the event RJR Tobacco and its affiliates or indemnitees,
including B&W, lose the Turner or Howard
cases, or one or more of the other pending lights
class action suits, 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.
Schwab [McLaughlin] v. Philip Morris USA, Inc., a
nation-wide lights
class-action,
was filed on May 11, 2004, in the U.S. District Court
for the Eastern District of New York, against RJR Tobacco and
B&W, as well as other tobacco manufacturers. The plaintiffs
seek compensatory and treble damages against each defendant,
jointly and severally, for all losses and damages suffered as a
result of the defendants alleged wrong-doings complained
of, including pre- and post-judgment interest, costs and
disbursements of the action, including attorneys fees and
experts fees and costs. The plaintiffs also seek
temporary, preliminary and permanent equitable
and/or
injunctive relief, including enjoining future wrong-doing,
rescission, disgorgement of defendants ill-gotten funds,
and attaching, impounding or imposing a constructive trust upon
or otherwise restricting the proceeds of defendants
ill-gotten funds. The plaintiffs brought the case pursuant to
RICO, challenging the practices of the defendants in connection
with the manufacturing, marketing, advertising, promotion,
distribution and sale of cigarettes that were labeled as
lights or light. The plaintiffs
motion for class certification and summary judgment motions by
both sides were heard in September 2005. Although trial was
scheduled to commence in January 2006, the court decided to
permit several months of additional discovery before deciding
the class certification issue. The defendants motions for
summary judgment, the plaintiffs supplemental brief in
support of class certification and various other motions were
filed on June 9, 2006. On September 25, 2006, the
court issued its decision, among other things, granting class
certification and setting a trial date of January 22, 2007.
On October 6, 2006, the defendants filed a petition asking
the U.S. Court of Appeals for the Second Circuit to review
the class certification ruling. The defendants also filed a
motion to stay the case pending resolution of the proposed
interlocutory appeal. On November 16, 2006, the Second
Circuit granted the defendants motions to stay the
district court proceedings and for review of the class
certification ruling. Briefing is complete. Oral argument has
not been scheduled.
A lights
class-action
case is pending against each of RJR Tobacco and B&W in
Missouri. On December 31, 2003, in Collora v. R. J.
Reynolds Tobacco Co. (a case filed in May 2000, and pending
in Circuit Court, St. Louis County, Missouri), a 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. The plaintiffs seek
mandatory injunctive relief sufficient to inform consumers of,
among other things, the fact that light smoke is
actually more mutagenic than regular tobacco smoke. The
plaintiffs claim that while promoting low tar and
nicotine deliveries, the defendants designed light cigarettes to
deliver higher levels of tar and nicotine than could be measured
by the standard testing apparatus, therefore achieving support
for the claim that the cigarettes were light and
that they contained low tar and nicotine. On
January 14, 2004, RJR and RJR Tobacco removed this case to
the U.S. 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 again removed the case to
the U.S. District Court for the Eastern District of
Missouri, based on the U.S. 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. The plaintiffs motion
to remand was granted on April 18, 2006. On
December 22, 2006, the plaintiffs filed a motion to
reassign Collora and the following cases to a single
general division: Craft v. Philip Morris Companies,
Inc. and Black v. Brown & Williamson
Tobacco Corp. (discussed below).
In Black v. Brown & Williamson Tobacco Corp. (a
case filed in November 2000, pending in Circuit Court, City of
St. Louis, Missouri), B&W removed the case to the
U.S. District Court for the Eastern District of Missouri on
September 23, 2005. The plaintiffs claim that while
promoting low tar and nicotine deliveries, the
defendants
146
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
designed light cigarettes to deliver higher levels of tar and
nicotine than could be measured by the standard testing
apparatus. They also claim that the defendants failed to
disclose that the smoke produced by the light
cigarettes is more mutagenic than regular tobacco smoke. On
October 25, 2005, the plaintiffs filed a motion to remand,
which was granted on March 17, 2006. As discussed in the
prior paragraph, on December 22, 2006, the plaintiffs filed
a motion to reassign this case and certain other cases to a
single general division.
RJR Tobacco and B&W, respectively, removed two Louisiana
lights
class-actions
to federal court. In Harper v. R. J. Reynolds Tobacco
Co. (filed in May 2003, and pending in U.S. District
Court, Western District, Louisiana), on January 27, 2005,
the judge denied the plaintiffs motions to remand. The
plaintiffs are claiming economic losses for the purchase of RJR
Tobaccos light cigarette brands in Louisiana.
The plaintiffs appealed the denial of the motion, and on
July 17, 2006, the Fifth Circuit Court of Appeals affirmed
the district courts order. On June 17, 2005, RJR
Tobacco and RJR filed a motion for summary judgment based on
federal preemption.
In Brown v. Brown & Williamson Tobacco Corp. (a
case filed in April 2003, and pending in U.S. District
Court, Western District, Louisiana), B&W filed a similar
motion for summary judgment on July 5, 2005. The plaintiffs
are seeking economic losses for the purchase of B&Ws
light cigarette brands in Louisiana, claiming that
these products were defective and marked in a fraudulent and
deceptive manner by defendants. On September 14, 2005, the
court granted the motion in part by dismissing with prejudice
the plaintiffs Louisiana Unfair Trade and Consumer
Protection Act claims. The remainder of the motion was denied.
On December 2, 2005, the judge denied B&Ws motion
for reconsideration, but certified the case for interlocutory
appeal. On February 10, 2006, the U.S. Court of
Appeals for the Fifth Circuit granted B&Ws petition to
appeal. On February 14, 2007, the Fifth Circuit reversed
the judgment and remanded the case with directions to dismiss
all claims with prejudice.
In Dahl v. R. J. Reynolds Tobacco Co. (a case filed in
April 2003, and pending in District Court, Hennepin County,
Minnesota), a judge dismissed the case on May 11, 2005,
because the lights claims are preempted by the
Federal Cigarette Labeling and Advertising Act. The plaintiffs
claim that while promoting low tar and nicotine
deliveries, the defendants designed light cigarettes
to deliver higher levels of tar and nicotine than could be
measured by the standard testing apparatus. They also claim that
the defendants failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes. On July 11, 2005,
the plaintiffs filed a notice of appeal with the Minnesota Court
of Appeals for the Fourth Judicial District. During the pendency
of the appeal, RJR Tobacco removed the case to the
U.S. 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, which was denied on February 14, 2006. On
March 7, 2006, the parties requested that the case be
transferred to the U.S. Court of Appeals for the Eighth
Circuit, which was granted on March 9, 2006. Briefing is
complete. Oral argument occurred on December 14, 2006. A
decision is pending.
In Thompson v. R. J. Reynolds Tobacco Co. (a case filed
in February 2003, and also pending in District Court, Hennepin
County, Minnesota), RJR Tobacco removed the case on
September 23, 2005 to the United States District Court for
the District of Minnesota, also based on Watson v.
Philip Morris Companies, Inc. The plaintiffs claim that
while promoting low tar and nicotine deliveries, the
defendants designed light cigarettes to deliver
higher levels of tar and nicotine than could be measured by the
standard testing apparatus. They also claim that the defendants
failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes. The plaintiffs
motion to remand was denied on February 14, 2006. On
August 7, 2006, the parties filed a stipulation to stay the
case pending resolution of the appeal in Dahl v. R. J.
Reynolds Tobacco Co.
In Huntsberry v. R. J. Reynolds Tobacco Co. (a case filed
in April 2004, and pending in Superior Court, King County,
Washington), the plaintiffs motion for class certification
was denied on April 21, 2006. The case was brought against
RJR Tobacco seeking, among other things, actual economic damages
in the form of a refund of amounts paid by each plaintiff and
the class to purchase RJR Tobaccos light
cigarettes, or in the alternative, diminished value as proven at
trial, treble damages in an amount up to $10,000 per
plaintiff and class member, and attorneys fees. The sum of
all actual damages, treble damages, and attorneys fees is
less than $75,000 per plaintiff or class member. The
plaintiffs allege that the defendants have misrepresented and
continue to misrepresent the tar and nicotine delivery and other
qualities of light cigarettes, deliberately design
and market light cigarettes to
147
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
cause smokers to believe the cigarettes are less hazardous to
smokers and deliver lower tar and nicotine than regular
cigarettes. On September 18, 2006, the plaintiffs
motion for discretionary review was denied. The plaintiffs
motion to modify the ruling with the Washington Court of Appeals
was denied on December 18, 2006. On January 18, 2007,
the plaintiffs filed a petition for review with the Washington
Supreme Court, asking the court to review the rulings that
denied their motions for class certification. The petition will
be considered during a February 22, 2007, motion calendar.
Rios v. R. J. Reynolds Tobacco Co. (a case filed in
February 2002, and pending in Circuit Court, Palm Beach County,
Florida), is dormant pending plaintiffs counsels
attempt to appeal the Florida Fourth District Court of
Appeals decertification in Hines v. Philip Morris,
Inc. The plaintiffs in Rios brought the action
against RJR Tobacco and RJR seeking to recover an unspecified
amount in compensatory (in excess of $15,000 but less than
$75,000 per claimant) and an unspecified amount in punitive
damages. The plaintiffs claim that while promoting
low tar and nicotine deliveries, the defendants
designed light cigarettes to deliver higher levels
of tar and nicotine than could be measured by the standard
testing apparatus. They also claim that the defendants failed to
disclose that the smoke produced by the light
cigarettes is more mutagenic per milligram of tar than
regular cigarettes.
Finally, in Rivera v. Brown & Williamson Tobacco
Corp. (filed in October 2006, pending in Circuit Court,
Broward County, Florida), B&W removed the case to the
U.S. District Court for the Southern District of Florida on
November 15, 2006, and filed their answers to the complaint
on November 22, 2006. The plaintiffs claim that while
promoting low tar and nicotine deliveries, the
defendants designed light cigarettes to deliver
higher levels of tar and nicotine than could be measured by the
standard testing apparatus. They also claim that the defendants
failed to disclose that the smoke produced by the
light cigarettes is more mutagenic per milligram of
tar than regular cigarettes.
Other
Class Actions
In Cleary v. Philip Morris, Inc. (a case filed in June
1998, and pending in Circuit Court, Cook County, Illinois), the
plaintiffs filed their motion for class certification on
December 21, 2001 in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W. The action is brought on behalf of persons who have
allegedly been injured by (1) the defendants
purported conspiracy pursuant to which defendants concealed
material facts regarding the addictive nature of nicotine,
(2) the defendants alleged acts of targeting its
advertising and marketing to minors, and (3) the
defendants claimed breach of the public right to
defendants compliance with the laws prohibiting the
distribution of cigarettes to minors. The plaintiffs request
that the defendants be required to disgorge all profits unjustly
received through its sale of cigarettes to plaintiffs and
classes, which in no event will be greater than $75,000 each,
inclusive of punitive damages, interest and costs. On
April 8, 2005, the plaintiffs filed a second amended
complaint. On February 3, 2006, a hearing on the
defendants motion to dismiss occurred. The court dismissed
count V (public nuisance) and count VI (unjust enrichment) on
March 27, 2006. On April 5, 2006, the plaintiffs filed
a motion to reconsider certain of the findings in the
courts ruling on defendants motion to dismiss counts
V and VI of the plaintiffs second amended complaint. The
plaintiffs motion for reconsideration was granted in part
and denied in part. The court stated that reconsideration would
not revive the plaintiffs public nuisance and unjust
enrichment claims because the plaintiffs still cannot allege a
special or separate harm. The court merely reconsidered certain
components of its analysis, but did not modify its original
decision. On July 11, 2006, the plaintiffs filed a motion
for class certification.
Young v. American Tobacco Co., Inc. (a case filed in
November 1997, and pending in Circuit Court, Orleans Parish,
Louisiana), is an ETS class action against U.S. cigarette
manufacturers, including RJR Tobacco and B&W, and parent
companies of U.S. cigarette manufacturers, including RJR,
on behalf of all residents of Louisiana who, though not
themselves cigarette smokers, have been exposed to secondhand
smoke from cigarettes which were manufactured by the defendants,
and who suffer injury as a result of that exposure. The
plaintiffs seek to recover an unspecified amount of compensatory
and punitive damages. On October 13, 2004, the trial court
stayed this case pending the outcome of the appeal in
Scott v. American Tobacco Co., Inc., discussed under
Medical Monitoring and Smoking Cessation
Cases above.
148
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
In Parsons v. A C & S, Inc. (a case filed in
February 1998, and pending in Circuit Court, Ohio County, West
Virginia), the plaintiff sued asbestos manufacturers,
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and parent companies of U.S. cigarette
manufacturers, including RJR, seeking to recover $1,000,000 in
compensatory and punitive damages individually and an
unspecified amount for the class in both compensatory and
punitive damages. The plaintiffs allege that
Mrs. Parsons use of tobacco products and exposure to
asbestos products caused her to develop lung cancer and to
become addicted to tobacco. The case has been stayed pending a
final resolution of the plaintiffs motion to refer tobacco
litigation to the judicial panel on multi-district litigation
filed in In Re: Tobacco Litigation in the Supreme Court
of Appeals of West Virginia. On December 26, 2000, three
defendants (Nitral Liquidators, Inc., Desseaux Corporation of
North American and Armstrong World Industries) filed bankruptcy
petitions in the U.S. Bankruptcy Court for the District of
Delaware, In re Armstrong World Industries, Inc. Pursuant
to section 362(a) of the Bankruptcy Code, Parsons is
automatically stayed with respect to all defendants.
In Jones v. American Tobacco Co., Inc. (a case filed in
December 1998, and pending in Circuit Court, Jackson County,
Missouri), the defendants removed the case to the
U.S. District Court for the Western District of Missouri on
February 16, 1999. The action was brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and parent companies of U.S. cigarette
manufacturers, including RJR, on behalf of tobacco product users
and purchasers on behalf of all similarly situated Missouri
consumers. The plaintiffs allege that their use of the
defendants tobacco products has caused them to become
addicted to nicotine. The plaintiffs seek to recover an
unspecified amount of compensatory and punitive damages. The
case was remanded to the Circuit Court on February 17,
1999. There has been limited activity in this case.
Finally, a class action complaint was filed against certain
cigarette manufacturers and their parents, including RAI and RJR
Tobacco, in December 2006, in the Circuit Court for Cook County,
Illinois. In Espinosa v. Philip Morris USA, Inc.,
the plaintiffs brought the case on behalf of any and all persons
similarly situated throughout Illinois
and/or the
United States who, from 1996 to the date of judgment, purchased,
not for resale, the defendants cigarettes. The plaintiffs
allege that the defendants increased the nicotine in their
cigarette products and failed to inform the plaintiff
and/or the
class. The plaintiffs seek to recover an amount not less than
the purchase price of defendants cigarette products, plus
interest, attorneys fees and costs and such other relief
as the court deems appropriate. The plaintiffs filed a motion
for class certification and a motion for preservation of
documents on December 11, 2006. On December 12, 2006,
the defendants removed the case to the U.S. District Court
for the Northern District of Illinois.
Broin
Settlement
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
149
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
subsequently denied motions to reconsider. On September 7,
1999, the Florida Supreme Court approved the settlement. 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 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 with each such
state.
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.
|
150
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (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
2004 and beyond:
Unadjusted
Original Participating Manufacturers Settlement Payment
Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 and
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
thereafter
|
|
|
First Four States
Settlements:(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mississippi Annual Payment
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
|
$
|
136
|
|
Florida Annual Payment
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
|
|
440
|
|
Texas Annual Payment
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
|
|
580
|
|
Minnesota Annual Payment
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
|
|
204
|
|
Remaining States Settlement:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Payments(1)
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,004
|
|
|
|
7,143
|
|
|
|
7,143
|
|
|
|
7,143
|
|
Additional Annual Payments (through
2017)(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
861
|
|
|
|
861
|
|
|
|
861
|
|
Base Foundation Funding
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
25
|
|
|
|
|
|
|
|
|
|
Growers Trust (through
2010)(2)
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
500
|
|
|
|
295
|
|
|
|
295
|
|
Offset by federal tobacco buyout(2)
|
|
|
|
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(500
|
)
|
|
|
(295
|
)
|
|
|
(295
|
)
|
Minnesota Blue Cross and Blue Shield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
8,889
|
|
|
$
|
8,389
|
|
|
$
|
8,389
|
|
|
$
|
8,389
|
|
|
$
|
9,389
|
|
|
$
|
9,364
|
|
|
$
|
9,364
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAIs Operating
Subsidiaries Settlement Expenses and Payment
Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement expenses
|
|
$
|
2,183
|
|
|
$
|
2,600
|
|
|
$
|
2,611
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement cash payments
|
|
$
|
2,046
|
|
|
$
|
2,732
|
|
|
$
|
2,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected settlement expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
>2,800
|
|
|
$
|
>2,750
|
|
|
$
|
>2,800
|
|
|
$
|
>2,900
|
|
Projected settlement cash payments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
>2,600
|
|
|
$
|
>2,800
|
|
|
$
|
>2,750
|
|
|
$
|
>2,800
|
|
|
|
|
(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. |
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, apparel and other merchandise, outdoor and transit
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 condition 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 value categories, RJR Tobaccos share of
the domestic premium and value 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 U.S. Department of Justice
brought an action against RJR Tobacco, B&W and other tobacco
companies in the U.S. District Court for the District of
Columbia. The government initially sought to recover federal
funds expended by the federal government in providing health
151
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
care to smokers who have developed diseases and injuries alleged
to be smoking-related. In addition, the government sought,
pursuant to the civil provisions of RICO, disgorgement of
profits the government contends were earned as a consequence of
a RICO racketeering enterprise. In September 2000,
the court dismissed the governments claims asserted under
the Medical Care Recovery Act as well as those under the
Medicare Secondary Payer provisions of the Social Security Act,
but did not dismiss the RICO claims. In February 2005, the
U.S. Court of Appeals for the District of Columbia ruled
that disgorgement is not an available remedy in this case. The
governments petition for rehearing was denied in April
2005, and its petition for writ of certiorari with the
U.S. Supreme Court was denied in October 2005. The bench
(non-jury) trial began in September 2004, and closing arguments
concluded on June 10, 2005.
On August 17, 2006, the court found certain defendants
liable for the RICO claims, but did not impose any direct
financial penalties. The court instead enjoined the defendants
from committing future racketeering acts, participating in
certain trade organizations, making misrepresentations
concerning smoking and health and youth marketing, and using
certain brand descriptors such as low tar,
light, ultra light, mild and
natural. The court also ordered defendants to issue
corrective communications on five subjects,
including smoking and health and addiction, and to comply with
further undertakings, including maintaining web sites of
historical corporate documents and disseminating certain
marketing information on a confidential basis to the government.
The court also placed restrictions on the ability of the
defendants to dispose of certain assets for use in the United
States, unless the transferee agrees to abide by the terms of
the courts order, and ordered the defendants to reimburse
the U.S. Department of Justice its taxable costs incurred
in connection with the case.
Certain defendants, including RJR Tobacco, filed notices of
appeal to the U.S. Court of Appeals for the District of
Columbia on September 11, 2006. The government filed its
notice of appeal on October 16, 2006. In addition, the
defendants, including RJR Tobacco, filed joint motions asking
the district court to clarify and to stay its order pending
defendants appeal. On September 28, 2006, the
district court denied defendants motion to stay. On
September 29, 2006, the defendants, including RJR Tobacco,
filed a motion asking the court of appeals to stay the district
courts order pending the defendants appeal. The
court granted the motion on October 31, 2006. On
November 28, 2006, the court of appeals stayed the appeals
pending the trial courts ruling on the defendants
motion for clarification.
The stay of the district courts order suspends the
enforcement of the order pending the outcome of defendants
appeal. RJR Tobacco does not know the timing of an appellate
decision or, if the order is affirmed, the compliance deadlines
that will be imposed. If the order is affirmed without
modification, then RJR Tobacco believes that certain provisions
of the order (such as the ban on certain brand style descriptors
and the corrective advertising requirements) would have adverse
business effects on the marketing of RJR Tobaccos current
product portfolio and that such effects could be material. Also,
if the order is affirmed, then RJR Tobacco would incur costs in
connection with complying with the order (such as the costs of
changing its current packaging to conform to the ban on certain
brand descriptors and the costs of corrective communications).
Given the uncertainty over the timing and substance of an
appellate decision, RJR Tobacco currently is not able to
estimate reasonably the costs of such compliance. Moreover, if
the order were ultimately affirmed and RJR Tobacco were to fail
to comply with the order on a timely basis, then RJR Tobacco
could be subject to substantial monetary fines or penalties.
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. All of the cases filed by local governments have been
dismissed. As of February 2, 2007, no such cases were
pending.
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. 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
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STATEMENTS (Continued)
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 two health-care reimbursement cases currently pending
against RJR Tobacco and its affiliates or indemnitees, including
B&W, in the United States. In the Republic of
Panama v. The American Tobacco Co. and State of Sao
Paulo v. The American Tobacco Co., the cases,
originally filed in Louisiana, were consolidated and then
dismissed by the trial court on the basis that Louisiana is not
an appropriate forum. These plaintiffs filed new cases in the
Superior Court for the State of Delaware in and for New Castle
County on July 19, 2005, against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, seeking restitution, damages and compensation for all
past and future damages including, but not limited to, all past
and future health-care expenditures for illnesses associated
with tobacco products, punitive or exemplary damages as may be
allowed by law, pre- and post-judgment interest and all costs as
provided by law, reasonable attorneys fees and costs for
all general and equitable relief. The plaintiffs allege that the
defendants are liable under breach of duty, negligence, breach
of implied warranty, breach of express warranty,
misrepresentation and conspiracy. On July 13, 2006, the
Delaware Superior Court granted the defendants motion to
dismiss. The plaintiffs filed notices of appeal to the Delaware
Supreme Court on July 19, 2006. On August 28, 2006,
the appeals were consolidated. Oral argument occurred on
December 6, 2006. On February 23, 2007, the Delaware
Supreme Court affirmed the dismissals.
Two 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 governments subsequent suit
against Canadian defendants and foreign defendants (including
RJR Tobacco) was dismissed in February 2000, when the B.C.
Supreme Court ruled that the legislation was unconstitutional
and set aside service ex juris against the foreign defendants
for that reason. The government then enacted a revised statute
and brought a new action (filed in January 2001, and pending in
Supreme Court, British Columbia). The plaintiff seeks to recover
the present value of the total expenditure by the government for
health-care benefits provided for insured persons resulting from
tobacco-related disease or the risk of tobacco-related disease,
the present value of the estimated total expenditure by the
government for health-care benefits that could reasonably be
expected will be provided for those insured persons resulting
from tobacco-related disease or the risk of tobacco-related
disease, court ordered interest, and costs, or in the
alternative, special or increased costs. The plaintiff alleges
that the defendants are liable under the following theories:
defective product, failure to warn, sale of cigarettes to
children and adolescents, strict liability, deceit and
misrepresentation, and violation of trade practice and
competition acts. In response to motions of certain defendants
challenging, among other things, the constitutionality of the
new statute, the court, in June 2003, dismissed the
governments action and set aside service ex juris. 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 23, 2005, the trial court found that
service was proper. On July 19, 2005, RJR Tobacco filed its
notice of appeal of this ruling. On September 28, 2005, the
Supreme Court, in response to motions of certain defendants,
ruled that the statute is constitutionally valid. On
September 15, 2006, the B.C. Court of Appeal unanimously
ruled that the foreign defendants served ex juris are subject to
British Columbia law, allowing the government to proceed with
its lawsuit against them. On November 10, 2006, RJR Tobacco
filed an application for leave to appeal. The defendants, on
November 24, 2006, filed a motion on consent to stay of
proceedings pending the Supreme Court of Canadas decision
on the leave to appeal.
On September 1, 1998, the General Health Services filed a
statement of claim against certain cigarette manufacturers,
including RJR Tobacco and B&W, in the District Court of
Jerusalem, Israel. The plaintiff seeks to recover the past and
future value of the total expenditures for health-care services
provided to residents of Israel resulting from tobacco-related
disease, court ordered interest for past expenditures from date
of filing the statement of claim, increased
and/or
punitive
and/or
exemplary damages and costs. The plaintiffs allege that the
defendants are liable under the following theories: negligence,
public nuisance, fraud, misleading advertisement, defective
153
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STATEMENTS (Continued)
product, failure to warn, sale of cigarettes to children and
adolescents, strict liability, deceit, concealment,
misrepresentation and conspiracy. In 2002, the plaintiff
obtained leave to serve RJR Tobacco and B&W outside the
jurisdiction. On behalf of RJR Tobacco, JTI filed a motion
challenging the grant of leave, which was denied. JTI appealed
the decision to the Supreme Court. A hearing occurred on
February 14, 2005, and a decision is pending.
Pursuant to the terms of the 1999 sale of RJR Tobaccos
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
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.
As of February 2, 2007, three other health-care cost
recovery cases were pending in the United States against RJR
Tobacco, B&W, as its indemnitee, or both, discussed below.
Union Cases. As of February 2, 2007,
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 U.S. 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 U.S. Supreme
Court has denied petitions for certiorari filed by unions in
cases from the Second, Third, Ninth and District of Columbia
Circuits.
Native American Tribe Cases. As of
February 2, 2007, 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. (a case filed in September 1997, and pending in
Tribal Court, Crow Creek Sioux, South Dakota). The plaintiffs
seek to recover actual and punitive damages, restitution,
funding of a clinical cessation program, funding of a corrective
public education program, and disgorgement of unjust profits
from sales to minors. The plaintiffs claim that the defendants
are liable under the following theories: unlawful marketing and
targeting of minors, contributing to the delinquency of minors,
unfair and deceptive acts or practices, unreasonable restraint
of trade and unfair method of competition, negligence,
negligence per se, conspiracy and restitution of unjust
enrichment. The case is dormant at this time.
Hospital Cases. As of February 2, 2007,
one case brought by hospitals was pending against cigarette
manufacturers, including RJR Tobacco and B&W: City of
St. Louis v. American Tobacco Co., Inc., filed in
November 1998, and pending in the Circuit Court of the City of
St. Louis, Missouri. This case seeks recovery of
uncompensated, unreimbursed health-care costs expended or to be
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 the
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. The case is in discovery.
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 U.S. District Court for the District of
Massachusetts. The
154
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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. The plaintiff alleges that the
defendants concealed, denied and manipulated the addictive
properties of their cigarettes; and engaged in tortious and
other wrongful conduct. On October 24, 2005, the defendants
filed a motion to dismiss or, in the alternative, transfer the
case to the U.S. District Court for the Middle District of
Florida where a virtually identical case against Philip Morris
and Liggett was dismissed. On August 28, 2006, the
defendants motion to dismiss was granted. On
September 7, 2006, the plaintiff filed a notice of appeal
with the U.S. Court of Appeals for the First Circuit. Oral
argument is scheduled for March 6, 2007.
Effective August 1, 2005, Minnesota enacted a health
impact fee that imposes a $0.75 per pack fee on
cigarettes, which is in addition to that states cigarette
excise tax of $0.48 per pack. The stated purpose of the
health impact fee is to recover for the state health care
costs related to or caused by tobacco use. RJR Tobacco and
other cigarette manufacturers filed a motion in Minnesota state
court asserting that imposition of the health impact fee
violated the terms of the settlement agreement entered into
between participating manufacturers and Minnesota in 1998. After
a hearing on this motion, the court ruled, on December 20,
2005, that the health impact fee violated the terms of the
settlement agreement and was unconstitutional. The state
appealed the courts ruling, and on May 16, 2006, the
Minnesota Supreme Court held that the health impact fee neither
violated the terms of the settlement agreement nor was
unconstitutional. On February 20, 2007, the U.S. Supreme
Court denied the defendants petition for writ of
certiorari.
Minnesotas health impact fee also led to the January 2006
filing of a
class-action
complaint in the Fourth Judicial District, Hennepin County,
Minnesota on behalf of consumers of cigarettes and other
tobacco products in the State of Minnesota from August 1,
2005 to the present. The
class-action
complaint named RJR Tobacco and various other entities as
defendants, and asserted an unjust enrichment claim, sought the
imposition of a constructive trust with respect to the monies
collected pursuant to the health impact fee, and requested that
these monies be distributed by the best means practicable
to the Class members. The plaintiffs allege that the
defendants were primarily responsible for remitting the health
impact fee to the State of Minnesota, but the ultimate burden of
the fees was passed on to end-purchase tobacco consumers. This
case was transferred to the court presiding over RJR
Tobaccos above-referenced motion seeking to enforce the
terms of the parties 1998 settlement agreement. On
August 28, 2006, following the ruling by the Minnesota
Supreme Court on RJR Tobaccos challenge to the health
impact fee, the plaintiffs voluntarily dismissed this action.
MSA-Enforcement
and Validity
As of February 2, 2007, there were 49 cases concerning the
enforcement, validity or interpretation of the MSA and other
state settlement agreements in which RJR Tobacco or B&W is a
party. This number includes those cases relating to disputed
payments under the MSA (discussed below).
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 case and, on June 9, 2004, filed
a new action in the U.S. 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
Attorney General for the State of California. 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 U.S. District Court for the
Northern District of California granted the defendants
motion to dismiss with prejudice. The plaintiff appealled to the
U.S. Court of Appeals for the Ninth Circuit. Oral argument
occurred on February 15, 2007.
155
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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
approximately $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. On
March 28, 2005, the U.S. 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 U.S. Court of Appeals for
the Fifth Circuit. On September 1, 2006, the Court of
Appeals affirmed the trial court.
On March 28, 2005, the National Association of Attorneys
General, referred to as NAAG, sent a notice, signed by 40
Attorneys General that one or more of the states intend to
initiate proceedings against RJR Tobacco for violating
Section III(r) of the MSA, the various Consent Decrees
implementing the MSA
and/or
consumer fraud statutes in various states, all in connection
with RJR Tobaccos advertisements for Eclipse cigarettes.
After a June 2005 meeting between representatives of RJR Tobacco
and NAAG, the Vermont Attorney General filed suit in July 2005,
in the Vermont Superior Court, Chittenden County, alleging that
certain Eclipse advertising violated both the MSA and the
Vermont Consumer Fraud Statute. The State of Vermont is seeking
declaratory, injunctive, and monetary relief. RJR Tobacco has
answered the complaint. Discovery is underway. The case is to be
trial ready on October 1, 2007.
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 in the Chancery Court of
Jackson County, Mississippi, 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. This matter is currently in the discovery
phase.
On May 17, 2006, the State of Florida filed a motion, in
the Circuit Court of the Fifteenth Judicial Circuit, in and for
Palm Beach County, Florida, to enforce the Settlement Agreement,
for an Accounting by Brown & Williamson Holdings, Inc.,
and for Order of Contempt, raising substantially the same issues
as raised by the Mississippi Attorney General and seeking
approximately $12.4 million in additional payments under
the Florida Settlement Agreement, as well as $17.0 million
in interest payments. Discovery in this matter is underway.
Effective October 11, 2006, RJR Tobacco entered into a
voluntary agreement with the Attorneys General of 40 states
wherein they settled claims that certain CAMEL, KOOL and SALEM
brand styles with fruit, candy or alcoholic beverage names were
alleged to violate the MSAs prohibition against taking any
action, directly or indirectly, to target youth in the
advertising, promotion or marketing of tobacco products. These
brand styles accounted for less than one-tenth of one percent of
RJR Tobaccos annual cigarette volume and the last of these
styles was discontinued earlier in 2006. There were no fines,
penalties or fees paid by RJR Tobacco as part of the agreement.
The agreement bans the future sale of these brand styles in the
United States and contains restrictions on how flavored
cigarettes (as defined in the agreement) can be marketed and
sold in the future.
The MSA includes an adjustment, referred to as an NPM
Adjustment, that potentially reduces RJR Tobaccos and
other participating manufacturers annual payment
obligations. Certain requirements must be satisfied before the
NPM Adjustment, which relates to a specified market year, is
available. An independent auditor designated under the MSA must
determine that the participating manufacturers have experienced
a certain market share loss to those manufacturers, referred to
as NPMs, that do not participate in the MSA, and an independent
firm of economic consultants must find that the disadvantages of
the MSA were a significant factor contributing to such loss.
For 2003, the MSA independent auditor determined that the
participating manufacturers suffered a market share loss
sufficient to trigger an NPM Adjustment. In March 2006, the
independent economic consulting firm
156
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
issued a final, non-appealable determination that the
disadvantages of the MSA were a significant factor
contributing to the 2003 market share loss. Based on the
foregoing determinations, on April 17, 2006, RJR Tobacco
placed approximately $647 million of its MSA payment into a
disputed payments account, in accordance with a procedure
established by the MSA. That amount represented RJR
Tobaccos share of the 2003 NPM Adjustment as calculated by
the MSA independent auditor.
The settling states contend they have diligently enforced their
respective Qualifying Statutes, within the meaning of the MSA,
and that RJR Tobacco and other participating manufacturers are
not entitled to the 2003 NPM Adjustment. The settling states
also contend that this dispute must be resolved by MSA courts in
each of the 52 settling states and territories. RJR Tobacco
believes that the MSA requires that this dispute be resolved by
arbitration before a panel of three former federal judges.
Between April 13, 2006 and February 2, 2007, 37 of the
settling states filed legal proceedings in their respective
courts seeking declaratory orders that they diligently enforced
their Qualifying Statutes during 2003
and/or
orders compelling RJR Tobacco and the other participating
manufacturers that placed money in the disputed payments account
to pay such disputed amounts to the settling states. RJR Tobacco
intends to defend these proceedings vigorously by, among other
things, moving to compel arbitration as provided in the MSA.
As of February 2, 2007, 34 out of 35 courts that had
addressed the question whether disputes concerning the 2003 NPM
Adjustment are arbitrable had ruled that arbitration is required
under the MSA.
On September 13, 2006, RJR Tobacco and certain of the other
participating manufacturers sent letters to the 15 settling
states that had not yet objected to the arbitration noticed by
the tobacco manufacturers
and/or filed
legal proceedings relating to the dispute regarding the 2003 NPM
Adjustment in their respective MSA courts. These letters stated
that unless the settling states indicated otherwise, the tobacco
manufacturers would assume that these settling states would not
object to the required arbitration. All but one of the settling
states that received these letters responded that they would not
agree to submit the dispute to arbitration and would oppose any
effort to compel arbitration of the dispute. The tobacco
manufacturers have filed motions to compel arbitration in the
MSA courts of all of these settling states, except certain of
the territories.
During 2006, proceedings were initiated and prosecuted with
respect to an NPM Adjustment for 2004. The independent auditor
determined that the participating manufacturers again suffered a
market share loss sufficient to trigger an NPM Adjustment for
2004. On April 17, 2006, RJR Tobacco and the other
cigarette manufacturers initiated the significant
factor proceedings called for under the MSA. On
February 12, 2007, the independent economic consulting firm
retained by the settling states and the cigarette manufacturers
issued a final, non-appealable determination that the
disadvantages of the MSA were a significant factor
contributing to the 2004 market share loss. RJR Tobacco is
evaluating what action to take in light of this determination.
On October 12, 2006, the State of New York sent a
30-day
notice, signed by twenty-six additional attorneys general, that
one or more of these states intended to initiate proceedings
seeking declarations construing one or more terms under the MSA.
The terms that the signatory states identified relate to the
questions presented to the economic consulting firm in the
context of the significant factor proceedings
relating to the expected NPM Adjustment for the year 2004. To
date, no actions have been filed pursuant to this notice.
Asbestos
Contribution Cases
As of February 2, 2007, no lawsuits were 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. The last of those cases,
Fibreboard Corp. v. R. J. Reynolds Tobacco Co.,
filed in November 1997, pending in Superior Court, Alameda
County, California, was dismissed with prejudice on
July 28, 2006. The plaintiffs brought the action against
the major U.S. cigarette manufacturers, including RJR
Tobacco and B&W, seeking: to recover an unspecified amount
in actual and punitive damages; a declaratory judgment
determining, among other things, that there has existed and
currently exists among defendants a conspiracy to abuse the
legal process and spread disinformation and that such conspiracy
has allowed tobacco companies to escape liability for their
relative contribution to injuries caused or
157
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
contributed to by a combination of smoking and exposure to
asbestos; and an order barring advertising directed in part to
those segments of the population exposed to asbestos. The
plaintiffs alleged that the use of the defendants products
is a substantial contributing factor, if not the predominant
factor, in the development of lung cancer and other cancers in
persons exposed to asbestos.
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 U.S. 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
U.S. Court of Appeals for the Eleventh Circuit affirmed
that decision on September 22, 2003. As of February 2,
2007, all state court cases on behalf of indirect purchasers
have been dismissed, except for two cases pending in Kansas and
in New Mexico.
In Smith v. Philip Morris Cos., Inc. (a case filed in
February 2000, pending in District Court, Seward County,
Kansas), the court granted class certification on
November 15, 2001, in an action brought against the major
U.S. cigarette manufacturers, including RJR Tobacco and
B&W, and the parent companies of the major
U.S. cigarette manufacturers, including RJR, seeking to
recover an unspecified amount in actual and punitive damages.
The plaintiffs allege that the defendants participated in a
conspiracy to fix or maintain the price of cigarettes sold in
the United States. Discovery is underway.
In Romero v. Philip Morris Cos., Inc. (a case filed in
April 2000, pending in District Court, Rio Arriba County, New
Mexico), a court granted class certification on May 14,
2003, but granted the defendants motion for summary
judgment on June 30, 2006, in an action brought against the
major U.S. cigarette manufacturers, including RJR Tobacco
and B&W, and the parent companies of the major
U.S. cigarette manufacturers, including RJR, seeking to
recover an amount not to exceed $74,000 per class member in
actual and punitive damages, exclusive of interest and costs.
The plaintiffs allege that the defendants conspired to fix,
raise, advance
and/or
stabilize prices for cigarettes in the State of New Mexico from
at least as early as January 1, 1998, through the present.
On August 14, 2006, the plaintiff filed a notice of appeal
to the New Mexico Court of Appeals.
In a gray market trademark suit originally brought by RJR
Tobacco in February 1999 in the U.S. District Court for the
Northern District of Illinois, Cigarettes Cheaper! asserted
antitrust counterclaims, alleging that it was denied promotional
resources in violation of the Robinson-Patman Act and that RJR
Tobacco had violated Section 1 of the Sherman Antitrust
Act. The defendants counterclaim sought to recover actual
and treble damages, attorneys fees and costs. 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. The court
severed RJR Tobaccos trademark claims (including a
trademark dilution claim) from the defendants
Robinson-Patman claims. Trial on the trademark claims began on
April 25, 2004, and on May 5, 2004, the jury returned
a verdict in favor of RJR Tobacco on all counts in the amount of
$3.5 million. Trial began on the Robinson-Patman claims 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
U.S. Court of Appeals for the Seventh Circuit. On
August 24, 2006, the Court of Appeals affirmed the judgment
of the district court. On September 7, 2006, the plaintiff
filed a petition for rehearing and a petition for rehearing en
banc. Both petitions were denied on September 15, 2006. On
December 14, 2006, the plaintiff filed a petition for writ
of certiorari with the U.S. Supreme Court, which was denied
on February 20, 2007.
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CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On February 16, 2000, an antitrust
class-action
complaint, DeLoach v. Philip Morris Cos., Inc., was
brought against RJR Tobacco, B&W and other cigarette
manufacturers and others, in the U.S. District Court for
the District of Columbia on behalf of a class of all tobacco
growers and tobacco allotment holders. The plaintiffs asserted
that the defendants conspired to fix the price of tobacco leaf
and to destroy the federal governments tobacco quota and
price support program. On November 30, 2000, the case was
moved to U.S. District Court for the Middle District of
North Carolina. In May 2003, the plaintiffs reached a
court-approved settlement with B&W and other cigarette
manufacturer defendants, but not RJR Tobacco. 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 $9.8 million, 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 April 22, 2004, RJR Tobacco and the plaintiffs settled,
and the court approved that settlement on March 21, 2005.
Under that settlement, RJR Tobacco paid $33 million into a
settlement fund, which included costs and attorneys fees. 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. The obligation to purchase leaf was extended an
additional year because the federal government eliminated the
tobacco price quota and price support program at the end of 2005.
Pursuant to an amended complaint filed in the U.S. District
Court for the Eastern District of Tennessee on October 23,
2003, in Smith Wholesale Co. v. R.J. Reynolds Tobacco
Co., Smith Wholesale and Rice Wholesale asserted federal
antitrust claims in connection with RJR Tobaccos
termination of distribution agreements with the plaintiffs. The
plaintiffs seek preliminary and permanent injunctive relief,
enjoining RJR Tobacco from, among other things: continuing with
the termination of the plaintiffs distributorship;
continuing to refuse to honor invoices from the plaintiffs
toward retail buydowns and retail contract payments; further
reducing the price discounts and back-end monies received by the
plaintiffs; and continuing its discriminatory pricing scheme.
The plaintiffs allege that RJR Tobacco, in August 2000,
implemented a discriminatory pricing scheme whereby it sold
cigarettes at different prices to competing distributors,
placing certain distributors at an extreme competitive
disadvantage. As a result of the purported pricing scheme, the
plaintiffs allegedly have suffered substantial damages in the
form of lost profits and sales, loss of customers, loss of
goodwill and additional injuries. Additional wholesalers,
together with the states of Tennessee and Mississippi, have
joined the case as plaintiffs. On June 3, 2005, the
district court granted summary judgment in RJR Tobaccos
favor. 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. Oral
argument in the U.S. Court of Appeals for the Sixth Circuit
occurred on April 21, 2006. RJR Tobacco reached a
non-monetary settlement with one wholesaler and with the states
of Tennessee and Mississippi on July 22, 2005. RJR Tobacco
terminated its distribution agreement with four plaintiffs, and
those plaintiffs moved for preliminary injunctions in the
district court and court of appeals. The courts denied those
motions on November 28 and November 29, 2005, respectively.
In March 2006, McLane Company, Inc., a distributor and RJR
Tobaccos largest customer, acquired one of the remaining
wholesaler plaintiffs, whose claim for damages in this case is
approximately $3 million.
On January 11, 2006, Smith Wholesale filed another lawsuit
against RJR Tobacco and its customer, H.T. Hackney Corp.,
in Carter County, Tennessee Circuit Court. Smith Wholesale seeks
$60 million in damages and a preliminary injunction against
RJR Tobaccos termination of Smith Wholesales
direct-buying status. Smith Wholesale alleges that the
defendants, through agreements with one another and other
actions, engaged in a scheme to damage competition in the
distribution of cigarettes and specifically damage the
plaintiff. The court has not set a hearing date on the
preliminary injunction. The case was removed to federal court on
January 26, 2006. RJR Tobacco filed a motion to dismiss on
February 13, 2006. On February 21, 2006, the
plaintiffs filed, among other things, a motion to remand. On
September 28, 2006, the court granted the plaintiffs
motion to remand the case to the Circuit Court for Carter
County, Tennessee. RJR Tobacco filed a motion to dismiss the
first amended and reinstated complaints on November 27,
2006. The plaintiff filed a motion for temporary injunction on
the same day.
159
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Other
Litigation and Developments
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 responded
appropriately to the subpoena and otherwise cooperated with this
grand jury investigation. Although this investigation has been
dormant for some time now, it remains a pending matter.
By purchase agreement dated May 12, 1999, referred to as
the 1999 Purchase Agreement, RJR and RJR Tobacco sold the
international tobacco business to JTI. RJR and RJR Tobacco
retained certain liabilities relating to the activities of
Northern Brands International, Inc., referred to as Northern
Brands, including those relating to a 1998 guilty plea entered
in the U.S. District Court for the Northern District of New
York, as well as an investigation conducted by the 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-Macdonald, Inc., referred to as
RJR-MI, which led to the termination of his severance agreement.
Under its reading of the indemnification provisions of the 1999
Purchase Agreement, JTI has requested indemnification for any
damages arising out of the matters described below.
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In February 2003, the RCMP filed criminal charges in the
Province of Ontario against and purported to serve summonses on
JTI-Macdonald Corp., referred to as 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 allege 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
each challenged both the propriety of the service of the
summonses and the jurisdiction of the court. On February 9,
2004, the Superior Court of Justice ruled in favor of these
companies. The government filed a notice of appeal from that
ruling on February 18, 2004, but has not actively pursued
an appeal. A preliminary hearing was 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. A decision is still pending.
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In July 2003, a Statement of Claim was filed against JTI-MC and
others in the Superior Court of Justice, Ontario, Canada by
Leslie and Kathleen Thompson. Mr. Thompson is a former
employee of Northern Brands and JTI-MCs predecessor,
RJR-MI. Mr. and Mrs. Thompson have alleged breach of
contract, breach of fiduciary duty and negligent
misrepresentation, among other claims. They are seeking lost
wages and other damages, including punitive damages, in an
aggregate amount exceeding $12 million.
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On September 18, 2003, RJR, RJR Tobacco, RJR-TI, RJR-PR,
and Northern Brands were served with a Statement of Claim filed
in August 2003 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 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. (However, in the
Companies Creditor Arrangement Act proceeding described
below, the Attorney General amended and increased Canadas
claim to $4.3 billion Canadian). The parties have agreed to
a stay of all proceedings pending in the Superior Court of
Justice, subject to notice by one of the parties that it wishes
to terminate the stay. On January 19, 2007, the court
ordered that the case be scheduled for trial no later than
December 31, 2008, subject to further order of the court.
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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, against JTI-MC for alleged unpaid
duties, penalties and interest in an amount of about
$1.36 billion Canadian; (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
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NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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applied for protection under the Companies Creditor
Arrangement Act in the Ontario Superior Court of Justice,
Toronto, Canada, referred to as CCAA Proceedings, and the court
entered an order staying the Quebec Ministry of Revenues
proceedings as well as other claims and proceedings against
JTI-MC. The stay has been extended to May 31, 2007. 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
($450 million Canadian); Nova Scotia ($326 million
Canadian); Prince Edward Island ($75 million Canadian) and
Manitoba ($23 million Canadian). In the CCAA Proceedings,
the Canadian federal government and some of the provincial
governments have asserted that they can make the same tax and
related claims against RJR and certain of its subsidiaries,
including RJR Tobacco. To date, none of those provincial
governments have filed and served RJR or any of its affiliates
with a formal Statement of Claim like the Canadian federal
government did in August and September 2003.
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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. 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.
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In addition, in a letter dated March 31, 2006, counsel for
JTI stated that JTI would be seeking indemnification under the
1999 Purchase Agreement for any damages it may incur or may have
already incurred arising out of the Southern District of New
York grand jury investigation mentioned above, a now-terminated
Eastern District of North Carolina grand jury investigation, and
various actions filed by the European Community and others in
the U.S. District Court for the Eastern District of New
York, referred to as the EDNY, against RJR Tobacco and certain
of its affiliates on November 3, 2000, August 6, 2001
and October 30, 2002 (see below) and against JTI on
January 11, 2002.
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 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 below.
On October 30, 2002, the European Community and ten of its
member states filed a complaint in the EDNY against RJR, RJR
Tobacco and several currently and formerly related companies.
The complaint contains many of the same or similar allegations
found in an earlier complaint (now dismissed) filed in August
2001 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 that were eventually sold in Iraq in
violation of U.S. sanctions. The plaintiffs seek
compensatory, punitive and treble damages among other types of
relief. This matter remains pending, but all proceedings were
stayed while the plaintiffs sought review first by the Court of
Appeals for the Second Circuit and then by the Supreme Court of
the dismissal of their August 2001 complaint. The Court of
Appeals for the Second Circuit affirmed the dismissal, and, on
January 9, 2006, the Supreme Court denied the
plaintiffs petition for a writ of certiorari. This case
remains stayed while the court and the parties work out a
scheduling order.
161
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On December 20, 2000, October 15, 2001, and
January 9, 2003, RJR and the other defendants named in each
of the European Community cases mentioned above filed
applications in the Court of First Instance in Luxembourg
challenging the 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
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 was
stayed pending resolution of the appeals from the
January 15, 2003, judgment denying the admissibility of the
first two applications. On September 12, 2006, the European
Court of Justice upheld the judgment of the Court of First
Instance and dismissed the appeals filed by RJR and its
affiliates. In light of that decision, on October 12, 2006,
RJR and its affiliates withdrew their pending application for
annulment filed in connection with the third European Community
complaint filed on October 30, 2002.
RJR Tobacco has been served in two reparations actions (filed in
October 2002) 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
the U.S. District Court for the Northern District of
Illinois by the Judicial Panel on Multi-District Litigation for
coordinated or consolidated pretrial proceedings with other
reparation actions. The plaintiffs in these actions are asking
for judgment in an amount to satisfy the jurisdictional
limitations of the court, punitive damages sufficient to punish
the defendants, an accounting, imposition of a constructive
trust, restitution of the value of their ancestors slave
labor, and restitution of the value of defendants unjust
enrichment based upon slave labor and the cost of the action.
RJR Tobacco is named, but has not been served, in another
reparations case. That case 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 U.S. 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. On December 13, 2006, the
Seventh Circuit affirmed the dismissal of all claims except the
consumer protection claims. The case was remanded to the
district court for further proceedings.
On June 8, 2001, in California v. R. J. Reynolds Tobacco
Co., the Attorney General of the State of California sued
RJR Tobacco in the Supreme Court of the State of California
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. The plaintiff was seeking a
permanent injunction, enjoining the defendants from distributing
coupons or rebate offers at public events for tobacco products,
that the defendants be ordered to pay a civil penalty for the
violation of unfair competition laws, and that the defendants be
permanently enjoined from the use of any information or other
material collected pursuant to the non-sale distribution of
coupons or other tobacco products. 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 22, 2005, the Supreme
Court of California affirmed the decision with respect to
liability, but remanded the case to the trial court to determine
if the fine imposed was excessive under the
U.S. Constitution. On January 19, 2006, RJR Tobacco
filed a motion to stay issuance of the remittitur pending
petition for a writ of certiorari to the U.S. Supreme
Court, which was granted on February 1, 2006. The parties
settled the case on March 22, 2006. RJR Tobacco agreed to
pay a total of $5 million in penalties, fees and costs.
After the California Supreme Court approved the settlement, RJR
Tobacco paid the settlement amount on June 7, 2006.
162
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On May 23, 2001 and July 30, 2002, Star Scientific,
Inc., referred to as Star, filed two patent infringement
actions, which have been consolidated, against RJR Tobacco in
the U.S. District Court for the District of Maryland. Both
patents at issue are entitled Method of Treating Tobacco
to Reduce Nitrosamine Content, and Products Produced
Thereby, and bear U.S. Patent Nos. 6,202,649 and
6,425,401. The plaintiffs seek: the entry of an injunction
restraining RJR Tobacco from further acts of infringement,
inducement of infringement, or contributory infringement of the
patents; an award of damages to compensate the plaintiffs
lost profits; an award of enhanced damages on account that the
defendants conduct was willful; an award of prejudgment
interest and a further award of post-judgment interest; an award
of reasonable attorneys fees; and an order requiring RJR Tobacco
to deliver up to the court for destruction all products
manufactured from any process which infringes upon, directly or
indirectly or otherwise, any claim of such patent. RJR Tobacco
has filed counterclaims seeking a declaration that the claims of
the two Star patents are invalid, unenforceable and not
infringed by RJR Tobacco. 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. Additionally, in response to the
courts invitation, RJR Tobacco filed two summary judgment
motions on January 20, 2005. On January 19, 2007, the
court released decisions on those two summary judgment motions.
The court granted RJR Tobaccos motion for summary judgment
of invalidity based on indefiniteness. The court granted in part
and denied in part RJR Tobaccos other summary
judgment motion concerning the effective filing date of the
patents in suit. The court also advised the parties on
January 19, 2007, that it expects to issue its ruling on
the inequitable conduct trial before the end of February 2007.
The court further stated that, by virtue of the grant of RJR
Tobaccos summary judgment motion of invalidity based on
indefiniteness, it will enter a final judgment in RJR
Tobaccos favor after the decision on the inequitable
conduct trial irrespective of whether that decision is in RJR
Tobaccos favor.
On September 22, 2005, RJR Tobacco filed a case in the
U.S. District Court for the Western District of
North Carolina against Market Basket Food Stores and other
cigarette retailers and wholesalers located in the states of
North Carolina, Tennessee, Virginia and Kentucky to stop and
remedy the ongoing conspiracy to abuse RJR Tobaccos
marketing programs, including the buy-down and coupon programs.
The complaint alleged violations of the federal and North
Carolina RICO statutes and the North Carolina Unfair and
Deceptive Trade Practices Act, along with common law fraud,
breach of contract and conspiracy. RJR Tobacco seeks actual
damages in an amount to be proven at trial, treble damages, an
accounting of the defendants profits, disgorgement of the
defendants ill-gotten proceeds and gains, a constructive
trust on all funds or property that are the proceeds or profits
of defendants participation in the scheme, costs of
investigating the acts giving rise to this cause of action,
attorneys fees and experts fees, and such other and
further relief as the court deems appropriate. A motion for
preliminary injunction requested that the court enjoin certain
defendants from performing the fraudulent acts detailed in the
complaint. On August 21, 2006, the court denied the
outstanding motions to dismiss in their entirety and lifted the
earlier stay of discovery. On January 30, 2007, the court
granted RJR Tobaccos motion for preliminary injunction.
Discovery is underway. As of February 2, 2007, RJR Tobacco
had settled with 12 of the 20 defendants.
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. 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. The scope of the indemnity will be at issue and has
not been determined.
Smokeless
Tobacco Litigation
As of February 2, 2007, Conwood is a defendant in 8 actions
brought by individual plaintiffs in West Virginia state court
seeking damages in connection with personal injuries allegedly
sustained as a result of the usage of Conwoods smokeless
tobacco products. These actions are pending before the same West
Virginia court as the 942 consolidated individual smoker
cases against RJR Tobacco, B&W, as RJR Tobaccos
indemnitee, or both. On December 3, 2001, the court severed
the smokeless tobacco defendants, and this litigation has been
dormant.
163
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Pursuant to an amended complaint filed in July 2005, Conwood is
a defendant in Vassallo v. United States Tobacco
Company, pending in the Eleventh Circuit Court in Miami-Dade
County, Florida. The individual plaintiff in this case alleges
that he sustained personal injuries including addiction and
cancer as a result of his use of smokeless tobacco products,
allegedly including products manufactured by Conwood. The
plaintiff seeks unspecified compensatory and consequential
damages in an amount greater than $15,000, as well as punitive
damages. This case is still in its early stages.
Tobacco
Buyout Legislation
On October 22, 2004, the President signed the Fair and
Equitable Tobacco Reform Act of 2004, referred to as FETRA,
eliminating the U.S. governments 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 $9.9 billion, including
approximately $9.6 billion payable to quota tobacco holders
and growers through industry assessments over ten years and
approximately $290 million for the liquidation of quota
tobacco stock. As a result of the tobacco buyout legislation,
the MSA Phase II obligations established in 1999 will be
continued as scheduled through the end of 2010, 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 $230 million to $280 million.
RAIs operating subsidiaries incurred $81 million in
2005 related to assessments from quota tobacco stock
liquidation. In the first quarter of 2006, a $9 million
favorable adjustment was recorded relating to the tobacco stock
liquidation assessment. Remaining contingent liabilities for
liquidation of quota tobacco stock, if any, will be recorded
when an assessment is made. See note 1 for additional
information related to federal tobacco buyout expenses.
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. In addition, future market
pricing could impact the carrying value of inventory, and
adversely affect RJR Tobaccos financial condition and
results of operations.
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 U.S. 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 require 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
U.S. 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. The parties
have filed supplemental briefs regarding the motion to dismiss.
On
164
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
June 6, 2006, the plaintiff filed a motion to amend the
complaint to name as party defendants six individuals who were
members of the two defendant committees. The defendants have
opposed that motion, 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 with third parties under the
Comprehensive Environmental Response, Compensation and Liability
Act 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 U.S. Environmental
Protection Agency 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.
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 certain liabilities, costs and
expenses incurred by B&W or its affiliates arising out of
the U.S. cigarette and tobacco business of B&W. As a
result of this indemnity, RJR Tobacco has assumed the defense of
pending B&W-specific tobacco-related litigation, has paid
the judgments and costs related to certain pre-business
combination tobacco-related litigation of B&W, and has
posted bonds on behalf of B&W, where necessary, in
connection with cases decided since the business combination. In
addition, pursuant to this indemnity, RJR Tobacco expensed
$4 million and $36 million during 2006 and 2005,
respectively, for funds to be reimbursed to BAT for costs and
expenses incurred arising out of tobacco-related litigation.
Although it is impossible to predict the possibility or amount
of any additional future payments by RJR Tobacco under this
indemnity, a significant indemnification claim by B&W
against RJR Tobacco could have an adverse effect on any or all
of RAI, RJR and RJR Tobacco.
As a result of the business combination of RJR Tobacco and the
U.S. cigarette and tobacco business of B&W, RJR Tobacco
also has agreed to indemnify Commonwealth Brands, Inc. for
certain claims brought in two individual smoking and health
cases, Croft v. Akron Gasket and Ryan v.
Philip Morris, U.S.A., Inc., to the extent, if any, such
indemnification is required by the 1996 Purchase Agreement. See
Litigation Affecting the Cigarette
Industry Other Litigation and Developments
above for further information on these cases.
In connection with the sale of the international tobacco
business to JTI, on May 12, 1999, pursuant to the 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;
|
|
|
|
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
|
165
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
any liabilities, costs and expenses incurred by JTI or any of
its affiliates arising out of certain activities of Northern
Brands.
|
As described above in Litigation Affecting the
Cigarette Industry 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 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 $94 million that were
recorded in 1999 in connection with these indemnification claims.
RJR Tobacco, Santa Fe, Conwood 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, Conwood 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, any fair value that results in a
liability position of the interest rate swaps will require full
collateralization with cash or securities. See note 13 for
further information.
Except as otherwise noted above, RAI is not able to estimate the
maximum potential amount of future payments, if any, related to
these guarantees and indemnification obligations.
Employees
At December 31, 2006, RAI and its subsidiaries had
approximately 7,500 full-time employees and
approximately 300 part-time employees. The
7,500 full-time employees include approximately 6,000 RJR
Tobacco employees and 800 Conwood employees. No employees of RAI
or its subsidiaries are unionized.
Note 15
Shareholders Equity
RAIs authorized capital stock at December 31, 2006,
consisted of 100 million shares of preferred stock, par
value $.01 per share, and 400 million shares of common
stock, par value $.0001 per share. Of the preferred stock,
four million shares are designated as Series A Junior
Participating Preferred Stock, none of which is issued or
outstanding. The Series A Preferred Stock will rank junior
as to dividends and upon liquidation to all other series of RAI
preferred stock, unless specified otherwise. Also, of the
preferred stock, one million shares are designated as
Series B Preferred Stock, all of which are issued and
outstanding. The Series B Preferred Stock ranks senior upon
liquidation, but not with respect to dividends, to all other
series of RAI capital stock, unless specified otherwise. As a
part of the B&W business combination, RJR is the holder of
the outstanding Series B Preferred Stock. In 2006, RAI
declared $43 million in dividends to RJR with respect to
the Series B Preferred Stock.
On July 30, 2004, RAIs board of directors adopted a
shareholder rights plan, pursuant to which RAI declared a
dividend of one preferred stock purchase right on each share of
RAIs common stock outstanding on July 30, 2004. The
board also authorized the issuance of rights for each share of
RAI common stock issued after the dividend record date, until
the occurrence of certain specified events. The rights will
expire on July 30, 2014, unless earlier redeemed, exercised
or exchanged under the terms of the rights plan.
The rights are not exercisable until a distribution date that is
the earlier of:
|
|
|
|
|
ten days following an announcement that a person or group, other
than BAT and its subsidiaries, except in certain circumstances,
has acquired beneficial ownership of at least 15% of RAIs
common stock, and
|
166
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
ten business days, or such later date as may be determined by
the board, following the announcement of a tender offer which
would result in a person becoming an acquiring person.
|
If the acquiring person or tender offeror is BAT or one of its
subsidiaries, then the foregoing 15% threshold is subject to
adjustment. The rights are initially exercisable for
1/100th of a share of RAIs Series A Junior
Participating Preferred Stock at a purchase price of $130,
subject to adjustment. Each fractional share of such preferred
stock would give the holder approximately the same dividend,
voting and liquidation rights as does one share of RAIs
common stock. Until the distribution date, the rights will be
evidenced by RAIs common stock certificates and trade with
such shares. Upon the occurrence of certain events after the
distribution date, holders of rights, other than the acquiring
person, will be entitled to receive upon exercise of the right,
in lieu of shares of preferred stock, RAI common stock or common
stock of the acquiring corporation having in either case a
market value of two times the exercise price of the right.
For the first and second quarter of 2004, RJRs board of
directors declared a quarterly cash dividend of $0.475 per
common share, or $1.90 on an annualized basis. RAIs board
of directors declared quarterly cash dividends of
$0.475 per common share for the third and fourth quarters
of 2004 and for the first and second quarters of 2005. The third
quarter 2005 cash dividend was increased to $0.525, and the
fourth quarter 2005 cash dividend was increased to
$0.625 per common share, or $2.50 on an annualized basis.
For the first and second quarters of 2006, quarterly cash
dividends were declared of $0.625 per common share and
quarterly cash dividends were declared of $0.75 per common
share in the third and fourth quarters of 2006, or $3.00 on an
annualized basis.
RAI repurchases and cancels shares of its common stock forfeited
with respect to the tax liability associated with certain option
exercises and vesting of restricted stock grants under the RAI
Long-Term Incentive Plan. During 2006, RAI repurchased and
cancelled 207 shares of its common stock.
Note 16
Stock Plans
In the first quarter of 2006, RAI adopted
SFAS No. 123(R), Share-Based Payment,
issued by the FASB in December 2004. 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. RAIs adoption of
SFAS No. 123(R) did not have a material impact on its
financial condition, results of operations or cash flows
primarily because all of RAIs outstanding stock options
are fully vested. Upon retirement, the holders grant under
the LTIP, defined below, generally vests on a pro-rata basis for
the portion of the vesting service period that has elapsed,
thereby maintaining an appropriate estimate of forfeitures
related to retirement. Based on historical experience, the
anticipated future forfeiture amount for other events is
immaterial and, therefore, no estimate has been recorded.
As of December 31, 2006, RAI had two stock plans, the
Equity Incentive Award Plan for Directors of Reynolds American
Inc., referred to as the EIAP, and the Reynolds American Inc.
Long-Term Incentive Plan, referred to as the LTIP. All share
amounts have been retroactively adjusted to reflect the
August 14, 2006,
two-for-one
stock split. See note 1 for additional information.
The EIAP currently provides for (1) grants of deferred
stock units to outside directors upon becoming a director or,
provided the director did not receive an initial award upon
his/her
election to the board, upon appointment to the position of
Non-Executive Chairman and (2) grants of deferred stock
units to outside directors on a quarterly and annual basis
thereafter. Directors may elect to receive shares of common
stock in lieu of their initial and annual grants of deferred
stock units. A maximum of 1,000,000 shares of common stock
may be issued under this plan, of which 652,421 shares were
available for grant as of December 31, 2006. Deferred stock
units granted under the EIAP have a value equal to, and bear
dividend equivalents at the same rate as, one share of
RAIs common stock, and have no voting rights. The
dividends are paid as additional units in an amount equal to the
number of common shares that could be purchased with the
dividends on the date of payment. As soon as practicable
following his or her last year of service on the board, the
director is paid in cash for the units granted quarterly and in
common stock for the units granted initially and annually,
unless the director elects to receive cash
167
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
for the initial and annual grants. Cash payments are based on
the average closing price of RAIs common stock during
December of the year preceding payment. Compensation expense
related to the EIAP was $4 million for each of the years
ended 2006, 2005 and 2004.
The LTIP provides for grants of incentive stock options, other
stock options, stock appreciation rights, restricted stock,
performance units and performance shares to key employees. The
total number of shares of common stock authorized for grant
under the LTIP is 27,545,628 shares. Of this authorization,
9,767,081 shares were available for grant as of
December 31, 2006.
In 2001, RJR granted 609,180 shares of restricted stock at
$26.48 to eligible employees under the 1999 LTIP. This grant was
accounted for as a variable grant and, accordingly, the fair
value was charged to shareholders equity as unearned
compensation and was amortized over the three-year vesting
period. Since the date of the grant, 118,204 restricted shares
were forfeited and restrictions on 490,976 shares lapsed.
In 2002, RJR granted 669,532 shares of restricted stock at
$26.745 to eligible employees under the 1999 LTIP. This grant
was accounted for as a variable grant and, accordingly, the fair
value was charged to shareholders equity as unearned
compensation and was amortized over the vesting period. Since
the date of the grant, 72,646 restricted shares were forfeited
and restrictions on 596,886 shares lapsed. Concurrent with
the completion of the B&W business combination, all
remaining restrictions lapsed and the remaining unamortized
equity was charged to compensation expense.
In 2003, RJR granted 802,628 shares of restricted stock at
$17.76 to eligible employees under the 1999 LTIP. The actual
number of shares granted was fixed and the market price of the
stock on the grant date was charged to shareholders equity
as unearned compensation and was amortized over the vesting
period. Since the date of the grant, 2,828 restricted shares
were forfeited and restrictions on 799,800 shares lapsed.
Concurrent with the completion of the B&W business
combination, all remaining restrictions lapsed and the remaining
unamortized equity was charged to compensation expense.
In 2004, RAI granted 972,432 performance shares to eligible
employees under the LTIP. The shares are phantom stock, payable
in cash, based on the closing price of RAI stock on the date of
vesting. The shares vest ratably over three years unless
forfeited. The actual number of shares granted is fixed. The
amount of the liability for the award is remeasured each
reporting period based on RAIs current stock price.
Compensation expense includes the effects of changes in the
stock price, the portion of vesting period elapsed and dividend
equivalents paid concurrently with RAI dividends. Since the date
of grant, 142,455 shares were cancelled, and 579,008 have
vested and were paid.
In 2005, RAI granted 552,194 performance shares to eligible
employees under the LTIP. The shares are phantom stock, payable
in cash, based on the closing price of RAI stock on the date of
vesting, March 2, 2008. The actual number of shares granted
is fixed. The amount of the liability for the award is
remeasured each reporting period based on RAIs current
stock price. Compensation expense includes the effects of
changes in the stock price, the portion of vesting period
elapsed and dividend equivalents paid concurrently with RAI
dividends. Since the date of grant, 33,531 shares were
cancelled, and 19,239 have vested and were paid.
On February 1, 2006, the Board of Directors of RAI approved
the grant of shares of restricted RAI common stock under the
LTIP, effective March 6, 2006. The 507,060 restricted
shares were granted based on the per share closing price of RAI
common stock on March 6, 2006, of $52.60. On
September 18, 2006, an additional 9,084 shares of
restricted stock were granted based on the per share closing
price of RAI common stock of $66.05. The amount of the liability
for the award is remeasured each reporting period based on
RAIs current stock price. The shares of restricted RAI
common stock generally will vest on March 6, 2009.
Compensation expense includes the effects of
168
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
changes in the stock price and the vesting period elapsed.
Dividends paid concurrently with RAI dividends are recognized as
a reduction of equity. The changes in restricted RAI common
stock during 2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Restricted
|
|
|
Grant Date
|
|
|
|
Stock
|
|
|
Fair Value
|
|
|
Outstanding at beginning of year
|
|
|
|
|
|
$
|
|
|
Granted
|
|
|
516,144
|
|
|
|
52.84
|
|
Forfeited
|
|
|
(3,924
|
)
|
|
|
52.60
|
|
Vested
|
|
|
(550
|
)
|
|
|
52.60
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of year
|
|
|
511,670
|
|
|
|
52.84
|
|
|
|
|
|
|
|
|
|
|
Payments related to stock-based compensation, including
dividends paid, were $22 million, $15 million and
$3 million for the years ended 2006, 2005 and 2004,
respectively.
Total compensation expense, including dividends, related to
stock-based compensation and the related tax benefits recognized
in selling, general and administrative expenses in the
consolidated statements of income were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2001 LTIP restricted stock
|
|
$
|
|
|
|
$
|
|
|
|
$
|
1
|
|
2002 LTIP restricted stock
|
|
|
|
|
|
|
|
|
|
|
14
|
|
2003 LTIP restricted stock
|
|
|
|
|
|
|
|
|
|
|
12
|
|
2004 LTIP performance shares
|
|
|
17
|
|
|
|
21
|
|
|
|
9
|
|
2005 LTIP performance shares
|
|
|
15
|
|
|
|
8
|
|
|
|
|
|
2006 LTIP restricted stock
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total compensation expense
|
|
$
|
42
|
|
|
$
|
29
|
|
|
$
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total related tax benefits
|
|
$
|
16
|
|
|
$
|
12
|
|
|
$
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the consolidated balance sheet as of December 31, 2006,
$14 million is included in other current liabilities and
$30 million is included in other noncurrent liabilities
relating to the 2004 and 2005 LTIP performance share grants and
the 2006 LTIP restricted stock grants. At December 31,
2006, there were $40 million of unrecognized compensation
costs related to restricted stock and performance shares,
calculated at the December 31, 2006, ending stock price,
which are expected to be recognized over a weighted-average
period of 1.7 years.
In the EIAP and the LTIP, options were granted primarily prior
to 1999 and to a lesser extent through 2003, all of which are
fully vested. For various price ranges, the weighted average
characteristics of stock options outstanding, all of which were
exercisable at December 31, 2006, were as follows:
Options
Outstanding as of December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
Weighted
|
|
|
|
|
|
|
Contractual
|
|
|
Average
|
|
Exercise Price Range
|
|
Shares
|
|
|
Life (Years)
|
|
|
Exercise Price
|
|
|
$13.05 - $16.85
|
|
|
486,178
|
|
|
|
3.1
|
|
|
$
|
13.65
|
|
19.93 - 24.16
|
|
|
7,746
|
|
|
|
0.7
|
|
|
|
21.35
|
|
34.90 - 34.90
|
|
|
20,000
|
|
|
|
5.4
|
|
|
|
34.90
|
|
RAI has a policy of issuing new shares of common stock to
satisfy share option exercises. Of the options outstanding as of
December 31, 2006, 42,800 were issued under the EIAP, and
under the LTIP, 431,124 were issued
169
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
prior to 1999 and 40,000 were issued in tandem with shares of
restricted stock in 1999. The changes in RAIs stock
options during 2006, 2005 and 2004 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Exercise
|
|
|
|
|
|
Exercise
|
|
|
|
|
|
Exercise
|
|
|
|
Options
|
|
|
Price
|
|
|
Options
|
|
|
Price
|
|
|
Options
|
|
|
Price
|
|
|
Outstanding at beginning of year
|
|
|
817,994
|
|
|
$
|
14.90
|
|
|
|
1,026,022
|
|
|
$
|
14.71
|
|
|
|
3,990,826
|
|
|
$
|
14.73
|
|
Expired
|
|
|
(61,232
|
)
|
|
|
16.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(242,838
|
)
|
|
|
15.05
|
|
|
|
(208,028
|
)
|
|
|
13.94
|
|
|
|
(2,964,804
|
)
|
|
|
14.73
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of year
|
|
|
513,924
|
|
|
|
14.59
|
|
|
|
817,994
|
|
|
|
14.90
|
|
|
|
1,026,022
|
|
|
|
14.71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of year
|
|
|
513,924
|
|
|
|
14.59
|
|
|
|
817,994
|
|
|
|
14.90
|
|
|
|
1,026,022
|
|
|
|
14.71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The intrinsic value of options exercised was $10 million,
$6 million and $59 million for the years ended
December 31, 2006, 2005 and 2004, respectively. The
aggregate intrinsic value of fully vested outstanding and
exercisable options at December 31, 2006, was
$26 million. Cash proceeds related to stock options
exercised and excess tax benefits related to stock-based
compensation were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Proceeds from exercise of stock
options
|
|
$
|
4
|
|
|
$
|
3
|
|
|
$
|
43
|
|
Excess tax benefits from
stock-based compensation
|
|
|
4
|
|
|
|
12
|
|
|
|
13
|
|
Equity compensation plan information is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Remaining Available for
|
|
|
|
Number of Securities
|
|
|
Weighted-Average
|
|
|
Future Issuance under
|
|
|
|
to be Issued Upon
|
|
|
Exercise Price of
|
|
|
Equity Compensation
|
|
|
|
Exercise of
|
|
|
Outstanding
|
|
|
Plans (Excluding
|
|
|
|
Outstanding Options,
|
|
|
Options, Warrants
|
|
|
Securities Reflected in
|
|
Plan Category
|
|
Warrants and Rights
|
|
|
and Rights
|
|
|
Column (a))
|
|
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
Equity Compensation Plans Approved
by Security Holders
|
|
|
471,124
|
|
|
$
|
13.65
|
|
|
|
9,767,081
|
|
Equity Compensation Plans Not
Approved by Security Holders(1)
|
|
|
42,800
|
|
|
|
24.95
|
|
|
|
652,421
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
513,924
|
|
|
|
14.59
|
|
|
|
10,419,502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
The EIAP is the only equity compensation plan not approved by
RAIs or RJRs public shareholders. The EIAP was
approved by RJRs sole shareholder, NGH, prior to
RJRs spin-off on June 15, 1999. |
Note 17
Retirement Benefits
RAI and certain of its subsidiaries sponsor a number of
non-contributory defined benefit pension plans covering most of
their employees, and also provide certain health and life
insurance benefits for most of their retired employees and their
dependents. These benefits are generally no longer provided to
employees hired on or after January 1, 2004.
In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and
Other Postretirement Plans-an amendment of FASB Statements
No. 87, 88, 106, and 132(R), which became effective
for RAI at December 31, 2006. SFAS No. 158
requires balance sheet recognition of the net asset or liability
for the overfunded or underfunded status of defined benefit
pension and other postretirement benefit plans, on a
plan-by-plan
basis, and recognition of changes in the funded status in the
year in which the changes occur.
170
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The incremental effect of applying SFAS No. 158 on
individual line items in the consolidated balance sheet as of
December 31, 2006, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Before
|
|
|
|
|
|
After
|
|
|
|
Application of
|
|
|
SFAS No. 158
|
|
|
Application of
|
|
|
|
SFAS No. 158
|
|
|
Adjustments
|
|
|
SFAS No. 158
|
|
|
Other assets and deferred charges
|
|
$
|
328
|
|
|
$
|
(16
|
)
|
|
$
|
312
|
|
Total assets
|
|
|
18,194
|
|
|
|
(16
|
)
|
|
|
18,178
|
|
Other current liabilities
|
|
|
1,468
|
|
|
|
(303
|
)
|
|
|
1,165
|
|
Total current liabilities
|
|
|
4,395
|
|
|
|
(303
|
)
|
|
|
4,092
|
|
Long-term retirement benefits
|
|
|
276
|
|
|
|
951
|
|
|
|
1,227
|
|
Deferred income taxes long-term
|
|
|
1,424
|
|
|
|
(257
|
)
|
|
|
1,167
|
|
Accumulated other comprehensive
loss
|
|
|
(11
|
)
|
|
|
(407
|
)
|
|
|
(418
|
)
|
Total shareholders equity
|
|
|
7,450
|
|
|
|
(407
|
)
|
|
|
7,043
|
|
Total liabilities and
shareholders equity
|
|
|
18,194
|
|
|
|
(16
|
)
|
|
|
18,178
|
|
The adoption of SFAS No. 158 had no effect on
RAIs net income or cash flow.
As part of the Conwood acquisition, RAI assumed certain pension
and postretirement benefit obligations and the related assets of
Conwoods plans. The liability for the projected benefit
obligation in excess of plan assets was recorded in accordance
with SFAS No. 87, Employers Accounting for
Pensions, and SFAS No. 106,
Employers Accounting for Postretirement Benefits
Other Than Pensions. All previously existing unrecognized
net gain or loss, unrecognized prior service cost, or
unrecognized transition obligation or asset existing at the date
of the Conwood acquisition were eliminated. As a result of the
Conwood acquisition, RAIs pension benefit obligation and
pension assets increased by $45 million and
$35 million, respectively, and the postretirement benefit
obligation increased by $37 million.
171
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The changes in benefit obligations and plan assets, as well as
the funded status of these plans at December 31 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement
|
|
|
|
Pension Benefits
|
|
|
Benefits
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Change in benefit obligation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligation at beginning of year
|
|
$
|
5,348
|
|
|
$
|
5,187
|
|
|
$
|
1,516
|
|
|
$
|
1,419
|
|
Assumed in business acquisition
|
|
|
45
|
|
|
|
|
|
|
|
37
|
|
|
|
|
|
Service cost
|
|
|
40
|
|
|
|
51
|
|
|
|
5
|
|
|
|
6
|
|
Interest cost
|
|
|
308
|
|
|
|
305
|
|
|
|
86
|
|
|
|
85
|
|
Actuarial (gain)/loss
|
|
|
(76
|
)
|
|
|
203
|
|
|
|
(45
|
)
|
|
|
61
|
|
Plan amendments
|
|
|
|
|
|
|
3
|
|
|
|
(3
|
)
|
|
|
57
|
|
Benefits paid
|
|
|
(374
|
)
|
|
|
(394
|
)
|
|
|
(106
|
)
|
|
|
(107
|
)
|
Settlements
|
|
|
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
Special termination benefits
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
Curtailment
|
|
|
2
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligation at end of year
|
|
$
|
5,293
|
|
|
$
|
5,348
|
|
|
$
|
1,490
|
|
|
$
|
1,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in plan assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at
beginning of year
|
|
$
|
4,469
|
|
|
$
|
4,231
|
|
|
$
|
350
|
|
|
$
|
335
|
|
Acquired in business acquisition
|
|
|
35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Actual return on plan assets
|
|
|
667
|
|
|
|
348
|
|
|
|
52
|
|
|
|
31
|
|
Employer contributions
|
|
|
313
|
|
|
|
290
|
|
|
|
78
|
|
|
|
91
|
|
Benefits paid
|
|
|
(374
|
)
|
|
|
(394
|
)
|
|
|
(106
|
)
|
|
|
(107
|
)
|
Settlements
|
|
|
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at end
of year
|
|
$
|
5,110
|
|
|
$
|
4,469
|
|
|
$
|
374
|
|
|
$
|
350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded status:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded status
|
|
$
|
(183
|
)
|
|
$
|
(879
|
)
|
|
$
|
(1,116
|
)
|
|
$
|
(1,166
|
)
|
Unrecognized prior service cost
|
|
|
N/A
|
|
|
|
19
|
|
|
|
N/A
|
|
|
|
(49
|
)
|
Unrecognized net actuarial loss
|
|
|
N/A
|
|
|
|
909
|
|
|
|
N/A
|
|
|
|
330
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net amount recognized
|
|
$
|
(183
|
)
|
|
$
|
49
|
|
|
$
|
(1,116
|
)
|
|
$
|
(885
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts recognized in the
consolidated balance sheets consist of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued benefit
current liability
|
|
$
|
(6
|
)
|
|
$
|
(231
|
)
|
|
$
|
(66
|
)
|
|
$
|
(76
|
)
|
Accrued benefit
long-term liability
|
|
|
(177
|
)
|
|
|
(565
|
)
|
|
|
(1,050
|
)
|
|
|
(809
|
)
|
Intangible asset
|
|
|
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive
loss
|
|
|
|
|
|
|
826
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net amount recognized
|
|
|
(183
|
)
|
|
|
49
|
|
|
|
(1,116
|
)
|
|
|
(885
|
)
|
Accumulated other comprehensive
loss SFAS No. 158
|
|
|
481
|
|
|
|
|
|
|
|
201
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net amounts recognized in the
consolidated balance sheets
|
|
$
|
298
|
|
|
$
|
49
|
|
|
$
|
(915
|
)
|
|
$
|
(885
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
172
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Amounts included in accumulated other comprehensive loss were as
follows as of December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
|
Postretirement
|
|
|
|
|
|
|
Benefits
|
|
|
Benefits
|
|
|
Total
|
|
|
Prior service cost (credit)
|
|
$
|
17
|
|
|
$
|
(40
|
)
|
|
$
|
(23
|
)
|
Net actuarial loss
|
|
|
464
|
|
|
|
241
|
|
|
|
705
|
|
Deferred income taxes
|
|
|
(186
|
)
|
|
|
(78
|
)
|
|
|
(264
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive
loss
|
|
$
|
295
|
|
|
$
|
123
|
|
|
$
|
418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement
|
|
|
|
Pension Benefits
|
|
|
Benefits
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Weighted-average assumptions used
to determine benefit obligations at December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
|
6.10
|
%
|
|
|
5.90
|
%
|
|
|
6.10
|
%
|
|
|
5.90
|
%
|
Rate of compensation increase
|
|
|
4.98
|
%
|
|
|
4.97
|
%
|
|
|
5.00
|
%
|
|
|
5.00
|
%
|
The measurement date used for all plans was December 31.
The accumulated benefit obligation, which represents benefits
earned to date, for all pension plans was $5,097 million
and $5,152 million for years ended December 31, 2006
and 2005, respectively.
Pension plans experiencing accumulated benefit obligations in
excess of plan assets are summarized below:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Projected benefit obligation
|
|
$
|
613
|
|
|
$
|
5,348
|
|
Accumulated benefit obligation
|
|
$
|
585
|
|
|
$
|
5,152
|
|
Plan assets
|
|
$
|
486
|
|
|
$
|
4,469
|
|
The components of the total benefit cost and assumptions are set
forth below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
Postretirement Benefits
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006
|
|
|
2005
|
|
|
2004(1)
|
|
|
Components of total benefit cost
(income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
|
$
|
40
|
|
|
$
|
51
|
|
|
$
|
44
|
|
|
$
|
5
|
|
|
$
|
6
|
|
|
$
|
5
|
|
Interest cost
|
|
|
308
|
|
|
|
305
|
|
|
|
235
|
|
|
|
86
|
|
|
|
85
|
|
|
|
64
|
|
Expected return on plan assets
|
|
|
(368
|
)
|
|
|
(334
|
)
|
|
|
(252
|
)
|
|
|
(28
|
)
|
|
|
(25
|
)
|
|
|
(11
|
)
|
Amortization of transition asset
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
Amortization of prior service cost
|
|
|
2
|
|
|
|
2
|
|
|
|
3
|
|
|
|
(12
|
)
|
|
|
(15
|
)
|
|
|
(18
|
)
|
Amortization of net loss (gain)
|
|
|
70
|
|
|
|
71
|
|
|
|
50
|
|
|
|
21
|
|
|
|
21
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost (income)
|
|
|
52
|
|
|
|
95
|
|
|
|
80
|
|
|
|
72
|
|
|
|
72
|
|
|
|
57
|
|
Curtailment/special benefits
|
|
|
2
|
|
|
|
3
|
|
|
|
3
|
|
|
|
|
|
|
|
(13
|
)
|
|
|
|
|
Adjustment for deferring cap
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
|
|
|
Adjustment to 2003 workforce
reduction
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
10
|
|
Settlements
|
|
|
|
|
|
|
2
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total benefit cost
|
|
$
|
54
|
|
|
$
|
100
|
|
|
$
|
81
|
|
|
$
|
72
|
|
|
$
|
68
|
|
|
$
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Excludes one-time cost which is included in the B&W business
combination. |
The estimated net loss and prior service cost for pension plans
that are expected to be amortized from accumulated other
comprehensive loss into net periodic benefit cost during 2007
are $40 million and $2 million,
173
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
respectively. The estimated net loss and prior service cost for
the postretirement plans that are expected to be amortized from
accumulated other comprehensive loss into net postretirement
health care costs during 2007 are $19 million and ($12)
million, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Postretirement Benefits
|
|
|
2006
|
|
2005
|
|
2004
|
|
2006
|
|
2005
|
|
2004
|
|
Weighted-average assumptions used
to determine net periodic benefit cost for years ended
December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
5.90%
|
|
6.05%;5.70%(1)
|
|
6.15%;6.27%(2)
|
|
5.91%
|
|
6.05%;5.70%;5.75%(3)
|
|
6.15%;6.45%(4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected long-term return on plan
assets
|
|
8.74%
|
|
8.79%
|
|
8.79%
|
|
8.00%
|
|
8.50%
|
|
8.50%
|
Rate of compensation increase
|
|
4.98%
|
|
4.97%
|
|
4.77%
|
|
5.00%
|
|
5.00%
|
|
4.79%
|
|
|
|
(1) |
|
The January 1, 2005 overall beginning discount rate of
6.05% was changed to 5.70% for the period from April 30,
2005 to December 31, 2005, for plans impacted by the sale
of the packaging operations. |
|
(2) |
|
A discount rate of 6.15% was used for the period from
January 1, 2004 to July 31, 2004, and a
weighted-average discount rate of 6.27% was used for the period
from August 1, 2004 to December 31, 2004, to reflect
the impact of the B&W business combination. |
|
(3) |
|
The January 1, 2005 overall beginning discount rate of
6.05% was changed for the pre-combination RJR Tobacco benefit
plans only, to a discount rate of 5.70% for the period
April 30, 2005 to September 15, 2005, and a discount
rate of 5.75% was used for the period from September 16,
2005 to December 31, 2005. |
|
(4) |
|
A discount rate of 6.15% was used for the period from
January 1, 2004 to July 31, 2004, and a
weighted-average discount rate of 6.45% was used for the period
from August 1, 2004 to December 31, 2004, to reflect
the impact of the B&W business combination. |
In 2000, RJR offered to its current and retired employees who
had earned non-qualified pension benefits a one-time opportunity
to elect to have at least 75% of their total earned qualified
and non-qualified pension benefits funded over a three-year
period. The total benefit cost of this program was
$2 million in 2005 and $3 million in 2004. This
program was completed in 2005.
RAI incurred curtailment costs of $2 million and
$3 million in 2006 and 2004, respectively, due to early
retirements under a non-qualified pension plan.
In 2004, after examining the results of a pilot program during
the first quarter of 2004, it was decided that approximately 750
sales positions that were expected to be outsourced as part of
the 2003 restructuring plan would not be eliminated.
Accordingly, associated curtailment and special benefits costs
were reversed from the restructuring charge. During the second
and third quarters of 2004, other amounts were reversed
reflecting
less-than-expected
workforce reductions, primarily in manufacturing. The total
increase to the pension benefits obligation and the
postretirement obligation was $2 million and
$1 million, respectively. The total adjustment in 2004 to
pension benefit income was $5 million and postretirement
benefits cost was $10 million as a result of the revision
of these planned workforce reductions.
On May 2, 2005, RJR Tobacco sold its packaging operations
and terminated the packaging employees. 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 $24 million loss on sale
of assets during 2005.
RAI has placed a limit, or cap, on how much it will pay for
medical and dental coverage for retirees as a group, excluding
pre-1993
retirees and former B&W retirees. In 2005, RAI deferred the
implementation of the postretirement benefits cost cap to 2006.
The one-time cost of this deferral was $9 million in 2005.
174
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The overall expected long-term rate of return on assets
assumptions for pension and postretirement assets are based on:
(1) the target asset allocation for plan assets,
(2) long-term capital markets forecasts for asset classes
employed, and (3) excess return expectations of active
management to the extent asset classes are actively managed.
SFAS Nos. 87 and 106 permit the delayed recognition of
asset fund gains and losses in ratable periods of up to five
years. RAI uses a five-year period wherein asset fund gains and
losses are reflected in the expense calculation at 20% per
year, beginning the year after the gains or losses occur. In
2006, an increase in the discount rate, additional funding, and
higher than expected asset returns resulted in a decrease of
additional minimum pension liabilities through a benefit of
$808 million, $491 million after tax, to other
comprehensive income. In 2005, a decline in the discount rate
and less than expected asset returns resulted in an increase of
additional minimum pension liabilities through a cost of
$143 million, $56 million after tax, to other
comprehensive income.
Plan assets are invested using a combination of active and
passive investment strategies. Active strategies employ multiple
investment management firms. Managers within each asset class
cover a range of investment styles and approaches and are
combined in a way that controls for capitalization, style
biases, such as equity investments, and interest rate exposures,
such as fixed income investments, against related benchmark
indices, while focusing primarily on issue selection as a means
to add value. Risk is controlled through diversification among
asset classes, managers, styles and securities. Risk is further
controlled both at the manager and asset class level by
assigning excess return and tracking error targets. Investment
managers are monitored to evaluate performance against these
benchmark indices and targets.
Allowable investment types include U.S. equity,
non-U.S. equity,
global equity, fixed income, real estate, private equity
investment, hedge funds and global tactical asset allocation.
The range of allowable investment types utilized for pension
assets was expanded in 2006 to enhance returns and more widely
diversify the plan. U.S. equities are composed of common
stocks of large, medium and small companies.
Non-U.S. equities
include equity securities issued by companies domiciled outside
the U.S. and in depository receipts, which represent ownership
of securities of
non-U.S. companies.
Global equities include a combination of both U.S. and
non-U.S. securities.
Fixed income includes fixed income securities issued or
guaranteed by the U.S. government, and to a lesser extent
by
non-U.S. governments,
or by their respective agencies and instrumentalities, mortgage
backed securities, including collateralized mortgage
obligations, corporate debt obligations and dollar-denominated
obligations issued in the United States by
non-U.S. banks
and corporations (Yankee bonds). Up to 25% of the fixed income
assets can be in debt securities that are below investment
grade. Real estate consists of publicly traded real estate
investment trust securities. The private equity investments
consist of the unregistered securities of private and public
companies. Hedge funds invest as a limited partner in portfolios
of primarily public securities, including equities and fixed
income. Global tactical asset allocation strategies evaluate
relative value within and across asset categories and
overweights the attractive markets/assets while simultaneously
underweighting less attractive markets/assets.
For pension assets, futures contracts are used for portfolio
rebalancing and to approach fully invested portfolio positions.
Otherwise, a small number of investment managers employ limited
use of derivatives, including futures contracts, options on
futures and interest rate swaps in place of direct investment in
securities to gain efficient exposure to markets.
The target pension asset allocation is 59% equity investments,
which includes U.S.,
non-U.S. and
global equity, 27% fixed income, 10% opportunistic investments,
which includes hedge funds and global tactical asset allocation,
and 4% alternative investments, which includes private equity
investments and real estate, with a rebalancing range of
approximately plus or minus 3% to 5% around the target asset
allocations. Asset category definitions were revised in 2006 to
include new investment types and to more closely reflect the
overall strategy for managing the plans assets.
The target postretirement asset allocation is 43%
U.S. equity investments, including private equity
investments, 17%
non-U.S. equity
investments, 38% debt securities, 1% hedge fund investments, 1%
real estate and other, with a rebalancing range of approximately
plus or minus 5% around the target asset allocations.
175
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
RAIs pension and postretirement plans weighted-average
asset allocations at December 31, 2006 and 2005, by asset
category were as follows:
|
|
|
|
|
|
|
|
|
|
|
Pension Plans
|
|
|
|
2006
|
|
|
2005
|
|
|
Asset Category:
|
|
|
|
|
|
|
|
|
Equities
|
|
|
60
|
%
|
|
|
61
|
%
|
Fixed income
|
|
|
25
|
%
|
|
|
26
|
%
|
Opportunistic
|
|
|
11
|
%
|
|
|
9
|
%
|
Alternative
|
|
|
4
|
%
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement
|
|
|
|
Plans
|
|
|
|
2006
|
|
|
2005
|
|
|
Asset Category:
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
|
44
|
%
|
|
|
47
|
%
|
Debt securities
|
|
|
35
|
%
|
|
|
24
|
%
|
Non-U.S. equity
securities
|
|
|
19
|
%
|
|
|
18
|
%
|
Hedge funds
|
|
|
1
|
%
|
|
|
5
|
%
|
Real estate and other
|
|
|
1
|
%
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
Additional information relating to RAIs significant
postretirement plans is as follows:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Weighted-average health-care cost
trend rate assumed for the following year
|
|
|
9.27
|
%
|
|
|
9.23
|
%
|
Rate to which the cost trend rate
is assumed to decline (the ultimate trend rate)
|
|
|
5.00
|
%
|
|
|
5.00
|
%
|
Year that the rate reaches the
ultimate trend rate
|
|
|
2016
|
|
|
|
2015
|
|
Assumed health-care cost trend rates have a significant effect
on the amounts reported for the health-care plans. A
one-percentage-point change in assumed health-care cost trend
rates would have had the following effects:
|
|
|
|
|
|
|
|
|
|
|
1-Percentage
|
|
|
1-Percentage
|
|
|
|
Point
|
|
|
Point
|
|
|
|
Increase
|
|
|
Decrease
|
|
|
Effect on total of service and
interest cost components
|
|
$
|
5
|
|
|
$
|
(5
|
)
|
Effect on benefit obligation
|
|
|
91
|
|
|
|
(78
|
)
|
RAI expects to contribute approximately $300 million to its
pension plans and expects payments related to its postretirement
plans to be $75 million during 2007.
176
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Estimated future benefits payments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement Benefits
|
|
|
|
|
|
|
Gross Projected
|
|
|
Expected
|
|
|
Net Projected
|
|
|
|
|
|
|
Benefit Payments
|
|
|
Medicare
|
|
|
Benefit Payments
|
|
|
|
Pension
|
|
|
Before Medicare
|
|
|
Part D
|
|
|
After Medicare
|
|
Year
|
|
Benefits
|
|
|
Part D Subsidies
|
|
|
Subsidies
|
|
|
Part D Subsidies
|
|
|
2007
|
|
$
|
381
|
|
|
$
|
118
|
|
|
$
|
3
|
|
|
$
|
115
|
|
2008
|
|
|
374
|
|
|
|
120
|
|
|
|
3
|
|
|
|
117
|
|
2009
|
|
|
369
|
|
|
|
123
|
|
|
|
4
|
|
|
|
119
|
|
2010
|
|
|
367
|
|
|
|
125
|
|
|
|
4
|
|
|
|
121
|
|
2011
|
|
|
366
|
|
|
|
126
|
|
|
|
4
|
|
|
|
122
|
|
2012-2016
|
|
|
1,947
|
|
|
|
606
|
|
|
|
24
|
|
|
|
582
|
|
On December 8, 2003, President Bush signed into law the
Medicare Prescription Drug, Improvement and Modernization Act of
2003. The Medicare Act expanded Medicare to include, for the
first time, coverage for prescription drugs. The Medicare Act
introduces a prescription drug benefit under Medicare
Part D as well as a federal subsidy to sponsors of retiree
health-care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. RAI
sponsors retiree medical programs, which include coverage for
prescription drugs.
In May 2004, the FASB issued FASB Staff Position
No. 106-2,
Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of
2003, referred to as FSP
106-2. RAI
adopted FSP
106-2 in the
third quarter of 2004, and as a result, net postretirement
health-care costs were reduced approximately $4 million.
The accumulated postretirement benefit obligation was reduced
approximately $82 million for the federal subsidy related
to benefits attributed to past service.
RAI sponsors qualified defined contribution plans. During 2004
and 2005, following a participants contribution, RAI
matched 50% based on a maximum of 6% of a participants
compensation for participants hired prior to January 1,
2004. For participants hired after December 31, 2003, RAI
matched 100% based on a maximum of 6% of a participants
compensation. Beginning in 2006, RAI enhanced the contributions
to certain qualified defined contribution plans based on a
sliding scale by providing higher, additional contributions to
certain employees closer to retirement with lower additional
contributions for certain other employees. The expense related
to these plans was $42 million, $20 million and
$18 million, in 2006, 2005 and 2004, respectively.
Note 18
Segment Information
RAIs largest reportable operating segment, RJR Tobacco, 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, MISTY and
CAPRI, are manufactured in a variety of styles and marketed in
the United States. Beginning in 2006, RJR Tobacco also manages a
contract manufacturing business through arrangements with BAT
affiliates that was previously managed by GPI and classified as
All Other. Prior period amounts have been reclassified
accordingly.
RAIs other reportable operating segment, Conwood, is the
second largest smokeless tobacco products manufacturer in the
United States. Conwoods primary brands include its largest
selling moist snuff brands, GRIZZLY and KODIAK, two of the six
best-selling brands of moist snuff in the United States.
Conwoods other products include loose leaf chewing
tobacco, dry snuff, plug and twist tobacco products, which held
the first or second position in market share in each category in
2006. The Conwood acquisition occurred on May 31, 2006, and
consequently, the RAI consolidated statement of income includes
only the results of operations of Conwood for June through
December 2006.
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.
Amounts related to the December 31, 2006, consolidated
assets are presented with separate
177
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
consolidating elimination adjustments. Prior period amounts for
consolidated assets have been reclassified accordingly.
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
DUNHILL and CAPTAIN BLACK tobacco products. GPI manufactures and
exports cigarettes to U.S. territories, U.S. duty-free
shops and U.S. overseas military bases, and manages a
contract manufacturing business.
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. GPI manages
RJRs interest in the joint venture. The joint venture,
headquartered in Switzerland, markets its products primarily in
Italy, France and Spain. Segment disclosures related to the
joint venture are included in the classification All Other.
178
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Segment Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
7,675
|
|
|
$
|
7,695
|
|
|
$
|
5,945
|
|
Conwood
|
|
|
291
|
|
|
|
|
|
|
|
|
|
All Other
|
|
|
544
|
|
|
|
561
|
|
|
|
492
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net sales
|
|
$
|
8,510
|
|
|
$
|
8,256
|
|
|
$
|
6,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
1,626
|
|
|
$
|
1,346
|
|
|
$
|
854
|
|
Conwood
|
|
|
160
|
|
|
|
|
|
|
|
|
|
All Other
|
|
|
194
|
|
|
|
144
|
|
|
|
84
|
|
Corporate expense
|
|
|
(50
|
)
|
|
|
(31
|
)
|
|
|
(56
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income
|
|
$
|
1,930
|
|
|
$
|
1,459
|
|
|
$
|
882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
12,832
|
|
|
$
|
13,514
|
|
|
$
|
13,473
|
|
Conwood
|
|
|
4,313
|
|
|
|
|
|
|
|
|
|
All Other
|
|
|
1,256
|
|
|
|
1,255
|
|
|
|
1,352
|
|
Corporate
|
|
|
14,133
|
|
|
|
10,700
|
|
|
|
10,524
|
|
Elimination adjustments
|
|
|
(14,356
|
)
|
|
|
(10,950
|
)
|
|
|
(10,921
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated assets
|
|
$
|
18,178
|
|
|
$
|
14,519
|
|
|
$
|
14,428
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
116
|
|
|
$
|
102
|
|
|
$
|
77
|
|
Conwood
|
|
|
4
|
|
|
|
|
|
|
|
|
|
All Other
|
|
|
13
|
|
|
|
8
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated capital expenditures
|
|
$
|
133
|
|
|
$
|
110
|
|
|
$
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco
|
|
$
|
149
|
|
|
$
|
188
|
|
|
$
|
148
|
|
Conwood
|
|
|
6
|
|
|
|
|
|
|
|
|
|
All Other
|
|
|
7
|
|
|
|
7
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated depreciation and
amortization expense
|
|
$
|
162
|
|
|
$
|
195
|
|
|
$
|
153
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation to income from
continuing operations before income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
1,930
|
|
|
$
|
1,459
|
|
|
$
|
882
|
|
Interest and debt expense
|
|
|
270
|
|
|
|
113
|
|
|
|
85
|
|
Interest income
|
|
|
(136
|
)
|
|
|
(85
|
)
|
|
|
(30
|
)
|
Other (income) expense
|
|
|
(13
|
)
|
|
|
15
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
before income taxes
|
|
$
|
1,809
|
|
|
$
|
1,416
|
|
|
$
|
829
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For further information related to restructuring and asset
impairment charges, see note 4. For further information
related to trademark impairments, see note 1.
Sales made by RJR Tobacco to McLane Company, Inc., a
distributor, comprised 29%, 27% and 30% of RJR Tobaccos
revenue in 2006, 2005 and 2004, respectively. Sales made by
Conwood to McLane Company, Inc.
179
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
comprised 17% of Conwoods consolidated revenue for June
through December 2006. No other customer accounted for 10% or
more of RJR Tobaccos or Conwoods revenue during
those periods.
Note 19
Related Party Transactions
RAIs operating subsidiaries engage in transactions with
related parties in the normal course of business. The following
is a summary of balances and transactions with affiliates as of
and for the years ended December 31:
Balances:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Accounts receivable, related party
|
|
$
|
62
|
|
|
$
|
67
|
|
Due to related party
|
|
|
9
|
|
|
|
31
|
|
Deferred revenue, related party
|
|
|
62
|
|
|
|
69
|
|
Transactions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Net sales, related party
|
|
$
|
500
|
|
|
$
|
477
|
|
|
$
|
241
|
|
Fixed assets sales to related
parties
|
|
|
7
|
|
|
|
1
|
|
|
|
|
|
Research and development services
billed to related parties
|
|
|
5
|
|
|
|
4
|
|
|
|
|
|
BAT related legal indemnification
expenses
|
|
|
4
|
|
|
|
36
|
|
|
|
|
|
Purchases from related parties
|
|
|
8
|
|
|
|
19
|
|
|
|
11
|
|
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, pipe
tobacco and little cigars to BAT affiliates. For 2006, pricing
for contract-manufactured cigarettes was generally calculated
based on 2004 prices, using B&Ws forecasted 2004
manufacturing costs plus 10%, increased by a multiple equal to
the increase in the Producer Price Index for 2005 and 2006,
reported by the U.S. Bureau of Labor Statistics. During
2006, net sales to BAT affiliates were $498 million,
primarily cigarettes, representing 5.9% of RAIs total net
sales. In the fourth quarter of 2006, RJR Tobacco recorded
$4 million, in selling, general and administrative
expenses, for billings to BAT related to carrying costs of leaf
no longer required for BAT contract manufacturing.
RJR Tobacco also had $2 million of sales of raw materials
to the R. J. Reynolds-Gallaher International Sarl joint venture
during 2006. In the fourth quarter of 2006, a foreign subsidiary
of Santa Fe entered into a distributor agreement with an
Italian subsidiary of Gallaher Group Plc and recorded less than
$1 million of cigarette sales related to this agreement for
2006.
RJR Tobacco recorded $62 million of deferred sales revenue
in 2006, relating to leaf sold to BAT affiliates that had not
been delivered as of December 31, 2006, given that RJR
Tobacco had a legal right to bill the BAT affiliates. Leaf sales
revenue to BAT affiliates will be recognized when the product is
shipped to the customer.
RJR Tobacco performs certain research and development for BAT
affiliates pursuant to a joint technology sharing agreement
entered into as a part of the B&W business combination.
During 2006, $5 million was accrued and billed to BAT
affiliates for these services recorded in selling, general and
administrative expenses, net of associated costs. In 2006, RJR
Tobacco also sold miscellaneous fixed assets to BAT for
$4 million, which was approximately $1 million higher
than net book value. This gain on sale of assets is recorded in
selling, general and administrative expenses. In addition, an
RJR subsidiary sold equipment to Gallaher Reynolds Equipment
Company, a joint venture with Gallaher Group Plc, for
$3 million which approximated the net book value.
RAIs operating subsidiaries also purchase unprocessed leaf
at market prices, and imports 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
180
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
of 10% of the local sales price. During 2006, the aggregate
purchases for leaf and cigarettes were $7 million, and
royalty expenses were $1 million.
In 2006, RJR Tobacco recorded $4 million in selling,
general and administrative expenses, for funds to be reimbursed
to BAT. These funds indemnify B&W and its affiliates for
costs and expenses related to tobacco-related litigation in the
United States. For additional information relating to this
indemnification, see note 14.
At December 31, 2006, $9 million of accounts payable
is included in due to related party in the consolidated balance
sheet, primarily relating to cigarette purchases and the 2006
litigation reimbursement accrual.
In 2006, RJR Tobacco seconded certain of its employees to BAT in
connection with particular assignments at BAT locations. During
their service with BAT, the seconded employees are paid by RJR
Tobacco and participate in employee benefit plans sponsored by
RAI. BAT will reimburse RJR Tobacco for certain costs of the
seconded employees compensation and benefits during the
secondment period on a quarterly basis. In 2006, $2 million
was billed to BAT relating to secondees.
In 2006, RJR Tobacco acquired certain intellectual property
rights for snus, a smokeless, spitless tobacco product, from BAT
for approximately $2 million. In addition, RJR Tobacco
entered into a contract manufacturing agreement with BAT for the
production of snus, with pricing generally calculated at BAT
costs of manufacturing plus 10%. In 2006, less than
$1 million of snus product was purchased from BAT.
Note 20
Lease 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
$24 million, $36 million and $37 million for
2006, 2005 and 2004, respectively.
|
|
|
|
|
|
|
Noncancellable
|
|
|
|
Operating Leases
|
|
|
2007
|
|
$
|
21
|
|
2008
|
|
|
18
|
|
2009
|
|
|
12
|
|
2010
|
|
|
10
|
|
2011
|
|
|
6
|
|
Thereafter
|
|
|
13
|
|
|
|
|
|
|
Total
|
|
$
|
80
|
|
|
|
|
|
|
The B&W business combination restructuring accrual includes
$38 million related to the lease obligations of the former
B&W facilities included in the table above.
|
|
Note 21
|
RAI
Guaranteed, Secured Notes Condensed Consolidating
Financial Statements
|
The following condensed consolidating financial statements have
been prepared pursuant to
Rule 3-10
of
Regulation S-X,
relating to the guarantors of RAIs $2.9 billion
guaranteed, secured notes. See note 12 for additional
information relating to these notes. RAIs direct, wholly
owned subsidiaries and certain of its indirectly owned
subsidiaries have fully and unconditionally guaranteed these
notes. 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 issuer; RJR, RJR Tobacco, Conwood, Santa Fe, Lane,
GPI, RJR Acquisition Corp., Conwood Holdings, Inc., and certain
of RJR Tobaccos other subsidiaries, the guarantors; other
indirect subsidiaries of RAI which are not guarantors; and
elimination adjustments.
181
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
7,984
|
|
|
$
|
90
|
|
|
$
|
(64
|
)
|
|
$
|
8,010
|
|
Net sales, related party
|
|
|
|
|
|
|
500
|
|
|
|
|
|
|
|
|
|
|
|
500
|
|
Cost of products sold
|
|
|
|
|
|
|
4,838
|
|
|
|
30
|
|
|
|
(65
|
)
|
|
|
4,803
|
|
Selling, general and administrative
expenses
|
|
|
48
|
|
|
|
1,575
|
|
|
|
35
|
|
|
|
|
|
|
|
1,658
|
|
Amortization expense
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(48
|
)
|
|
|
1,952
|
|
|
|
25
|
|
|
|
1
|
|
|
|
1,930
|
|
Interest and debt expense
|
|
|
194
|
|
|
|
76
|
|
|
|
|
|
|
|
|
|
|
|
270
|
|
Interest income
|
|
|
(2
|
)
|
|
|
(133
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
(136
|
)
|
Intercompany interest (income)
expense
|
|
|
(118
|
)
|
|
|
116
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income
|
|
|
|
|
|
|
(43
|
)
|
|
|
|
|
|
|
43
|
|
|
|
|
|
Other (income) expense, net
|
|
|
7
|
|
|
|
(3
|
)
|
|
|
(17
|
)
|
|
|
|
|
|
|
(13
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
(129
|
)
|
|
|
1,939
|
|
|
|
41
|
|
|
|
(42
|
)
|
|
|
1,809
|
|
Provision for (benefit from) income
taxes
|
|
|
(44
|
)
|
|
|
712
|
|
|
|
5
|
|
|
|
|
|
|
|
673
|
|
Equity income from subsidiaries
|
|
|
1,295
|
|
|
|
36
|
|
|
|
|
|
|
|
(1,331
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
1,210
|
|
|
|
1,263
|
|
|
|
36
|
|
|
|
(1,373
|
)
|
|
|
1,136
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,210
|
|
|
$
|
1,337
|
|
|
$
|
36
|
|
|
$
|
(1,373
|
)
|
|
$
|
1,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
7,758
|
|
|
$
|
87
|
|
|
$
|
(66
|
)
|
|
$
|
7,779
|
|
Net sales, related party
|
|
|
|
|
|
|
477
|
|
|
|
|
|
|
|
|
|
|
|
477
|
|
Cost of products sold
|
|
|
|
|
|
|
4,960
|
|
|
|
26
|
|
|
|
(67
|
)
|
|
|
4,919
|
|
Selling, general and administrative
expenses
|
|
|
28
|
|
|
|
1,556
|
|
|
|
26
|
|
|
|
1
|
|
|
|
1,611
|
|
Loss on sale of assets
|
|
|
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
Amortization expense
|
|
|
|
|
|
|
41
|
|
|
|
|
|
|
|
|
|
|
|
41
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
200
|
|
|
|
|
|
|
|
|
|
|
|
200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(28
|
)
|
|
|
1,452
|
|
|
|
35
|
|
|
|
|
|
|
|
1,459
|
|
Interest and debt expense
|
|
|
|
|
|
|
113
|
|
|
|
|
|
|
|
|
|
|
|
113
|
|
Interest income
|
|
|
(1
|
)
|
|
|
(82
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
(85
|
)
|
Intercompany interest (income)
expense
|
|
|
24
|
|
|
|
(25
|
)
|
|
|
1
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income
|
|
|
|
|
|
|
(60
|
)
|
|
|
|
|
|
|
60
|
|
|
|
|
|
Other (income) expense, net
|
|
|
|
|
|
|
25
|
|
|
|
(10
|
)
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
(51
|
)
|
|
|
1,481
|
|
|
|
46
|
|
|
|
(60
|
)
|
|
|
1,416
|
|
Provision for (benefit from) income
taxes
|
|
|
(34
|
)
|
|
|
459
|
|
|
|
6
|
|
|
|
|
|
|
|
431
|
|
Equity income from subsidiaries
|
|
|
1,059
|
|
|
|
40
|
|
|
|
|
|
|
|
(1,099
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
|
1,042
|
|
|
|
1,062
|
|
|
|
40
|
|
|
|
(1,159
|
)
|
|
|
985
|
|
Gain on sale of discontinued
businesses, net of income taxes
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
1,042
|
|
|
|
1,064
|
|
|
|
40
|
|
|
|
(1,159
|
)
|
|
|
987
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,042
|
|
|
$
|
1,119
|
|
|
$
|
40
|
|
|
$
|
(1,159
|
)
|
|
$
|
1,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
6,173
|
|
|
$
|
79
|
|
|
$
|
(56
|
)
|
|
$
|
6,196
|
|
Net sales, related party
|
|
|
|
|
|
|
241
|
|
|
|
|
|
|
|
|
|
|
|
241
|
|
Cost of products sold
|
|
|
|
|
|
|
3,906
|
|
|
|
22
|
|
|
|
(56
|
)
|
|
|
3,872
|
|
Selling, general and administrative
expenses
|
|
|
17
|
|
|
|
1,411
|
|
|
|
27
|
|
|
|
|
|
|
|
1,455
|
|
Amortization expense
|
|
|
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(17
|
)
|
|
|
869
|
|
|
|
30
|
|
|
|
|
|
|
|
882
|
|
Interest and debt expense
|
|
|
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
85
|
|
Interest income
|
|
|
|
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
(30
|
)
|
Intercompany interest (income)
expense
|
|
|
7
|
|
|
|
(9
|
)
|
|
|
2
|
|
|
|
|
|
|
|
|
|
Other (income) expense, net
|
|
|
|
|
|
|
5
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing
operations before income taxes
|
|
|
(24
|
)
|
|
|
818
|
|
|
|
35
|
|
|
|
|
|
|
|
829
|
|
Provision for (benefit from) income
taxes
|
|
|
(4
|
)
|
|
|
203
|
|
|
|
3
|
|
|
|
|
|
|
|
202
|
|
Equity income from subsidiaries
|
|
|
708
|
|
|
|
32
|
|
|
|
|
|
|
|
(740
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
|
688
|
|
|
|
647
|
|
|
|
32
|
|
|
|
(740
|
)
|
|
|
627
|
|
Gain on sale of discontinued
businesses, net of income taxes
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
688
|
|
|
|
659
|
|
|
|
32
|
|
|
|
(740
|
)
|
|
|
639
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
688
|
|
|
$
|
708
|
|
|
$
|
32
|
|
|
$
|
(740
|
)
|
|
$
|
688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
182
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Statements of Cash Flows
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating
activities
|
|
$
|
1,023
|
|
|
$
|
1,946
|
|
|
$
|
25
|
|
|
$
|
(1,537
|
)
|
|
$
|
1,457
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(7,677
|
)
|
|
|
|
|
|
|
|
|
|
|
(7,677
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
7,760
|
|
|
|
|
|
|
|
|
|
|
|
7,760
|
|
Capital expenditures
|
|
|
|
|
|
|
(132
|
)
|
|
|
(4
|
)
|
|
|
|
|
|
|
(136
|
)
|
Distributions from equity
investments
|
|
|
|
|
|
|
|
|
|
|
18
|
|
|
|
|
|
|
|
18
|
|
Acquisition
|
|
|
|
|
|
|
(3,519
|
)
|
|
|
|
|
|
|
|
|
|
|
(3,519
|
)
|
Net intercompany investments
|
|
|
(211
|
)
|
|
|
211
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net proceeds from the sale of
fixed assets
|
|
|
|
|
|
|
22
|
|
|
|
2
|
|
|
|
|
|
|
|
24
|
|
Net proceeds from the sale of
businesses
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Other
|
|
|
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
(4
|
)
|
Intercompany notes receivable
|
|
|
(3,168
|
)
|
|
|
(105
|
)
|
|
|
|
|
|
|
3,273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
investing activities
|
|
|
(3,379
|
)
|
|
|
(3,441
|
)
|
|
|
16
|
|
|
|
3,273
|
|
|
|
(3,531
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock
|
|
|
(775
|
)
|
|
|
(1,494
|
)
|
|
|
|
|
|
|
1,494
|
|
|
|
(775
|
)
|
Dividends paid on preferred stock
|
|
|
(43
|
)
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Excess tax benefit from
stock-based compensation
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Repayments of long-term debt
|
|
|
|
|
|
|
(190
|
)
|
|
|
|
|
|
|
|
|
|
|
(190
|
)
|
Repayments of term loan credit
facility
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8
|
)
|
Proceeds from issuance of
long-term debt
|
|
|
1,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641
|
|
Principal borrowings under term
loan credit facility
|
|
|
1,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,550
|
|
Deferred debt issuance costs
|
|
|
(52
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52
|
)
|
Intercompany notes payable
|
|
|
104
|
|
|
|
3,168
|
|
|
|
1
|
|
|
|
(3,273
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from financing
activities
|
|
|
2,425
|
|
|
|
1,484
|
|
|
|
1
|
|
|
|
(1,736
|
)
|
|
|
2,174
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
69
|
|
|
|
(11
|
)
|
|
|
42
|
|
|
|
|
|
|
|
100
|
|
Cash and cash equivalents at
beginning of year
|
|
|
227
|
|
|
|
1,076
|
|
|
|
30
|
|
|
|
|
|
|
|
1,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end
of year
|
|
$
|
296
|
|
|
$
|
1,065
|
|
|
$
|
72
|
|
|
$
|
|
|
|
$
|
1,433
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating
activities
|
|
$
|
726
|
|
|
$
|
1,107
|
|
|
$
|
28
|
|
|
$
|
(588
|
)
|
|
$
|
1,273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(10,883
|
)
|
|
|
|
|
|
|
|
|
|
|
(10,883
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
9,985
|
|
|
|
|
|
|
|
|
|
|
|
9,985
|
|
Purchases of long-term investments
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
Capital expenditures
|
|
|
|
|
|
|
(103
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
(105
|
)
|
Distributions from equity
investments
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
12
|
|
Acquisition
|
|
|
|
|
|
|
(45
|
)
|
|
|
|
|
|
|
|
|
|
|
(45
|
)
|
Net proceeds from the sale of
businesses
|
|
|
|
|
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
48
|
|
Other, net
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Intercompany notes receivable
|
|
|
|
|
|
|
16
|
|
|
|
|
|
|
|
(16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
investing activities
|
|
|
|
|
|
|
(983
|
)
|
|
|
10
|
|
|
|
(16
|
)
|
|
|
(989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
183
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
Cash flows from (used in)
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock
|
|
|
(575
|
)
|
|
|
(463
|
)
|
|
|
(76
|
)
|
|
|
539
|
|
|
|
(575
|
)
|
Dividends paid on preferred stock
|
|
|
(49
|
)
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Repurchase of common stock
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
Repayments of long-term debt
|
|
|
|
|
|
|
(360
|
)
|
|
|
|
|
|
|
|
|
|
|
(360
|
)
|
Proceeds from issuance of
long-term debt
|
|
|
|
|
|
|
499
|
|
|
|
|
|
|
|
|
|
|
|
499
|
|
Deferred debt issuance costs
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
(7
|
)
|
Debt retirement costs
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
(7
|
)
|
Intercompany notes payable
|
|
|
(16
|
)
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing
activities
|
|
|
(640
|
)
|
|
|
(338
|
)
|
|
|
(76
|
)
|
|
|
604
|
|
|
|
(450
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
86
|
|
|
|
(214
|
)
|
|
|
(38
|
)
|
|
|
|
|
|
|
(166
|
)
|
Cash and cash equivalents at
beginning of year
|
|
|
141
|
|
|
|
1,290
|
|
|
|
68
|
|
|
|
|
|
|
|
1,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end
of year
|
|
$
|
227
|
|
|
$
|
1,076
|
|
|
$
|
30
|
|
|
$
|
|
|
|
$
|
1,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating
activities
|
|
$
|
295
|
|
|
$
|
1,039
|
|
|
$
|
24
|
|
|
$
|
(622
|
)
|
|
$
|
736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(4,569
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,569
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
4,757
|
|
|
|
|
|
|
|
|
|
|
|
4,757
|
|
Purchases of long-term investments
|
|
|
|
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
|
|
(10
|
)
|
Proceeds from sale of long-term
investments
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Capital expenditures
|
|
|
|
|
|
|
(90
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
(92
|
)
|
Acquisitions, net of cash acquired
|
|
|
(403
|
)
|
|
|
568
|
|
|
|
|
|
|
|
|
|
|
|
165
|
|
Distributions from (investment in)
equity investments
|
|
|
|
|
|
|
(4
|
)
|
|
|
9
|
|
|
|
|
|
|
|
5
|
|
Other, net
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Intercompany notes receivable
|
|
|
|
|
|
|
(400
|
)
|
|
|
|
|
|
|
400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
investing activities
|
|
|
(403
|
)
|
|
|
256
|
|
|
|
7
|
|
|
|
400
|
|
|
|
260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in)
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock
|
|
|
(43
|
)
|
|
|
(28
|
)
|
|
|
|
|
|
|
|
|
|
|
(71
|
)
|
Dividends paid on common stock
|
|
|
(140
|
)
|
|
|
(865
|
)
|
|
|
|
|
|
|
622
|
|
|
|
(383
|
)
|
Repayments of long-term debt
|
|
|
|
|
|
|
(56
|
)
|
|
|
|
|
|
|
|
|
|
|
(56
|
)
|
Proceeds from exercise of stock
options
|
|
|
32
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
Intercompany notes payable
|
|
|
400
|
|
|
|
|
|
|
|
|
|
|
|
(400
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
financing activities
|
|
|
249
|
|
|
|
(938
|
)
|
|
|
|
|
|
|
222
|
|
|
|
(467
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
141
|
|
|
|
357
|
|
|
|
31
|
|
|
|
|
|
|
|
529
|
|
Cash and cash equivalents at
beginning of year
|
|
|
|
|
|
|
933
|
|
|
|
37
|
|
|
|
|
|
|
|
970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end
of year
|
|
$
|
141
|
|
|
$
|
1,290
|
|
|
$
|
68
|
|
|
$
|
|
|
|
$
|
1,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
184
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
December 31,
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
296
|
|
|
$
|
1,065
|
|
|
$
|
72
|
|
|
$
|
|
|
|
$
|
1,433
|
|
Short-term investments
|
|
|
|
|
|
|
1,293
|
|
|
|
|
|
|
|
|
|
|
|
1,293
|
|
Accounts receivable, net
|
|
|
4
|
|
|
|
91
|
|
|
|
5
|
|
|
|
|
|
|
|
100
|
|
Accounts receivable, related party
|
|
|
|
|
|
|
59
|
|
|
|
3
|
|
|
|
|
|
|
|
62
|
|
Income tax receivable
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
Inventories
|
|
|
|
|
|
|
1,135
|
|
|
|
20
|
|
|
|
|
|
|
|
1,155
|
|
Deferred income taxes, net
|
|
|
3
|
|
|
|
790
|
|
|
|
|
|
|
|
|
|
|
|
793
|
|
Prepaid expenses
|
|
|
6
|
|
|
|
94
|
|
|
|
3
|
|
|
|
(11
|
)
|
|
|
92
|
|
Short-term intercompany notes and
interest receivable
|
|
|
83
|
|
|
|
97
|
|
|
|
|
|
|
|
(180
|
)
|
|
|
|
|
Other intercompany receivables
|
|
|
522
|
|
|
|
|
|
|
|
6
|
|
|
|
(528
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
914
|
|
|
|
4,631
|
|
|
|
109
|
|
|
|
(719
|
)
|
|
|
4,935
|
|
Property, plant and equipment, net
|
|
|
|
|
|
|
1,046
|
|
|
|
16
|
|
|
|
|
|
|
|
1,062
|
|
Trademarks, net
|
|
|
|
|
|
|
3,479
|
|
|
|
|
|
|
|
|
|
|
|
3,479
|
|
Goodwill
|
|
|
|
|
|
|
8,167
|
|
|
|
8
|
|
|
|
|
|
|
|
8,175
|
|
Other intangibles, net
|
|
|
|
|
|
|
215
|
|
|
|
|
|
|
|
|
|
|
|
215
|
|
Long-term intercompany notes
|
|
|
2,160
|
|
|
|
472
|
|
|
|
|
|
|
|
(2,632
|
)
|
|
|
|
|
Investment in subsidiaries
|
|
|
9,253
|
|
|
|
69
|
|
|
|
|
|
|
|
(9,322
|
)
|
|
|
|
|
Other assets and deferred charges
|
|
|
96
|
|
|
|
204
|
|
|
|
38
|
|
|
|
(26
|
)
|
|
|
312
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
12,423
|
|
|
$
|
18,283
|
|
|
$
|
171
|
|
|
$
|
(12,699
|
)
|
|
$
|
18,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
shareholders equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related
accruals
|
|
$
|
|
|
|
$
|
2,237
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,237
|
|
Accounts payable and other accrued
liabilities
|
|
|
323
|
|
|
|
1,111
|
|
|
|
17
|
|
|
|
(11
|
)
|
|
|
1,440
|
|
Due to related party
|
|
|
|
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
9
|
|
Deferred revenue, related party
|
|
|
|
|
|
|
62
|
|
|
|
|
|
|
|
|
|
|
|
62
|
|
Current maturities of long-term
debt
|
|
|
252
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
344
|
|
Short-term intercompany notes and
interest payable
|
|
|
26
|
|
|
|
83
|
|
|
|
71
|
|
|
|
(180
|
)
|
|
|
|
|
Other intercompany payables
|
|
|
|
|
|
|
528
|
|
|
|
|
|
|
|
(528
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
601
|
|
|
|
4,122
|
|
|
|
88
|
|
|
|
(719
|
)
|
|
|
4,092
|
|
Intercompany notes and interest
payable
|
|
|
472
|
|
|
|
2,160
|
|
|
|
|
|
|
|
(2,632
|
)
|
|
|
|
|
Long-term debt (less current
maturities)
|
|
|
4,229
|
|
|
|
160
|
|
|
|
|
|
|
|
|
|
|
|
4,389
|
|
Deferred income taxes, net
|
|
|
|
|
|
|
1,193
|
|
|
|
|
|
|
|
(26
|
)
|
|
|
1,167
|
|
Long-term retirement benefits,
(less current portion)
|
|
|
41
|
|
|
|
1,172
|
|
|
|
14
|
|
|
|
|
|
|
|
1,227
|
|
Other noncurrent liabilities
|
|
|
37
|
|
|
|
222
|
|
|
|
1
|
|
|
|
|
|
|
|
260
|
|
Shareholders equity
|
|
|
7,043
|
|
|
|
9,254
|
|
|
|
68
|
|
|
|
(9,322
|
)
|
|
|
7,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
shareholders equity
|
|
$
|
12,423
|
|
|
$
|
18,283
|
|
|
$
|
171
|
|
|
$
|
(12,699
|
)
|
|
$
|
18,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
185
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
December 31,
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
227
|
|
|
$
|
1,076
|
|
|
$
|
30
|
|
|
$
|
|
|
|
$
|
1,333
|
|
Short-term investments
|
|
|
|
|
|
|
1,373
|
|
|
|
|
|
|
|
|
|
|
|
1,373
|
|
Accounts receivable, net
|
|
|
|
|
|
|
95
|
|
|
|
4
|
|
|
|
|
|
|
|
99
|
|
Accounts receivable, related party
|
|
|
|
|
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
67
|
|
Income tax receivable
|
|
|
|
|
|
|
159
|
|
|
|
|
|
|
|
|
|
|
|
159
|
|
Inventories
|
|
|
|
|
|
|
1,053
|
|
|
|
13
|
|
|
|
|
|
|
|
1,066
|
|
Deferred income taxes, net
|
|
|
3
|
|
|
|
862
|
|
|
|
|
|
|
|
|
|
|
|
865
|
|
Prepaid expenses
|
|
|
6
|
|
|
|
95
|
|
|
|
3
|
|
|
|
(6
|
)
|
|
|
98
|
|
Assets held for sale
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
Short-term intercompany notes and
interest receivable
|
|
|
|
|
|
|
83
|
|
|
|
10
|
|
|
|
(93
|
)
|
|
|
|
|
Other intercompany receivables
|
|
|
248
|
|
|
|
|
|
|
|
11
|
|
|
|
(259
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
484
|
|
|
|
4,868
|
|
|
|
71
|
|
|
|
(358
|
)
|
|
|
5,065
|
|
Property, plant and equipment, net
|
|
|
|
|
|
|
1,037
|
|
|
|
16
|
|
|
|
|
|
|
|
1,053
|
|
Trademarks, net
|
|
|
|
|
|
|
2,188
|
|
|
|
|
|
|
|
|
|
|
|
2,188
|
|
Goodwill
|
|
|
|
|
|
|
5,664
|
|
|
|
8
|
|
|
|
|
|
|
|
5,672
|
|
Other intangibles, net
|
|
|
|
|
|
|
226
|
|
|
|
|
|
|
|
|
|
|
|
226
|
|
Long-term intercompany notes
|
|
|
|
|
|
|
367
|
|
|
|
|
|
|
|
(367
|
)
|
|
|
|
|
Investment in subsidiaries
|
|
|
6,860
|
|
|
|
44
|
|
|
|
|
|
|
|
(6,904
|
)
|
|
|
|
|
Other assets and deferred charges
|
|
|
20
|
|
|
|
272
|
|
|
|
36
|
|
|
|
(13
|
)
|
|
|
315
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
7,364
|
|
|
$
|
14,666
|
|
|
$
|
131
|
|
|
$
|
(7,642
|
)
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
shareholders equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related
accruals
|
|
$
|
|
|
|
$
|
2,254
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,254
|
|
Accounts payable and other accrued
liabilities
|
|
|
383
|
|
|
|
1,210
|
|
|
|
18
|
|
|
|
(6
|
)
|
|
|
1,605
|
|
Due to related party
|
|
|
|
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
31
|
|
Deferred revenue, related party
|
|
|
|
|
|
|
69
|
|
|
|
|
|
|
|
|
|
|
|
69
|
|
Current maturities of long-term
debt
|
|
|
|
|
|
|
190
|
|
|
|
|
|
|
|
|
|
|
|
190
|
|
Short-term intercompany notes and
interest payable
|
|
|
23
|
|
|
|
9
|
|
|
|
61
|
|
|
|
(93
|
)
|
|
|
|
|
Other intercompany payables
|
|
|
|
|
|
|
259
|
|
|
|
|
|
|
|
(259
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
406
|
|
|
|
4,022
|
|
|
|
79
|
|
|
|
(358
|
)
|
|
|
4,149
|
|
Intercompany notes and interest
payable
|
|
|
367
|
|
|
|
|
|
|
|
|
|
|
|
(367
|
)
|
|
|
|
|
Long-term debt (less current
maturities)
|
|
|
|
|
|
|
1,558
|
|
|
|
|
|
|
|
|
|
|
|
1,558
|
|
Deferred income taxes, net
|
|
|
|
|
|
|
652
|
|
|
|
|
|
|
|
(13
|
)
|
|
|
639
|
|
Long-term retirement benefits,
(less current portion)
|
|
|
25
|
|
|
|
1,340
|
|
|
|
9
|
|
|
|
|
|
|
|
1,374
|
|
Other noncurrent liabilities
|
|
|
13
|
|
|
|
233
|
|
|
|
|
|
|
|
|
|
|
|
246
|
|
Shareholders equity
|
|
|
6,553
|
|
|
|
6,861
|
|
|
|
43
|
|
|
|
(6,904
|
)
|
|
|
6,553
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
shareholders equity
|
|
$
|
7,364
|
|
|
$
|
14,666
|
|
|
$
|
131
|
|
|
$
|
(7,642
|
)
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
186
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 22
|
RJR
Guaranteed, Unsecured Notes Condensed Consolidating
Financial Statements
|
The following condensed consolidating financial statements have
been prepared pursuant to
Rule 3-10
of
Regulation S-X,
relating to the guarantees of RJRs $161 million
unsecured notes. See note 12 and note 24 for
additional information relating to these notes. RAI and certain
of its direct or indirect, wholly owned subsidiaries, have fully
and unconditionally guaranteed these notes. On
September 30, 2006, GPI and RJR Packaging, LLC were added
as guarantors of RJRs long-term unsecured notes. The
guarantees are full and unconditional and joint and several. As
of and for the year ended December 31, 2006, 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., GPI and certain of RJRs other subsidiaries, the
other guarantors; other subsidiaries of RAI and RJR, including
Santa Fe, Lane, and Conwood, which are not guarantors; and
elimination adjustments. Comparative information for 2005 and
2004 represents the guarantor subsidiaries as of and during
those periods. Certain reclassifications were made to conform
prior years financial statements to the current
presentation.
187
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7,421
|
|
|
$
|
747
|
|
|
$
|
(158
|
)
|
|
$
|
8,010
|
|
Net sales, related party
|
|
|
|
|
|
|
|
|
|
|
487
|
|
|
|
13
|
|
|
|
|
|
|
|
500
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
4,678
|
|
|
|
283
|
|
|
|
(158
|
)
|
|
|
4,803
|
|
Selling, general and administrative
expenses
|
|
|
48
|
|
|
|
2
|
|
|
|
1,436
|
|
|
|
172
|
|
|
|
|
|
|
|
1,658
|
|
Amortization expense
|
|
|
|
|
|
|
|
|
|
|
27
|
|
|
|
1
|
|
|
|
|
|
|
|
28
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(48
|
)
|
|
|
(2
|
)
|
|
|
1,676
|
|
|
|
304
|
|
|
|
|
|
|
|
1,930
|
|
Interest and debt expense
|
|
|
194
|
|
|
|
70
|
|
|
|
2
|
|
|
|
4
|
|
|
|
|
|
|
|
270
|
|
Interest income
|
|
|
(2
|
)
|
|
|
(9
|
)
|
|
|
(121
|
)
|
|
|
(4
|
)
|
|
|
|
|
|
|
(136
|
)
|
Intercompany interest (income)
expense
|
|
|
(118
|
)
|
|
|
23
|
|
|
|
(49
|
)
|
|
|
144
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income
|
|
|
|
|
|
|
(43
|
)
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
|
|
|
Other (income) expense, net
|
|
|
7
|
|
|
|
(4
|
)
|
|
|
1
|
|
|
|
(17
|
)
|
|
|
|
|
|
|
(13
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
(129
|
)
|
|
|
(39
|
)
|
|
|
1,843
|
|
|
|
177
|
|
|
|
(43
|
)
|
|
|
1,809
|
|
Provision for (benefit from) income
taxes
|
|
|
(44
|
)
|
|
|
(52
|
)
|
|
|
703
|
|
|
|
66
|
|
|
|
|
|
|
|
673
|
|
Equity income from subsidiaries
|
|
|
1,295
|
|
|
|
1,246
|
|
|
|
32
|
|
|
|
|
|
|
|
(2,573
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
1,210
|
|
|
|
1,259
|
|
|
|
1,172
|
|
|
|
111
|
|
|
|
(2,616
|
)
|
|
|
1,136
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,210
|
|
|
$
|
1,259
|
|
|
$
|
1,246
|
|
|
$
|
111
|
|
|
$
|
(2,616
|
)
|
|
$
|
1,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
|
|
|
$
|
7,450
|
|
|
$
|
449
|
|
|
$
|
(120
|
)
|
|
$
|
7,779
|
|
Net sales, related party
|
|
|
|
|
|
|
|
|
|
|
463
|
|
|
|
14
|
|
|
|
|
|
|
|
477
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
4,811
|
|
|
|
230
|
|
|
|
(122
|
)
|
|
|
4,919
|
|
Selling, general and administrative
expenses
|
|
|
28
|
|
|
|
2
|
|
|
|
1,492
|
|
|
|
88
|
|
|
|
1
|
|
|
|
1,611
|
|
Loss on sale of assets
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
Amortization expense
|
|
|
|
|
|
|
|
|
|
|
41
|
|
|
|
|
|
|
|
|
|
|
|
41
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
|
|
|
|
198
|
|
|
|
2
|
|
|
|
|
|
|
|
200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(28
|
)
|
|
|
(2
|
)
|
|
|
1,345
|
|
|
|
143
|
|
|
|
1
|
|
|
|
1,459
|
|
Interest and debt expense
|
|
|
|
|
|
|
112
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
113
|
|
Interest income
|
|
|
(1
|
)
|
|
|
(8
|
)
|
|
|
(74
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
(85
|
)
|
Intercompany interest (income)
expense
|
|
|
24
|
|
|
|
(5
|
)
|
|
|
(35
|
)
|
|
|
16
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income
|
|
|
|
|
|
|
(60
|
)
|
|
|
|
|
|
|
|
|
|
|
60
|
|
|
|
|
|
Other (income) expense, net
|
|
|
|
|
|
|
25
|
|
|
|
1
|
|
|
|
(11
|
)
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
|
(51
|
)
|
|
|
(66
|
)
|
|
|
1,452
|
|
|
|
140
|
|
|
|
(59
|
)
|
|
|
1,416
|
|
Provision for (benefit from) income
taxes
|
|
|
(34
|
)
|
|
|
(167
|
)
|
|
|
591
|
|
|
|
41
|
|
|
|
|
|
|
|
431
|
|
Equity income from subsidiaries
|
|
|
1,059
|
|
|
|
958
|
|
|
|
31
|
|
|
|
|
|
|
|
(2,048
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
|
1,042
|
|
|
|
1,059
|
|
|
|
892
|
|
|
|
99
|
|
|
|
(2,107
|
)
|
|
|
985
|
|
Gain on sale of discontinued
businesses, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
1,042
|
|
|
|
1,059
|
|
|
|
894
|
|
|
|
99
|
|
|
|
(2,107
|
)
|
|
|
987
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,042
|
|
|
$
|
1,059
|
|
|
$
|
949
|
|
|
$
|
99
|
|
|
$
|
(2,107
|
)
|
|
$
|
1,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
188
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
|
|
|
$
|
|
|
|
$
|
5,982
|
|
|
$
|
298
|
|
|
$
|
(84
|
)
|
|
$
|
6,196
|
|
Net sales, related party
|
|
|
|
|
|
|
|
|
|
|
235
|
|
|
|
6
|
|
|
|
|
|
|
|
241
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
3,821
|
|
|
|
133
|
|
|
|
(82
|
)
|
|
|
3,872
|
|
Selling, general and administrative
expenses
|
|
|
17
|
|
|
|
38
|
|
|
|
1,315
|
|
|
|
85
|
|
|
|
|
|
|
|
1,455
|
|
Amortization expense
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
Restructuring and asset impairment
charges
|
|
|
|
|
|
|
(1
|
)
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
Goodwill and trademark impairment
charges
|
|
|
|
|
|
|
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(17
|
)
|
|
|
(37
|
)
|
|
|
852
|
|
|
|
86
|
|
|
|
(2
|
)
|
|
|
882
|
|
Interest and debt expense
|
|
|
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
85
|
|
Interest income
|
|
|
|
|
|
|
(5
|
)
|
|
|
(24
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
(30
|
)
|
Intercompany interest (income)
expense
|
|
|
7
|
|
|
|
(7
|
)
|
|
|
(13
|
)
|
|
|
13
|
|
|
|
|
|
|
|
|
|
Other (income) expense, net
|
|
|
|
|
|
|
3
|
|
|
|
1
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing
operations before income taxes
|
|
|
(24
|
)
|
|
|
(113
|
)
|
|
|
888
|
|
|
|
80
|
|
|
|
(2
|
)
|
|
|
829
|
|
Provision for (benefit from) income
taxes
|
|
|
(4
|
)
|
|
|
(92
|
)
|
|
|
274
|
|
|
|
24
|
|
|
|
|
|
|
|
202
|
|
Equity income from subsidiaries
|
|
|
708
|
|
|
|
692
|
|
|
|
28
|
|
|
|
|
|
|
|
(1,428
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing
operations
|
|
|
688
|
|
|
|
671
|
|
|
|
642
|
|
|
|
56
|
|
|
|
(1,430
|
)
|
|
|
627
|
|
Gain on sale of discontinued
businesses, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary
item
|
|
|
688
|
|
|
|
671
|
|
|
|
654
|
|
|
|
56
|
|
|
|
(1,430
|
)
|
|
|
639
|
|
Extraordinary item gain
on acquisition
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
688
|
|
|
$
|
671
|
|
|
$
|
703
|
|
|
$
|
56
|
|
|
$
|
(1,430
|
)
|
|
$
|
688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
189
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Statements of Cash Flows
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities
|
|
$
|
1,023
|
|
|
$
|
1,364
|
|
|
$
|
1,915
|
|
|
$
|
212
|
|
|
$
|
(3,057
|
)
|
|
$
|
1,457
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions from equity
investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
|
|
|
|
|
|
|
|
18
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(5
|
)
|
|
|
(7,672
|
)
|
|
|
|
|
|
|
|
|
|
|
(7,677
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
|
|
|
|
7,760
|
|
|
|
|
|
|
|
|
|
|
|
7,760
|
|
Intercompany notes receivable
|
|
|
(3,168
|
)
|
|
|
(3,153
|
)
|
|
|
(110
|
)
|
|
|
1
|
|
|
|
6,430
|
|
|
|
|
|
Net intercompany investments
|
|
|
(211
|
)
|
|
|
294
|
|
|
|
(464
|
)
|
|
|
381
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
|
|
|
|
|
|
|
|
(119
|
)
|
|
|
(17
|
)
|
|
|
|
|
|
|
(136
|
)
|
Acquisition
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,519
|
)
|
|
|
|
|
|
|
(3,519
|
)
|
Net proceeds from the sale of
businesses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
3
|
|
Net proceeds from the sale of fixed
assets
|
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
4
|
|
|
|
|
|
|
|
24
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in investing
Activities
|
|
|
(3,379
|
)
|
|
|
(2,864
|
)
|
|
|
(589
|
)
|
|
|
(3,129
|
)
|
|
|
6,430
|
|
|
|
(3,531
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock
|
|
|
(775
|
)
|
|
|
(1,494
|
)
|
|
|
(1,520
|
)
|
|
|
|
|
|
|
3,014
|
|
|
|
(775
|
)
|
Dividends paid on preferred stock
|
|
|
(43
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Excess tax benefit from stock-based
compensation
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Repayments of long-term debt
|
|
|
|
|
|
|
(190
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(190
|
)
|
Repayments of term loan credit
facility
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8
|
)
|
Proceeds from issuance of long-term
debt
|
|
|
1,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641
|
|
Principal borrowings under term
loan credit facility
|
|
|
1,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,550
|
|
Deferred debt issuance costs
|
|
|
(52
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52
|
)
|
Intercompany notes payable
|
|
|
104
|
|
|
|
3,173
|
|
|
|
(1
|
)
|
|
|
3,154
|
|
|
|
(6,430
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
financing activities
|
|
|
2,425
|
|
|
|
1,489
|
|
|
|
(1,521
|
)
|
|
|
3,154
|
|
|
|
(3,373
|
)
|
|
|
2,174
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
69
|
|
|
|
(11
|
)
|
|
|
(195
|
)
|
|
|
237
|
|
|
|
|
|
|
|
100
|
|
Cash and cash equivalents at
beginning of year
|
|
|
227
|
|
|
|
33
|
|
|
|
1,043
|
|
|
|
30
|
|
|
|
|
|
|
|
1,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
296
|
|
|
$
|
22
|
|
|
$
|
848
|
|
|
$
|
267
|
|
|
$
|
|
|
|
$
|
1,433
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities
|
|
$
|
726
|
|
|
$
|
343
|
|
|
$
|
1,147
|
|
|
$
|
79
|
|
|
$
|
(1,022
|
)
|
|
$
|
1,273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
|
|
|
|
(10,883
|
)
|
|
|
|
|
|
|
|
|
|
|
(10,883
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
|
|
|
|
9,985
|
|
|
|
|
|
|
|
|
|
|
|
9,985
|
|
Purchases of long-term investments
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
Capital expenditures
|
|
|
|
|
|
|
|
|
|
|
(97
|
)
|
|
|
(10
|
)
|
|
|
2
|
|
|
|
(105
|
)
|
Distributions from equity
investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
12
|
|
Investment (to subsidiaries) from
parent
|
|
|
|
|
|
|
(22
|
)
|
|
|
7
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
Acquisition
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(45
|
)
|
|
|
|
|
|
|
(45
|
)
|
Net proceeds from the sale of
businesses
|
|
|
|
|
|
|
|
|
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
48
|
|
Other, net
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
4
|
|
Intercompany notes receivable
|
|
|
|
|
|
|
18
|
|
|
|
11
|
|
|
|
|
|
|
|
(29
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in investing
activities
|
|
|
|
|
|
|
(9
|
)
|
|
|
(923
|
)
|
|
|
(28
|
)
|
|
|
(29
|
)
|
|
|
(989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock
|
|
|
(575
|
)
|
|
|
(463
|
)
|
|
|
(435
|
)
|
|
|
(75
|
)
|
|
|
973
|
|
|
|
(575
|
)
|
Dividends paid on preferred stock
|
|
|
(49
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Repurchase of common stock
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
Repayments of long-term debt
|
|
|
|
|
|
|
(360
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(360
|
)
|
Proceeds from issuance of long-term
debt
|
|
|
|
|
|
|
499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
499
|
|
Deferred debt issuance costs
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7
|
)
|
Debt retirement costs
|
|
|
|
|
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7
|
)
|
Intercompany notes payable
|
|
|
(16
|
)
|
|
|
6
|
|
|
|
(2
|
)
|
|
|
(17
|
)
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing
activities
|
|
|
(640
|
)
|
|
|
(332
|
)
|
|
|
(437
|
)
|
|
|
(92
|
)
|
|
|
1,051
|
|
|
|
(450
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
86
|
|
|
|
2
|
|
|
|
(213
|
)
|
|
|
(41
|
)
|
|
|
|
|
|
|
(166
|
)
|
Cash and cash equivalents at
beginning of year
|
|
|
141
|
|
|
|
31
|
|
|
|
1,256
|
|
|
|
71
|
|
|
|
|
|
|
|
1,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
227
|
|
|
$
|
33
|
|
|
$
|
1,043
|
|
|
$
|
30
|
|
|
$
|
|
|
|
$
|
1,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
190
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
For the Year Ended
December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities
|
|
$
|
295
|
|
|
$
|
601
|
|
|
$
|
1,083
|
|
|
$
|
49
|
|
|
$
|
(1,292
|
)
|
|
$
|
736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
|
|
|
|
(2
|
)
|
|
|
(4,567
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,569
|
)
|
Proceeds from sale of short-term
investments
|
|
|
|
|
|
|
|
|
|
|
4,757
|
|
|
|
|
|
|
|
|
|
|
|
4,757
|
|
Purchases of long-term investments
|
|
|
|
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10
|
)
|
Proceeds from sale of long-term
investments
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Capital expenditures
|
|
|
|
|
|
|
|
|
|
|
(76
|
)
|
|
|
(16
|
)
|
|
|
|
|
|
|
(92
|
)
|
Acquisitions, net of cash acquired
|
|
|
(403
|
)
|
|
|
(35
|
)
|
|
|
603
|
|
|
|
|
|
|
|
|
|
|
|
165
|
|
Distributions from (investment in)
equity investments
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
5
|
|
Other, net
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Intercompany notes receivable
|
|
|
|
|
|
|
18
|
|
|
|
(413
|
)
|
|
|
2
|
|
|
|
393
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
investing activities
|
|
|
(403
|
)
|
|
|
(30
|
)
|
|
|
307
|
|
|
|
(7
|
)
|
|
|
393
|
|
|
|
260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock
|
|
|
(43
|
)
|
|
|
(28
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(71
|
)
|
Dividends paid on common stock
|
|
|
(140
|
)
|
|
|
(865
|
)
|
|
|
(670
|
)
|
|
|
|
|
|
|
1,292
|
|
|
|
(383
|
)
|
Repayments of long-term debt
|
|
|
|
|
|
|
(56
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(56
|
)
|
Proceeds from exercise of stock
options
|
|
|
32
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
|
|
Intercompany notes payable
|
|
|
400
|
|
|
|
12
|
|
|
|
(5
|
)
|
|
|
(14
|
)
|
|
|
(393
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)
financing activities
|
|
|
249
|
|
|
|
(926
|
)
|
|
|
(675
|
)
|
|
|
(14
|
)
|
|
|
899
|
|
|
|
(467
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
141
|
|
|
|
(355
|
)
|
|
|
715
|
|
|
|
28
|
|
|
|
|
|
|
|
529
|
|
Cash and cash equivalents at
beginning of year
|
|
|
|
|
|
|
386
|
|
|
|
541
|
|
|
|
43
|
|
|
|
|
|
|
|
970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
year
|
|
$
|
141
|
|
|
$
|
31
|
|
|
$
|
1,256
|
|
|
$
|
71
|
|
|
$
|
|
|
|
$
|
1,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
191
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Condensed
Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
December 31,
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
296
|
|
|
$
|
22
|
|
|
$
|
848
|
|
|
$
|
267
|
|
|
$
|
|
|
|
$
|
1,433
|
|
Short-term investments
|
|
|
|
|
|
|
117
|
|
|
|
1,176
|
|
|
|
|
|
|
|
|
|
|
|
1,293
|
|
Accounts receivable, net
|
|
|
4
|
|
|
|
2
|
|
|
|
64
|
|
|
|
30
|
|
|
|
|
|
|
|
100
|
|
Accounts receivable, related party
|
|
|
|
|
|
|
|
|
|
|
51
|
|
|
|
11
|
|
|
|
|
|
|
|
62
|
|
Income tax receivable
|
|
|
|
|
|
|
1
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
7
|
|
Inventories
|
|
|
|
|
|
|
|
|
|
|
910
|
|
|
|
246
|
|
|
|
(1
|
)
|
|
|
1,155
|
|
Deferred income taxes, net
|
|
|
3
|
|
|
|
1
|
|
|
|
768
|
|
|
|
21
|
|
|
|
|
|
|
|
793
|
|
Prepaid expenses
|
|
|
6
|
|
|
|
|
|
|
|
96
|
|
|
|
6
|
|
|
|
(16
|
)
|
|
|
92
|
|
Short-term intercompany notes and
interest receivable
|
|
|
83
|
|
|
|
99
|
|
|
|
433
|
|
|
|
|
|
|
|
(615
|
)
|
|
|
|
|
Other intercompany receivables
|
|
|
522
|
|
|
|
38
|
|
|
|
|
|
|
|
29
|
|
|
|
(589
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
914
|
|
|
|
280
|
|
|
|
4,352
|
|
|
|
610
|
|
|
|
(1,221
|
)
|
|
|
4,935
|
|
Property, plant and equipment, net
|
|
|
|
|
|
|
|
|
|
|
955
|
|
|
|
107
|
|
|
|
|
|
|
|
1,062
|
|
Trademarks, net
|
|
|
|
|
|
|
|
|
|
|
1,906
|
|
|
|
1,573
|
|
|
|
|
|
|
|
3,479
|
|
Goodwill
|
|
|
|
|
|
|
|
|
|
|
5,303
|
|
|
|
2,872
|
|
|
|
|
|
|
|
8,175
|
|
Other intangibles, net
|
|
|
|
|
|
|
|
|
|
|
180
|
|
|
|
35
|
|
|
|
|
|
|
|
215
|
|
Long-term intercompany notes
|
|
|
2,160
|
|
|
|
244
|
|
|
|
472
|
|
|
|
|
|
|
|
(2,876
|
)
|
|
|
|
|
Investment in subsidiaries
|
|
|
9,253
|
|
|
|
7,684
|
|
|
|
52
|
|
|
|
|
|
|
|
(16,989
|
)
|
|
|
|
|
Other assets and deferred charges
|
|
|
96
|
|
|
|
29
|
|
|
|
173
|
|
|
|
40
|
|
|
|
(26
|
)
|
|
|
312
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
12,423
|
|
|
$
|
8,237
|
|
|
$
|
13,393
|
|
|
$
|
5,237
|
|
|
$
|
(21,112
|
)
|
|
$
|
18,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
shareholders equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related
accruals
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,216
|
|
|
$
|
21
|
|
|
$
|
|
|
|
$
|
2,237
|
|
Accounts payable and other accrued
liabilities
|
|
|
323
|
|
|
|
8
|
|
|
|
998
|
|
|
|
127
|
|
|
|
(16
|
)
|
|
|
1,440
|
|
Due to related party
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
9
|
|
Deferred revenue, related party
|
|
|
|
|
|
|
|
|
|
|
62
|
|
|
|
|
|
|
|
|
|
|
|
62
|
|
Current maturities of long-term
debt
|
|
|
252
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
344
|
|
Short-term intercompany notes and
interest payable
|
|
|
26
|
|
|
|
407
|
|
|
|
3
|
|
|
|
179
|
|
|
|
(615
|
)
|
|
|
|
|
Other intercompany payables
|
|
|
|
|
|
|
|
|
|
|
589
|
|
|
|
|
|
|
|
(589
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
601
|
|
|
|
507
|
|
|
|
3,877
|
|
|
|
327
|
|
|
|
(1,220
|
)
|
|
|
4,092
|
|
Intercompany notes and interest
payable
|
|
|
472
|
|
|
|
|
|
|
|
4
|
|
|
|
2,400
|
|
|
|
(2,876
|
)
|
|
|
|
|
Long-term debt (less current
maturities)
|
|
|
4,229
|
|
|
|
160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,389
|
|
Deferred income taxes, net
|
|
|
|
|
|
|
|
|
|
|
605
|
|
|
|
588
|
|
|
|
(26
|
)
|
|
|
1,167
|
|
Long-term retirement benefits
|
|
|
41
|
|
|
|
19
|
|
|
|
1,101
|
|
|
|
66
|
|
|
|
|
|
|
|
1,227
|
|
Other noncurrent liabilities
|
|
|
37
|
|
|
|
91
|
|
|
|
123
|
|
|
|
9
|
|
|
|
|
|
|
|
260
|
|
Shareholders equity
|
|
|
7,043
|
|
|
|
7,460
|
|
|
|
7,683
|
|
|
|
1,847
|
|
|
|
(16,990
|
)
|
|
|
7,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
shareholders equity
|
|
$
|
12,423
|
|
|
$
|
8,237
|
|
|
$
|
13,393
|
|
|
$
|
5,237
|
|
|
$
|
(21,112
|
)
|
|
$
|
18,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
192
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent
|
|
|
|
|
|
Other
|
|
|
Non-
|
|
|
|
|
|
|
|
|
|
Guarantor
|
|
|
Issuer
|
|
|
Guarantors
|
|
|
Guarantors
|
|
|
Eliminations
|
|
|
Consolidated
|
|
|
December 31,
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
227
|
|
|
$
|
33
|
|
|
$
|
1,043
|
|
|
$
|
30
|
|
|
$
|
|
|
|
$
|
1,333
|
|
Short-term investments
|
|
|
|
|
|
|
111
|
|
|
|
1,262
|
|
|
|
|
|
|
|
|
|
|
|
1,373
|
|
Accounts receivable, net
|
|
|
|
|
|
|
8
|
|
|
|
61
|
|
|
|
30
|
|
|
|
|
|
|
|
99
|
|
Accounts receivable, related party
|
|
|
|
|
|
|
|
|
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
67
|
|
Income tax receivable
|
|
|
|
|
|
|
74
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
159
|
|
Inventories
|
|
|
|
|
|
|
|
|
|
|
974
|
|
|
|
92
|
|
|
|
|
|
|
|
1,066
|
|
Deferred income taxes, net
|
|
|
3
|
|
|
|
2
|
|
|
|
844
|
|
|
|
16
|
|
|
|
|
|
|
|
865
|
|
Prepaid expenses
|
|
|
6
|
|
|
|
5
|
|
|
|
89
|
|
|
|
5
|
|
|
|
(7
|
)
|
|
|
98
|
|
Assets held for sale
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
4
|
|
|
|
|
|
|
|
5
|
|
Short-term intercompany notes and
interest receivable
|
|
|
|
|
|
|
88
|
|
|
|
424
|
|
|
|
9
|
|
|
|
(521
|
)
|
|
|
|
|
Other intercompany receivables
|
|
|
248
|
|
|
|
|
|
|
|
|
|
|
|
78
|
|
|
|
(326
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
484
|
|
|
|
321
|
|
|
|
4,850
|
|
|
|
264
|
|
|
|
(854
|
)
|
|
|
5,065
|
|
Property, plant and equipment, net
|
|
|
|
|
|
|
|
|
|
|
995
|
|
|
|
58
|
|
|
|
|
|
|
|
1,053
|
|
Trademarks, net
|
|
|
|
|
|
|
|
|
|
|
2,008
|
|
|
|
180
|
|
|
|
|
|
|
|
2,188
|
|
Goodwill
|
|
|
|
|
|
|
|
|
|
|
5,309
|
|
|
|
363
|
|
|
|
|
|
|
|
5,672
|
|
Other intangibles, net
|
|
|
|
|
|
|
|
|
|
|
147
|
|
|
|
79
|
|
|
|
|
|
|
|
226
|
|
Long-term intercompany notes
|
|
|
|
|
|
|
263
|
|
|
|
367
|
|
|
|
|
|
|
|
(630
|
)
|
|
|
|
|
Investment in subsidiaries
|
|
|
6,860
|
|
|
|
8,472
|
|
|
|
29
|
|
|
|
|
|
|
|
(15,361
|
)
|
|
|
|
|
Other assets and deferred charges
|
|
|
20
|
|
|
|
60
|
|
|
|
204
|
|
|
|
44
|
|
|
|
(13
|
)
|
|
|
315
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
7,364
|
|
|
$
|
9,116
|
|
|
$
|
13,909
|
|
|
$
|
988
|
|
|
$
|
(16,858
|
)
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
shareholders equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related
accruals
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,236
|
|
|
$
|
18
|
|
|
$
|
|
|
|
$
|
2,254
|
|
Accounts payable and other accrued
liabilities
|
|
|
383
|
|
|
|
40
|
|
|
|
1,086
|
|
|
|
103
|
|
|
|
(7
|
)
|
|
|
1,605
|
|
Due to related party
|
|
|
|
|
|
|
|
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
31
|
|
Deferred revenue, related party
|
|
|
|
|
|
|
|
|
|
|
69
|
|
|
|
|
|
|
|
|
|
|
|
69
|
|
Current maturities of long-term
debt
|
|
|
|
|
|
|
190
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
190
|
|
Short-term intercompany notes and
interest payable
|
|
|
23
|
|
|
|
401
|
|
|
|
12
|
|
|
|
85
|
|
|
|
(521
|
)
|
|
|
|
|
Other intercompany payables
|
|
|
|
|
|
|
323
|
|
|
|
3
|
|
|
|
|
|
|
|
(326
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
406
|
|
|
|
954
|
|
|
|
3,437
|
|
|
|
206
|
|
|
|
(854
|
)
|
|
|
4,149
|
|
Intercompany notes and interest
payable
|
|
|
367
|
|
|
|
|
|
|
|
7
|
|
|
|
256
|
|
|
|
(630
|
)
|
|
|
|
|
Long-term debt (less current
maturities)
|
|
|
|
|
|
|
1,558
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,558
|
|
Deferred income taxes, net
|
|
|
|
|
|
|
5
|
|
|
|
562
|
|
|
|
84
|
|
|
|
(12
|
)
|
|
|
639
|
|
Long-term retirement benefits
|
|
|
25
|
|
|
|
18
|
|
|
|
1,317
|
|
|
|
14
|
|
|
|
|
|
|
|
1,374
|
|
Other noncurrent liabilities
|
|
|
13
|
|
|
|
91
|
|
|
|
137
|
|
|
|
5
|
|
|
|
|
|
|
|
246
|
|
Shareholders equity
|
|
|
6,553
|
|
|
|
6,490
|
|
|
|
8,449
|
|
|
|
423
|
|
|
|
(15,362
|
)
|
|
|
6,553
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
shareholders equity
|
|
$
|
7,364
|
|
|
$
|
9,116
|
|
|
$
|
13,909
|
|
|
$
|
988
|
|
|
$
|
(16,858
|
)
|
|
$
|
14,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
193
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Note 23
Quarterly Results of Operations (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth(2)
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
1,960
|
|
|
$
|
2,291
|
|
|
$
|
2,190
|
|
|
$
|
2,069
|
|
Gross profit
|
|
|
795
|
|
|
|
1,015
|
|
|
|
988
|
|
|
|
909
|
|
Net income from continuing
operations
|
|
|
280
|
|
|
|
367
|
|
|
|
309
|
|
|
|
180
|
|
Extraordinary item, net of income
taxes
|
|
|
65
|
|
|
|
9
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
345
|
|
|
|
376
|
|
|
|
309
|
|
|
|
180
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per share data (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income from continuing
operations
|
|
|
0.95
|
|
|
|
1.24
|
|
|
|
1.05
|
|
|
|
0.61
|
|
Extraordinary item, net of income
taxes
|
|
|
0.22
|
|
|
|
0.03
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
1.17
|
|
|
|
1.27
|
|
|
|
1.05
|
|
|
|
0.61
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income from continuing
operations
|
|
|
0.95
|
|
|
|
1.24
|
|
|
|
1.05
|
|
|
|
0.61
|
|
Extraordinary item, net of income
taxes
|
|
|
0.22
|
|
|
|
0.03
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
1.17
|
|
|
|
1.27
|
|
|
|
1.05
|
|
|
|
0.61
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
1,957
|
|
|
$
|
2,103
|
|
|
$
|
2,149
|
|
|
$
|
2,047
|
|
Gross profit
|
|
|
846
|
|
|
|
862
|
|
|
|
765
|
|
|
|
864
|
|
Net income from continuing
operations
|
|
|
281
|
|
|
|
251
|
|
|
|
213
|
|
|
|
240
|
|
Discontinued operations, net of
income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Extraordinary item, net of income
taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
55
|
|
Net income
|
|
|
281
|
|
|
|
251
|
|
|
|
213
|
|
|
|
297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per share data (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income from continuing
operations
|
|
|
0.95
|
|
|
|
0.85
|
|
|
|
0.72
|
|
|
|
0.81
|
|
Discontinued operations, net of
income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.01
|
|
Extraordinary item, net of income
taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.19
|
|
Net income
|
|
|
0.95
|
|
|
|
0.85
|
|
|
|
0.72
|
|
|
|
1.01
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income from continuing
operations
|
|
|
0.95
|
|
|
|
0.85
|
|
|
|
0.72
|
|
|
|
0.81
|
|
Discontinued operations, net of
income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.01
|
|
Extraordinary item, net of income
taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.19
|
|
Net income
|
|
|
0.95
|
|
|
|
0.85
|
|
|
|
0.72
|
|
|
|
1.01
|
|
|
|
|
(1) |
|
Income per share is computed independently for each of the
periods presented. The sum of the income per share amounts for
the quarters may not equal the total for the year. |
|
(2) |
|
Fourth quarter 2006 net income from continuing operations
includes a $90 million trademark impairment. Fourth quarter
2005 net income from continuing operations includes a
$198 million trademark impairment. |
Note 24
Subsequent Events
On October 25, 2006, RAI filed a registration statement
with the SEC, which became effective November 7, 2006,
pursuant to which RAI offered to exchange $161 million of
RJR unsecured notes for RAI registered secured notes. At the
expiration of the exchange offer on February 15, 2007, 29%
of the RJR unsecured notes had been validly tendered for
exchange and were accepted by RAI.
194
|
|
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
None.
|
|
Item 9A.
|
Controls
and Procedures
|
Disclosure
Controls and Procedures
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.
Internal
Control over Financial Reporting
Limitation
on the Effectiveness of Controls
Internal controls are designed to provide reasonable assurance
that assets are safeguarded and transactions are properly
recorded, executed and reported in accordance with
managements authorization. The effectiveness of internal
controls is supported by qualified personnel and an organization
structure that provides an appropriate division of
responsibility and formalized procedures. An internal audit
staff regularly monitors the adequacy and effectiveness of
internal controls, including reporting to RAIs audit
committee. Because of its inherent limitations, a system of
internal control over financial reporting can provide only
reasonable assurance and may not prevent or detect
misstatements. See Managements Report on Internal
Control over Financial Reporting in Item 8.
Changes
in Controls
There have been no changes in RAIs internal controls over
financial reporting that occurred during the fourth quarter that
have materially affected, or are reasonably likely to materially
affect, RAIs internal controls over financial reporting.
|
|
Item 9B.
|
Other
Information
|
None.
195
PART III
|
|
Item 10.
|
Directors,
Executive Officers and Corporate Governance
|
Item 10 is incorporated by reference to the following
sections of RAIs definitive Proxy Statement to be filed
with the SEC on or about March 30, 2007, referred to as the
Proxy Statement: The Board of Directors
Item 1: Election of Directors; The Board of
Directors Biographies of Board Members;
The Board of Directors Governance
Agreement; The Board of Directors
Committees and Meetings of the Board of Directors
Audit Committee; The Board of Directors
Code of Conduct; and Security Ownership of Certain
Beneficial Owners and Management Section 16(a)
Beneficial Ownership Reporting Compliance. For information
regarding the executive officers and certain significant
employees of RAI, see Executive Officers and Certain
Significant Employees of the Registrant in Item 4 of
Part I of this report.
|
|
Item 11.
|
Executive
Compensation
|
Item 11 is incorporated by reference to the following
sections of the Proxy Statement: Executive
Compensation; Executive Compensation-Compensation
Committee Report; The Board of Directors
Committees and Meetings of the Board of Directors
Compensation Committee; Compensation Committee Interlocks and
Insider Participation; and The Board of
Directors Director Compensation.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
Item 12 is incorporated by reference to the following
sections of the Proxy Statement: Security Ownership of
Certain Beneficial Owners and Management Stock
Ownership of Principal Shareholders; Security
Ownership of Certain Beneficial Owners and
Management Stock Ownership of Management;
Security Ownership of Certain Beneficial Owners and
Management Standstill Provisions; Transfer
Restrictions. For information regarding securities
authorized for issuance under equity compensation plans, see
note 16 to consolidated financial statements.
|
|
Item 13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
Item 13 is incorporated by reference to the following
sections of the Proxy Statement: Certain Relationships and
Related Transactions; and The Board of
Directors-Determination of Independence of Directors.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
Item 14 is incorporated by reference to the following
sections of the Proxy Statement: Audit Matters-Audit
Committees Audit and Non-Audit Services Pre-Approval
Policy; and Audit Matters Fees of
Independent Auditors.
PART IV
|
|
Item 15.
|
Exhibits
and Financial Statement Schedules
|
(a) The following documents are filed as a part of this
report:
(1) Consolidated Statements of Income for the years ended
December 31, 2006, 2005 and 2004.
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005 and 2004.
Consolidated Balance Sheets as of December 31, 2006 and
2005.
Consolidated Statements of Shareholders Equity and
Comprehensive Income for the years ended December 31, 2006,
2005 and 2004.
|
|
|
|
(2)
|
Financial Statement Schedules have been omitted because the
information required has been separately disclosed in the
consolidated financial statements or notes.
|
196
(3) See (b) below.
|
|
|
|
(b)
|
Exhibit Numbers 10.37 through 10.72 below are management
contracts, compensatory plans or arrangements. The following
exhibits are filed or furnished, as the case may be, as part of
this report:
|
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
2
|
.1
|
|
Purchase Agreement, dated
April 24, 2006, by and among(i) Reynolds American
Inc., (ii) Reynolds American Inc.s direct, wholly
owned acquisition subsidiary, Pinch Acquisition Corporation,
(iii) Karl J. Breyer, Marshall E. Eisenberg and Thomas J.
Pritzker, not individually, but solely as co-trustees of those
certain separate and distinct trusts listed therein, and
(iv) GP Investor, L.L.C. (incorporated by reference to
Exhibit 2.1 to Reynolds American Inc.s
Form 8-K
dated April 24, 2006).
|
|
2
|
.2
|
|
Amendment No. 1, dated as of
May 31, 2006, to the Purchase Agreement, dated as of
April 24, 2006, by and among Karl J. Breyer, Marshall E.
Eisenberg and Thomas J. Pritzker, not individually, but solely
as co-trustees of those certain separate and distinct trusts
listed therein, GP Investor, L.L.C., Reynolds American Inc. and
Conwood Holdings, Inc. (f/k/a Pinch Acquisition Corporation)
(incorporated by reference to Exhibit 2.1 to Reynolds
American Inc.s
Form 8-K
dated May 31, 2006).
|
|
3
|
.1
|
|
Amended and Restated Certificate
of Incorporation of Reynolds American Inc. (incorporated by
reference to Exhibit 1 to Reynolds American Inc.s
Form 8-A
filed July 29, 2004).
|
|
3
|
.2
|
|
Amended and Restated Bylaws of
Reynolds American Inc. (incorporated by reference to
Exhibit 3.1 to Reynolds American Inc.s
Form 8-K
dated November 29, 2006).
|
|
4
|
.1
|
|
Rights Agreement, between Reynolds
American Inc. and The Bank of New York, as rights agent
(incorporated by reference to Exhibit 3 to Reynolds
American Inc.s
Form 8-A
filed July 29, 2004).
|
|
4
|
.2
|
|
Amended and Restated Indenture,
dated as of July 24, 1995, between RJR Nabisco, Inc. and
The Bank of New York (incorporated by reference to
Exhibit 4.1 to RJR Nabisco, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 1995, filed August 8,
1995).
|
|
4
|
.3
|
|
First Supplemental Indenture and
Waiver, dated as of April 27, 1999, between RJR Nabisco,
Inc. and The Bank of New York, to the Amended and Restated
Indenture, dated as of July 24, 1995, between RJR Nabisco,
Inc. and The Bank of New York, as successor trustee
(incorporated by reference to Exhibit 10.3 to R.J. Reynolds
Tobacco Holdings, Inc.s
Form 8-A
filed May 19, 1999).
|
|
4
|
.4
|
|
Indenture, dated as of
May 15, 1999, among RJR Nabisco, Inc., R.J. Reynolds
Tobacco Company and The Bank of New York, as trustee
(incorporated by reference to Exhibit 10.2 to R.J. Reynolds
Tobacco Holdings, Inc.s
Form 8-A
filed May 19, 1999).
|
|
4
|
.5
|
|
Guarantee, dated as of
May 18, 1999, by R.J. Reynolds Tobacco Company to the
holders and to The Bank of New York, as Trustee, issued in
connection with the Indenture, dated as of May 15, 1999,
among RJR Nabisco, Inc., R.J. Reynolds Tobacco Company and The
Bank of New York, as Trustee (incorporated by reference to
Exhibit 10.6 to R.J. Reynolds Tobacco Holdings, Inc.s
Form 8-A
filed May 19, 1999).
|
|
4
|
.6
|
|
First Supplemental Indenture,
dated as of December 12, 2000, among RJR Acquisition Corp.,
R. J. Reynolds Tobacco Holdings, Inc., R.J. Reynolds Tobacco
Company and The Bank of New York, as Trustee, to the Indenture,
dated as of May 15, 1999, among RJR Nabisco, Inc., R.J.
Reynolds Tobacco Company and The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.6 to R.J. Reynolds
Tobacco Holdings, Inc.s Annual Report on
Form 10-K
for the year ended December 31, 2000, filed March 1,
2001).
|
|
4
|
.7
|
|
Second Supplemental Indenture,
dated as of June 30, 2003, among GMB, Inc., FSH, Inc., R.J.
Reynolds Tobacco Co., Santa Fe Natural Tobacco Company,
Inc., RJR Packaging, LLC, R.J. Reynolds Tobacco Holdings, Inc.,
R.J. Reynolds Tobacco Company, RJR Acquisition Corp. and The
Bank of New York, as Trustee, to the Indenture, dated
May 15, 1999, among RJR Nabisco, Inc., R.J. Reynolds
Tobacco Company and The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.1 to R.J. Reynolds
Tobacco Holdings, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2003, filed August 8,
2003).
|
197
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
4
|
.8
|
|
Third Supplemental Indenture,
dated as of July 30, 2004, among R.J. Reynolds Tobacco
Holdings, Inc., Reynolds American Inc., R.J. Reynolds Tobacco
Company, RJR Acquisition Corp., GMB, Inc., FHS, Inc., R.J.
Reynolds Tobacco Co., RJR Packaging, LLC, BWT Brands, Inc. and
The Bank of New York, as Trustee, to the Indenture dated
May 15, 1999, among RJR Nabisco, Inc., R.J. Reynolds
Tobacco Company and The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.2 to Reynolds
American Inc.s
Form 8-K
dated July 30, 2004).
|
|
4
|
.9
|
|
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 Reynolds American Inc.s From
8-K dated
July 11, 2005).
|
|
4
|
.10
|
|
Fifth Supplemental Indenture,
dated May 31, 2006, to Indenture dated May 15, 1999,
among R.J. Reynolds Tobacco Holdings, Inc., Reynolds American
Inc. and certain subsidiaries of R.J. Reynolds Tobacco Holdings,
Inc. as guarantors and The Bank of New York Trust Company, N.A.
as Trustee (incorporated by reference to Exhibit 4.5 to
Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
4
|
.11
|
|
Sixth Supplemental Indenture,
dated June 20, 2006, to Indenture, dated May 15, 1999,
among R.J. Reynolds Tobacco Holdings, Inc., Reynolds American
Inc. and certain subsidiaries of R.J. Reynolds Tobacco Holdings,
Inc. as guarantors and The Bank of New York Trust Company, N.A.
as Trustee (incorporated by reference to Exhibit 4.6 to
Reynolds American Inc.s
Form 8-K
dated June 20, 2006).
|
|
4
|
.12
|
|
Seventh Supplemental Indenture,
dated September 30, 2006, to Indenture, dated May 15,
1999, among R.J. Reynolds Tobacco Holdings, Inc., Reynolds
American Inc. and certain subsidiaries of R.J. Reynolds Tobacco
Holdings, Inc. as guarantors, and The Bank of New York Trust
Company, N.A., as successor to The Bank of New York, as Trustee,
as amended (incorporated by reference to Exhibit 4.3 to
Reynolds American Inc.s
Form 8-K
dated September 30, 2006).
|
|
4
|
.13
|
|
Indenture, dated as of
May 20, 2002, by and among R.J. Reynolds Tobacco Holdings,
Inc., R. J. Reynolds Tobacco Company, RJR Acquisition Corp. and
The Bank of New York (incorporated by reference to
Exhibit 4.3 to R.J. Reynolds Tobacco Holdings, Inc.s
Form 8-K
dated May 15, 2002).
|
|
4
|
.14
|
|
First Supplemental Indenture dated
as of June 30, 2003, among GMB, Inc., FSH, Inc., R. J.
Reynolds Tobacco Co., Santa Fe Natural Tobacco Company,
Inc., RJR Packaging, LLC, R. J. Reynolds Tobacco Holdings, Inc.,
R.J. Reynolds Tobacco Company, RJR Acquisition Corp. and The
Bank of New York, as Trustee, to the Indenture dated as of
May 20, 2002, among R. J. Reynolds Tobacco Holdings, Inc.,
R.J. Reynolds Tobacco Company, RJR Acquisition Corp. and The
Bank of New York, as Trustee (incorporated by reference to
Exhibit 4.2 to R.J. Reynolds Tobacco Holdings, Inc.s
Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2003, filed August 8,
2003).
|
|
4
|
.15
|
|
Second Supplemental Indenture,
dated as of July 30, 2004, among R.J. Reynolds Tobacco
Holdings, Inc., Reynolds American Inc., R.J. Reynolds Tobacco
Company, RJR Acquisition Corp., GMB, Inc., FSH, Inc., R.J.
Reynolds Tobacco Co., RJR Packaging, LLC, BWT Brands, Inc. and
The Bank of New York, as Trustee, to the Indenture dated
May 20, 2002, among R.J. Reynolds Tobacco Holdings, Inc.,
R.J. Reynolds Tobacco Company, RJR Acquisition Corp. and The
Bank of New York (incorporated by reference to Exhibit 4.3
to Reynolds American Inc.s
Form 8-K
dated July 30, 2004).
|
|
4
|
.16
|
|
Third Supplemental Indenture,
dated May 31, 2006, to Indenture, dated May 20, 2002,
among R.J. Reynolds Tobacco Holdings, Inc., Reynolds American
Inc. and certain subsidiaries of R.J. Reynolds Tobacco Holdings,
Inc. as guarantors and The Bank of New York Trust Company, N.A.
as Trustee (incorporated by reference to Exhibit 4.6 to
Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
4
|
.17
|
|
Fourth Supplemental Indenture,
dated June 20, 2006, to Indenture, dated May 20, 2002,
among R.J. Reynolds Tobacco Holdings, Inc., Reynolds American
Inc. and certain subsidiaries of R.J. Reynolds Tobacco Holdings,
Inc. as guarantors and The Bank of New York Trust Company, N.A.
as Trustee (incorporated by reference to Exhibit 4.7 to
Reynolds American Inc.s
Form 8-K
dated June 20, 2006).
|
|
4
|
.18
|
|
Fifth Supplemental Indenture,
dated September 30, 2006, to Indenture, dated May 20,
2002, among R.J. Reynolds Tobacco Holdings, Inc., Reynolds
American Inc. and certain subsidiaries of R.J. Reynolds Tobacco
Holdings, Inc. as guarantors, and The Bank of New York Trust
Company, N.A., as successor to The Bank of New York, as Trustee,
as amended (incorporated by reference to Exhibit 4.2 to
Reynolds American Inc.s
Form 8-K
dated September 30, 2006).
|
198
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
4
|
.19
|
|
Indenture, dated May 31,
2006, among Reynolds American Inc. and certain of its
subsidiaries as guarantors and The Bank of New York Trust
Company, N.A. as Trustee (incorporated by reference to
Exhibit 4.1 to Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
4
|
.20
|
|
First Supplemental Indenture,
dated September 30, 2006, to Indenture, dated May 31,
2006, among Reynolds American Inc. and certain of its
subsidiaries as guarantors and The Bank of New York Trust
Company, N.A., as successor to The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.1 to Reynolds
American Inc.s
Form 8-K
dated September 30, 2006).
|
|
4
|
.21
|
|
In accordance with
Item 601(b)(4)(iii) of
Regulation S-K,
Reynolds American Inc. agrees to furnish to the SEC, upon
request, a copy of each instrument that defines the rights of
holders of such long term debt not filed or incorporated by
reference as an exhibit to this Annual Report on
Form 10-K
for the fiscal year ended December 31, 2006.
|
|
10
|
.1
|
|
Fourth Amended and Restated Credit
Agreement, dated as of May 31, 2006, among Reynolds
American Inc., the agents and other parties named therein, and
the lending institutions listed from time to time on
Annex I thereto (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.2
|
|
Second Amended and Restated Pledge
Agreement, dated as of May 31, 2006, among Reynolds
American Inc., certain of its subsidiaries as pledgors and
JPMorgan Chase Bank, N.A. as collateral agent (incorporated by
reference to Exhibit 10.2 to Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.3
|
|
Second Amended and Restated
Security Agreement, dated as of May 31, 2006, among
Reynolds American Inc., certain of its subsidiaries as assignors
and JPMorgan Chase Bank, N.A. as collateral agent (incorporated
by reference to Exhibit 10.3 to Reynolds American
Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.4
|
|
Fifth Amended and Restated
Subsidiary Guaranty, dated as of May 31, 2006, among
certain of the subsidiaries of Reynolds American Inc. as
guarantors and JPMorgan Chase Bank, N.A. as administrative agent
(incorporated by reference to Exhibit 10.4 to Reynolds
American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.5
|
|
Form of First Amended and Restated
Deed of Trust, Security Agreement, Assignment of Leases, Rents
and Profits, Financing Statement and Fixture Filing (North
Carolina) made as of May 31, 2006, by R. J. Reynolds
Tobacco Company, as the Trustor, to The Fidelity Company, as
Trustee (incorporated by reference to Exhibit 10.5 to
Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.6
|
|
Form of First Amended and Restated
Deed to Secure Debt, Security Agreement, Assignment of Leases,
Rents and Profits (Bibb County, Georgia) made as of May 31,
2006, by R. J. Reynolds Tobacco Company, as the Grantor, to
JPMorgan Chase Bank, N.A., as Administrative Agent and
Collateral Agent for the Secured Creditors, as the Grantee
(incorporated by reference to Exhibit 10.6 to Reynolds
American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.7
|
|
Form of First Amended and Restated
Mortgage, Security Agreement, Assignment of Leases, Rents and
Profits, Financing Statement and Fixture Filing (Cherokee
County, South Carolina) made as of May 31, 2006, by R. J.
Reynolds Tobacco Company, as the Mortgagor, to JPMorgan Chase
Bank, N.A., as Administrative Agent and Collateral Agent for the
Secured Creditors, as the Mortgagee (incorporated by reference
to Exhibit 10.7 to Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.8
|
|
Purchase Agreement, dated
June 22, 2005, by and among R.J. Reynolds Tobacco Holdings,
Inc., the guarantors listed therein and Citigroup Global Markets
Inc. and J.P. Morgan Securities, Inc., as representatives of the
initial purchasers listed therein (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated June 22, 2005).
|
|
10
|
.9
|
|
Purchase Agreement, dated
May 18, 2006, by and among Reynolds American Inc., the
guarantors listed therein, and Lehman Brothers Inc.,
J.P. Morgan Securities Inc. and Citigroup Global Markets
Inc., for themselves and as representatives of the initial
purchasers listed therein (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s Quarterly
Report on
Form 10-Q
for the quarter ended June 30, 2006).
|
199
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
10
|
.10
|
|
Registration Rights Agreement,
dated June 29, 2005, by and among R.J. Reynolds Tobacco
Holdings, Inc., the guarantors listed in Schedule 1
thereto, Citigroup Capital Markets Inc., J.P. Morgan
Securities Inc. and the initial purchasers named in
Schedule 2 thereto (incorporated by reference to
Exhibit 4.2 to Reynolds American Inc.s
Form 8-K
dated July 6, 2005).
|
|
10
|
.11
|
|
Registration Rights Agreement,
dated May 31, 2006, by and among Reynolds American Inc.,
the guarantors listed in Schedule 1 thereto, Lehman
Brothers Inc., J.P. Morgan Securities Inc. and Citigroup
Global Markets Inc., and the initial purchasers named in
Schedule 2 thereto (incorporated by reference to
Exhibit 10.8 to Reynolds American Inc.s
Form 8-K
dated May 31, 2006).
|
|
10
|
.12
|
|
Registration Rights Agreement,
dated June 20, 2006, by and among Reynolds American Inc.,
the guarantors listed in Schedule 1 thereto, and The Bank
of New York Trust Company, N.A. (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated June 20, 2006).
|
|
10
|
.13
|
|
Subsidiary Assumption and Joinder
Agreement dated as of September 30, 2006 among JPMorgan
Chase Bank, N.A., as Administrative Agent, R. J. Reynolds Global
Products, Inc., RJR Packaging, LLC and Scott Tobacco LLC
(incorporated by reference to Exhibit 10.1 to Reynolds
American Inc.s
Form 8-K
dated September 30, 2006).
|
|
10
|
.14
|
|
Formation Agreement, dated as of
July 30, 2004, among Brown & Williamson Tobacco
Corporation (n/k/a Brown & Williamson Holdings, Inc.),
Brown & Williamson U.S.A., Inc. (n/k/a R. J. Reynolds
Tobacco Company) and Reynolds American Inc. (incorporated by
reference to Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated July 30, 2004).
|
|
10
|
.15
|
|
Governance Agreement, dated as of
July 30, 2004, among British American Tobacco p.l.c.,
Brown & Williamson Tobacco Corporation (n/k/a
Brown & Williamson Holdings, Inc.) and Reynolds
American Inc. (incorporated by reference to Exhibit 10.2 to
Reynolds American Inc.s
Form 8-K
dated July 30, 2004).
|
|
10
|
.16
|
|
Amendment No. 1 to the
Governance Agreement, dated as of November 18, 2004, among
British American Tobacco p.l.c., Brown & Williamson
Holdings, Inc. and Reynolds American Inc. (incorporated by
reference to Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated November 18, 2004).
|
|
10
|
.17
|
|
Non-Competition Agreement, dated
as of July 30, 2004, between Reynolds American Inc. and
British American Tobacco p.l.c. (incorporated by reference to
Exhibit 10.3 to Reynolds American Inc.s
Form 8-K
dated July 30, 2004).
|
|
10
|
.18
|
|
Contract Manufacturing Agreement,
dated as of July 30, 2004, by and between R. J. Reynolds
Tobacco Company and BATUS Japan, Inc. (incorporated by reference
to Exhibit 10.4 to Reynolds American Inc.s
Form 8-K
dated July 30, 2004).
|
|
10
|
.19
|
|
October 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. (incorporated by reference to Exhibit 10.2 to
Reynolds American Inc.s Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2005, filed
November 3, 2005).
|
|
10
|
.20
|
|
Contract Manufacturing Agreement,
dated as of July 30, 2004, by and between R. J. Reynolds
Tobacco Company and B.A.T. (U.K. & Export) Limited
(incorporated by reference to Exhibit 10.5 to Reynolds
American Inc.s
Form 8-K
dated July 30, 2004).
|
|
10
|
.21
|
|
Purchase Agreement dated as of
March 9, 1999, as amended and restated as of May 11,
1999, among R. J. Reynolds Tobacco Company, RJR Nabisco, Inc.
and Japan Tobacco Inc. (incorporated by reference to
Exhibit 2.1 to R. J. Reynolds Tobacco Holdings, Inc.s
Form 8-K
dated May 12, 1999).
|
|
10
|
.22
|
|
Tax Sharing Agreement dated as of
June 14, 1999, among RJR Nabisco Holdings Corp., R. J.
Reynolds Tobacco Holdings, Inc., R. J. Reynolds Tobacco Company
and Nabisco Holdings Corp. (incorporated by reference to
Exhibit 10.1 to R. J. Reynolds Tobacco Holdings,
Inc.s
Form 8-K
dated June 14, 1999).
|
|
10
|
.23
|
|
Amendment to Tax Sharing Agreement
dated June 25, 2000, among Nabisco Group Holdings Corp., R.
J. Reynolds Tobacco Holdings, Inc., Nabisco Holdings Corp. and
R. J. Reynolds Tobacco Company (incorporated by reference to
Exhibit 10.2 to R. J. Reynolds Tobacco Holdings,
Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2000, filed August 7,
2000).
|
200
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
10
|
.24
|
|
Agreement dated as of May 20,
1999, among Pension Benefit Guaranty Corporation, RJR Nabisco
Holdings Corp. and R. J. Reynolds Tobacco Company (incorporated
by reference to Exhibit 10.16 to R. J. Reynolds Tobacco
Holdings, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 1999, filed August 16,
1999).
|
|
10
|
.25
|
|
Amendment effective as of
June 14, 1999, to the Agreement effective as of
May 20, 1999, by and among the Pension Benefit Guaranty
Corporation, R. J. Reynolds Tobacco Holdings, Inc. and R. J.
Reynolds Tobacco Company (incorporated by reference to
Exhibit 10.3 to R. J. Reynolds Tobacco Holdings,
Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 2000, filed August 7,
2000).
|
|
10
|
.26
|
|
Second Amendment effective as of
January 7, 2002, to the Agreement effective as of
May 20, 1999, by and among the Pension Benefit Guaranty
Corporation, R. J. Reynolds Tobacco Holdings, Inc. and R. J.
Reynolds Tobacco Company (incorporated by reference to
Exhibit 10.9 to R. J. Reynolds Tobacco Holdings,
Inc.s Annual Report on
Form 10-K
for the year ended December 31, 2001, filed
February 28, 2002).
|
|
10
|
.27
|
|
Settlement Agreement dated
August 25, 1997, between the State of Florida and settling
defendants in The State of Florida v. American Tobacco Co.
(incorporated by reference to Exhibit 2 to R. J. Reynolds
Tobacco Holdings, Inc.s
Form 8-K
dated August 25, 1997).
|
|
10
|
.28
|
|
Comprehensive Settlement Agreement
and Release dated January 16, 1998, between the State of
Texas and settling defendants in The State of Texas v.
American Tobacco Co. (incorporated by reference to
Exhibit 2 to R. J. Reynolds Tobacco Holdings, Inc.s
Form 8-K
dated January 16, 1998).
|
|
10
|
.29
|
|
Settlement Agreement and Release
in re: The State of Minnesota v. Philip Morris, Inc., by
and among the State of Minnesota, Blue Cross and Blue Shield of
Minnesota and the various tobacco company defendants named
therein, dated as of May 8, 1998 (incorporated by reference
to Exhibit 99.1 to R. J. Reynolds Tobacco Holdings,
Inc.s Quarterly Report on
Form 10-Q
for the quarter ended March 30, 1998, filed May 15,
1998).
|
|
10
|
.30
|
|
Settlement Agreement and
Stipulation for Entry of Consent Judgment in re: The State of
Minnesota v. Philip Morris, Inc., by and among the State of
Minnesota, Blue Cross and Blue Shield of Minnesota and the
various tobacco company defendants named therein, dated as of
May 8, 1998 (incorporated by reference to Exhibit 99.2
to R. J. Reynolds Tobacco Holdings, Inc.s Quarterly Report
on
Form 10-Q
for the quarter ended March 30, 1998, filed May 15,
1998).
|
|
10
|
.31
|
|
Form of Consent Judgment by Judge
Kenneth J. Fitzpatrick, Judge of District Court in re: The State
of Minnesota v. Philip Morris, Inc. (incorporated by
reference to Exhibit 99.3 to R. J. Reynolds Tobacco
Holdings, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended March 30, 1998, filed May 15,
1998).
|
|
10
|
.32
|
|
Stipulation of Amendment to
Settlement Agreement and for Entry of Agreed Order dated
July 2, 1998, by and among the Mississippi Defendants,
Mississippi and the Mississippi Counsel in connection with the
Mississippi Action (incorporated by reference to
Exhibit 99.2 to R. J. Reynolds Tobacco Holdings,
Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 1998, filed August 14,
1998).
|
|
10
|
.33
|
|
Stipulation of Amendment to
Settlement Agreement and for Entry of Consent Decree dated
July 24, 1998, by and among the Texas Defendants, Texas and
the Texas Counsel in connection with the Texas Action
(incorporated by reference to Exhibit 99.4 to R. J.
Reynolds Tobacco Holdings, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 1998, filed August 14,
1998).
|
|
10
|
.34
|
|
Stipulation of Amendment to
Settlement Agreement and for Entry of Consent Decree dated
September 11, 1998, by and among the State of Florida and
the tobacco companies named therein (incorporated by reference
to Exhibit 99.1 to R. J. Reynolds Tobacco Holdings,
Inc.s Quarterly Report on
Form 10-Q
for the quarter ended September 30, 1998, filed
November 12, 1998).
|
|
10
|
.35
|
|
Master Settlement Agreement,
referred to as the MSA, dated November 23, 1998, between
the Settling States named in the MSA and the Participating
Manufacturers also named therein (incorporated by reference to
Exhibit 4 to R. J. Reynolds Tobacco Holdings, Inc.s
Form 8-K
dated November 23, 1998).
|
|
10
|
.36
|
|
Amended and Restated Directors and
Officers Indemnification Agreement (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated February 1, 2005).
|
201
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
10
|
.37
|
|
Reynolds American Inc. Outside
Directors Compensation Summary, effective January 1,
2007 (incorporated by reference to Exhibit 10.1 to Reynolds
American Inc.s
Form 8-K
dated September 13, 2006).
|
|
10
|
.38
|
|
Amended and Restated Equity
Incentive Award Plan for Directors of Reynolds American Inc.,
referred to as the EIAP, dated September 13, 2006
(incorporated by reference to Exhibit 10.32 to Reynolds
American Inc.s
Form S-4
filed October 3, 2006).
|
|
10
|
.39
|
|
Form of Deferred Stock Unit
Agreement between Reynolds American Inc. and the Director named
therein, pursuant to the EIAP (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated August 30, 2004).
|
|
10
|
.40
|
|
Form of Deferred Stock Unit
Agreement between R. J. Reynolds Tobacco Holdings, Inc. and the
Director named therein, pursuant to the EIAP (incorporated by
reference to Exhibit 10.9 to R. J. Reynolds Tobacco
Holdings, Inc.s Quarterly Report on
Form 10-Q
for the quarter ended June 30, 1999, filed August 16,
1999).
|
|
10
|
.41
|
|
Amended and Restated (effective as
of February 2, 2005) Deferred Compensation Plan for
Directors of Reynolds American Inc., referred to as the DCP
(incorporated by reference to Exhibit 10.3 to Reynolds
American Inc.s
Form 8-K
dated February 1, 2005).
|
|
10
|
.42
|
|
Amendment No. 1 to the DCP,
dated July 19, 2006 (incorporated by reference to
Exhibit 10.12 to Reynolds American Inc.s Quarterly
Report on
Form 10-Q
for the quarter ended June 30, 2006).
|
|
10
|
.43
|
|
Amended and Restated Reynolds
American Inc. Long-Term Incentive Plan (incorporated by
reference to Exhibit 10.42 to Reynolds American Inc.s
Annual Report on
Form 10-K
for the fiscal year ended December 31, 2004, filed
March 9, 2005).
|
|
10
|
.44
|
|
Form of Performance Unit Agreement
(one-year vesting), dated February 9, 2006, between
Reynolds American Inc. and the grantee named therein
(incorporated by reference to Exhibit 10.1 to Reynolds
American Inc.s
Form 8-K
dated February 9, 2006).
|
|
10
|
.45
|
|
Form of Performance Unit Agreement
(one-year vesting), dated February 6, 2007, between
Reynolds American Inc. and the grantee named therein.
|
|
10
|
.46
|
|
Form of Performance Unit Agreement
(three-year vesting), dated March 2, 2005, between Reynolds
American Inc. and the grantee named therein (incorporated by
reference to Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated March 2, 2005).
|
|
10
|
.47
|
|
Form of Performance Unit Agreement
(three-year vesting), dated March 6, 2006, between Reynolds
American Inc. and the grantee named therein (incorporated by
reference to Exhibit 10.3 to Reynolds American Inc.s
Quarterly Report on
Form 10-Q
for the quarter ended March 31, 2006, filed May 5,
2006).
|
|
10
|
.48
|
|
Performance Unit Agreement, dated
January 1, 2007, between Reynolds American Inc. and Daniel
M. Delen.
|
|
10
|
.49
|
|
Form of Performance Share
Agreement, dated August 31, 2004, between Reynolds American
Inc. and the grantee named therein (incorporated by reference to
Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated August 31, 2004).
|
|
10
|
.50
|
|
Form of Performance Share
Agreement, dated March 2, 2005, between Reynolds American
Inc. and the grantee named therein (incorporated by reference to
Exhibit 10.2 to Reynolds American Inc.s
Form 8-K
dated March 2, 2005).
|
|
10
|
.51
|
|
Form of Restricted Stock
Agreement, dated March 6, 2006, between Reynolds American
Inc. and the grantee named therein (incorporated by reference to
Exhibit 10.4 to Reynolds American Inc.s Quarterly
Report on
Form 10-Q
for the quarter ended March 31, 2006, filed May 5,
2006).
|
|
10
|
.52
|
|
Offer of Employment Letter, dated
July 29, 2004, by Reynolds American Inc. and Susan M. Ivey,
accepted by Ms. Ivey on July 30, 2004 (incorporated by
reference to Exhibit 10.22 to Reynolds American Inc.s
Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2004, filed
November 5, 2004).
|
|
10
|
.53
|
|
Letter Agreement regarding
Severance Benefits and Change of Control Protections dated
October 7, 2004, between Reynolds American Inc. and Susan
M. Ivey (incorporated by reference to Exhibit 10.1 to
Reynolds American Inc.s
Form 8-K
dated October 7, 2004).
|
|
10
|
.54
|
|
Offer of Employment Letter dated
July 29, 2004, by Reynolds American Inc. and Jeffrey A.
Eckmann, accepted by Mr. Eckmann on July 29, 2004
(incorporated by reference to Exhibit 10.24 to Reynolds
American Inc.s Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2004, filed
November 5, 2004).
|
202
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
10
|
.55
|
|
Letter Agreement, dated
February 2, 2005, between Reynolds American Inc. and
Jeffrey A. Eckmann, amending July 29, 2004 offer letter
(incorporated by reference to Exhibit 10.5 to Reynolds
American Inc.s
Form 8-K
dated February 1, 2005).
|
|
10
|
.56
|
|
Offer of Employment Letter, dated
August 18, 2006, by Reynolds American Inc. and E. Julia
(Judy) Lambeth, accepted by Ms. Lambeth on August 19,
2006 (incorporated by reference to Exhibit 10.1 to Reynolds
American Inc.s
Form 8-K
dated August 19, 2006).
|
|
10
|
.57
|
|
Retention Bonus Letter, dated
June 30, 2006, between Reynolds American Inc. and Charles
A. Blixt.
|
|
10
|
.58
|
|
Retention Bonus Letter, dated
February 20, 2007, between Reynolds American Inc. and
McDara P. Folan, III.
|
|
10
|
.59
|
|
Letter Agreement regarding
Severance Benefits, dated January 17, 2007, between
Reynolds American Inc. and Lynn J. Beasley, accepted by
Ms. Beasley on February 26, 2007.
|
|
10
|
.60
|
|
Form of Amended Letter Agreement
regarding Severance Benefits and Change of Control Protections
between Reynolds American Inc. and the officer named therein
(incorporated by reference to Exhibit 10.6 to Reynolds
American Inc.s
Form 8-K
dated February 1, 2005).
|
|
10
|
.61
|
|
Reynolds American Inc. Executive
Severance Plan, effective January 1, 2007.
|
|
10
|
.62
|
|
Reynolds American Inc. Annual
Incentive Award Plan, as amended (incorporated by reference to
Exhibit 10.2 to Reynolds American Inc.s
Form 8-K
dated November 30, 2005).
|
|
10
|
.63
|
|
Amendment No. 1 to Annual
Incentive Award Plan, amended and restated as of January 1,
2006, dated July 18, 2006 (incorporated by reference to
Exhibit 10.11 to Reynolds American Inc.s Quarterly
Report on
Form 10-Q
for the quarter ended June 30, 2006, filed August 4,
2006).
|
|
10
|
.64
|
|
Retention Trust Agreement
dated May 13, 1998, by and between RJR Nabisco, Inc. and
Wachovia Bank, N.A. (incorporated by reference to
Exhibit 10.6 to RJR Nabisco Holdings, Inc.s Quarterly
Report on
Form 10-Q
for the quarter ended June 30, 1998, filed August 14,
1998).
|
|
10
|
.65
|
|
Amendment No. 1 to Retention
Trust Agreement, dated May 13, 1998, by and between
RJR Nabisco, Inc. and Wachovia Bank, N.A., dated October 1,
2006 (incorporated by reference to Exhibit 10.56 to
Reynolds American Inc.s
S-4 filed
October 3, 2006).
|
|
10
|
.66
|
|
Amendment No. 2 to Retention
Trust Agreement, dated May 13, 1998, as amended, by
and between R.J. Reynolds Tobacco Holdings, Inc., as successor
to RJR Nabisco, Inc., and Wachovia Bank, N.A.
|
|
10
|
.67
|
|
Supplemental Pension Plan for
Executives of Brown & Williamson Tobacco Corporation
(n/k/a Brown & Williamson Holdings, Inc.) (as amended
through July 29, 2004) (incorporated by reference to
Exhibit 10.67 to Reynolds American Inc.s Annual
Report on
Form 10-K
for the fiscal year ended December 31, 2004, filed
March 9, 2005).
|
|
10
|
.68
|
|
Form of Brown &
Williamson Tobacco Corporation (n/k/a Brown &
Williamson Holdings, Inc.) Trust Agreement for the
executive officer named therein (incorporated by reference to
Exhibit 10.68 to Reynolds American Inc.s Annual
Report on
Form 10-K
for the fiscal year ended December 31, 2004, filed
March 9, 2005).
|
|
10
|
.69
|
|
Brown & Williamson
Tobacco Corporation (n/k/a Brown & Williamson Holdings,
Inc.) Health Care Plan for Salaried Employees (as amended
through July 29, 2004 by Amendment Nos. 1 and
2) (incorporated by reference to Exhibit 10.69 to
Reynolds American Inc.s Annual Report on
Form 10-K
for the fiscal year ended December 31, 2004, filed
March 9, 2005).
|
|
10
|
.70
|
|
Amendment No. 3, entered into
as of December 31, 2004, to the Brown & Williamson
Tobacco Corporation (n/k/a Brown & Williamson Holdings,
Inc.) Health Care Plan for Salaried Employees (incorporated by
reference to Exhibit 10.70 to Reynolds American Inc.s
Annual Report on
Form 10-K
for the fiscal year ended December 31, 2004, filed
March 9, 2005).
|
|
10
|
.71
|
|
Amendment No. 4, entered into
as of April 20, 2005, to the Brown & Williamson Tobacco
Corporation Health Care Plan for Salaried Employees.
|
|
10
|
.72
|
|
Amendment No. 5, entered into
as of December 29, 2006, to the Brown & Williamson
Tobacco Corporation Health Care Plan for Salaried Employees.
|
203
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
|
|
|
10
|
.73
|
|
Supply Agreement, dated
May 2, 2005, by and between R. J. Reynolds Tobacco Company
and Alcan Packaging Food and Tobacco Inc. (incorporated by
reference to Exhibit 10.1 to Reynolds American Inc.s
Form 8-K
dated May 2, 2005).
|
|
10
|
.74
|
|
First Amendment to Supply
Agreement, dated September 16, 2005, by and between R. J.
Reynolds Tobacco Company and Alcan Packaging Food and Tobacco
Inc. (incorporated by reference to Exhibit 10.1 to Reynolds
American Inc.s Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2005, filed
November 3, 2005).
|
|
10
|
.75
|
|
Supply Agreement, dated
May 2, 2005, by and between R. J. Reynolds Tobacco Company
and Alcoa Flexible Packaging, LLC (incorporated by reference to
Exhibit 10.2 to Reynolds American Inc.s
Form 8-K
dated May 2, 2005).
|
|
10
|
.76
|
|
Supply Agreement, dated
May 2, 2005, by and between R. J. Reynolds Tobacco Company
and Mundet Inc. (incorporated by reference to Exhibit 10.3
to Reynolds American Inc.s
Form 8-K
dated May 2, 2005).
|
|
12
|
.1
|
|
Computation of Ratio of Earnings
to Fixed Charges/Deficiency in the Coverage of Fixed Charges by
Earnings Before Fixed Charges for each of the five years within
the period ended December 31, 2006.
|
|
21
|
.1
|
|
Subsidiaries of the Registrant.
|
|
23
|
.1
|
|
Consent of Independent Registered
Public Accounting Firm.
|
|
23
|
.2
|
|
Consent of Independent Auditor.
|
|
31
|
.1
|
|
Certification of Chief Executive
Officer relating to RAIs Annual Report on
Form 10-K
for the fiscal year ended December 31, 2006.
|
|
31
|
.2
|
|
Certification of Chief Financial
Officer relating to RAIs Annual Report on
Form 10-K
for the fiscal year ended December 31, 2006.
|
|
32
|
.1
|
|
Certification of Chief Executive
Officer and Chief Financial Officer relating to RAIs
Annual Report on
Form 10-K
for the fiscal year ended December 31, 2006, pursuant to
Section 18 U.S.C. §1350, adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
herewith).
|
|
99
|
.1
|
|
R. J. Reynolds Tobacco Company and
Subsidiaries Audited Financial Statements as of
December 31, 2006.
|
204
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
REYNOLDS AMERICAN INC.
(Registrant)
Dated: February 27, 2007
Susan M. Ivey
Chairman of the Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
date indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
/s/ Susan
M. Ivey
Susan
M. Ivey
|
|
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Dianne
M. Neal
Dianne
M. Neal
|
|
Executive Vice President and
Chief Financial Officer
(principal financial officer)
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Michael
S. Desmond
Michael
S. Desmond
|
|
Senior Vice President and
Chief Accounting Officer
(principal accounting officer)
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Betsy
S. Atkins
Betsy
S. Atkins
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ John
T.
Chain, Jr.
John
T. Chain, Jr.
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Martin
D.
Feinstein
Martin
D. Feinstein
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Antonio
Monteiro de
Castro
Antonio
Monteiro de Castro
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Nana
Mensah
Nana
Mensah
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ H.G.L.
Powell
H.G.L.
Powell
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Joseph
P. Viviano
Joseph
P. Viviano
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Thomas
C. Wajnert
Thomas
C. Wajnert
|
|
Director
|
|
February 27, 2007
|
|
|
|
|
|
/s/ Neil
R.
Withington
Neil
R. Withington
|
|
Director
|
|
February 27, 2007
|
205