Reynolds American
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2007
OR
|
|
|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 1-32258
Reynolds American Inc.
(Exact name of registrant as specified in its charter)
|
|
|
North Carolina
|
|
20-0546644 |
(State or other jurisdiction of
|
|
(I.R.S. Employer Identification Number) |
incorporation or organization) |
|
|
401 North Main Street
Winston-Salem, NC 27101
(Address of principal executive offices) (Zip Code)
(336) 741-2000
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant is 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
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date: 294,998,893 shares of common stock, par value $.0001 per share, as
of July 13, 2007
PART I Financial Information
Item 1. Financial Statements
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three |
|
|
For the Six |
|
|
|
Months Ended June 30, |
|
|
Months Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Net sales1 |
|
$ |
2,227 |
|
|
$ |
2,170 |
|
|
$ |
4,245 |
|
|
$ |
3,985 |
|
Net sales, related party |
|
|
121 |
|
|
|
121 |
|
|
|
251 |
|
|
|
266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
2,348 |
|
|
|
2,291 |
|
|
|
4,496 |
|
|
|
4,251 |
|
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold1, 2 |
|
|
1,343 |
|
|
|
1,276 |
|
|
|
2,518 |
|
|
|
2,441 |
|
Selling, general and administrative expenses |
|
|
404 |
|
|
|
392 |
|
|
|
797 |
|
|
|
734 |
|
Amortization expense |
|
|
6 |
|
|
|
7 |
|
|
|
12 |
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
595 |
|
|
|
616 |
|
|
|
1,169 |
|
|
|
1,062 |
|
Interest and debt expense |
|
|
87 |
|
|
|
52 |
|
|
|
176 |
|
|
|
87 |
|
Interest income |
|
|
(23 |
) |
|
|
(23 |
) |
|
|
(61 |
) |
|
|
(59 |
) |
Other expense (income), net |
|
|
16 |
|
|
|
(3 |
) |
|
|
15 |
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before
income taxes |
|
|
515 |
|
|
|
590 |
|
|
|
1,039 |
|
|
|
1,037 |
|
Provision for income taxes |
|
|
191 |
|
|
|
223 |
|
|
|
387 |
|
|
|
390 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
324 |
|
|
|
367 |
|
|
|
652 |
|
|
|
647 |
|
Extraordinary item gain on acquisition |
|
|
1 |
|
|
|
9 |
|
|
|
1 |
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
325 |
|
|
$ |
376 |
|
|
$ |
653 |
|
|
$ |
721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
1.10 |
|
|
$ |
1.24 |
|
|
$ |
2.22 |
|
|
$ |
2.19 |
|
Extraordinary item |
|
|
|
|
|
|
0.03 |
|
|
|
|
|
|
|
0.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
1.10 |
|
|
$ |
1.27 |
|
|
$ |
2.22 |
|
|
$ |
2.44 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
1.10 |
|
|
$ |
1.24 |
|
|
$ |
2.21 |
|
|
$ |
2.19 |
|
Extraordinary item |
|
|
|
|
|
|
0.03 |
|
|
|
|
|
|
|
0.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
1.10 |
|
|
$ |
1.27 |
|
|
$ |
2.21 |
|
|
$ |
2.44 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends declared per share |
|
$ |
0.75 |
|
|
$ |
0.625 |
|
|
$ |
1.50 |
|
|
$ |
1.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Excludes excise taxes of $529 million and $569 million for the three months ended June
30, 2007 and 2006, respectively, and $1,023 million and $1,069 million for the six months
ended June 30, 2007 and 2006, respectively. |
|
2 |
|
See Master Settlement Agreement and Federal Tobacco Buyout Expenses in note 1. |
See Notes to Condensed Consolidated Financial Statements (Unaudited)
3
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended |
|
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
Cash flows from (used in) operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
653 |
|
|
$ |
721 |
|
Adjustments to reconcile to net cash flows from (used in) operating
activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
70 |
|
|
|
87 |
|
Restructuring and asset impairment charges, net of cash payments |
|
|
(2 |
) |
|
|
(11 |
) |
Acquisition restructuring charges, net of cash payments |
|
|
(4 |
) |
|
|
(65 |
) |
Deferred income tax expense (benefit) |
|
|
(14 |
) |
|
|
34 |
|
Loss on extinguishment of debt |
|
|
19 |
|
|
|
|
|
Extraordinary item gain on acquisition |
|
|
(1 |
) |
|
|
(74 |
) |
Other changes, that provided (used) cash: |
|
|
|
|
|
|
|
|
Accounts and other receivables |
|
|
(3 |
) |
|
|
142 |
|
Inventories |
|
|
99 |
|
|
|
89 |
|
Related party, net |
|
|
(9 |
) |
|
|
(4 |
) |
Accounts Payable |
|
|
(75 |
) |
|
|
(25 |
) |
Accrued liabilities including income taxes and other working capital |
|
|
296 |
|
|
|
125 |
|
Tobacco settlement and related expenses |
|
|
(653 |
) |
|
|
(758 |
) |
Pension and postretirement |
|
|
(313 |
) |
|
|
(177 |
) |
Litigation bonds |
|
|
92 |
|
|
|
24 |
|
Other, net |
|
|
(11 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
|
Net cash flows from operating activities |
|
|
144 |
|
|
|
103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
Purchases of short-term investments |
|
|
(3,001 |
) |
|
|
(2,966 |
) |
Proceeds from short-term investments |
|
|
3,451 |
|
|
|
3,621 |
|
Capital expenditures |
|
|
(60 |
) |
|
|
(73 |
) |
Distribution from equity investees |
|
|
9 |
|
|
|
8 |
|
Proceeds from sale of business |
|
|
|
|
|
|
3 |
|
Business acquisition |
|
|
|
|
|
|
(3,517 |
) |
Other, net |
|
|
(1 |
) |
|
|
3 |
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing activities |
|
|
398 |
|
|
|
(2,921 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(444 |
) |
|
|
(368 |
) |
Repayment of long-term debt |
|
|
(300 |
) |
|
|
(190 |
) |
Proceeds from issuance of long-term debt |
|
|
1,547 |
|
|
|
1,641 |
|
Principal borrowings under term loan |
|
|
|
|
|
|
1,550 |
|
Repayment of term loan |
|
|
(1,542 |
) |
|
|
|
|
Deferred debt issuance cost |
|
|
(14 |
) |
|
|
(48 |
) |
Proceeds from exercise of stock options |
|
|
|
|
|
|
3 |
|
Excess tax benefit from stock-based compensation |
|
|
1 |
|
|
|
2 |
|
Repurchase of common stock |
|
|
(60 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) financing activities |
|
|
(812 |
) |
|
|
2,590 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(270 |
) |
|
|
(228 |
) |
Cash and cash equivalents at beginning of period |
|
|
1,433 |
|
|
|
1,333 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
1,163 |
|
|
$ |
1,105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes paid, net of refunds |
|
$ |
65 |
|
|
$ |
67 |
|
Interest paid |
|
$ |
178 |
|
|
$ |
64 |
|
See Notes to Condensed Consolidated Financial Statements (Unaudited)
4
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Assets |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
1,163 |
|
|
$ |
1,433 |
|
Short-term investments |
|
|
843 |
|
|
|
1,293 |
|
Accounts and other receivables, net of allowance (2007 $2; 2006 $4) |
|
|
110 |
|
|
|
107 |
|
Accounts receivable, related party |
|
|
48 |
|
|
|
62 |
|
Inventories |
|
|
1,056 |
|
|
|
1,155 |
|
Deferred income taxes |
|
|
835 |
|
|
|
793 |
|
Prepaid expenses and other current assets |
|
|
119 |
|
|
|
92 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
4,174 |
|
|
|
4,935 |
|
Property, plant and equipment, net of accumulated depreciation (2007
$1,503; 2006 $1,449) |
|
|
1,064 |
|
|
|
1,062 |
|
Trademarks, net of accumulated amortization (2007 $521; 2006 $517) |
|
|
3,475 |
|
|
|
3,479 |
|
Goodwill |
|
|
8,175 |
|
|
|
8,175 |
|
Other intangibles, net of accumulated amortization (2007 $65; 2006 $57) |
|
|
207 |
|
|
|
215 |
|
Other assets and deferred charges |
|
|
535 |
|
|
|
312 |
|
|
|
|
|
|
|
|
|
|
$ |
17,630 |
|
|
$ |
18,178 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
200 |
|
|
$ |
275 |
|
Tobacco settlement and related accruals |
|
|
1,584 |
|
|
|
2,237 |
|
Due to related party |
|
|
9 |
|
|
|
9 |
|
Deferred revenue, related party |
|
|
39 |
|
|
|
62 |
|
Current maturities of long-term debt |
|
|
29 |
|
|
|
344 |
|
Other current liabilities |
|
|
1,491 |
|
|
|
1,165 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
3,352 |
|
|
|
4,092 |
|
Long-term debt (less current maturities) |
|
|
4,399 |
|
|
|
4,389 |
|
Deferred income taxes |
|
|
1,087 |
|
|
|
1,167 |
|
Long-term retirement benefits (less current portion) |
|
|
1,171 |
|
|
|
1,227 |
|
Other noncurrent liabilities |
|
|
404 |
|
|
|
260 |
|
Commitments and contingencies: |
|
|
|
|
|
|
|
|
Shareholders equity: |
|
|
|
|
|
|
|
|
Common stock (shares issued: 2007 294,995,393; 2006 295,624,741) |
|
|
|
|
|
|
|
|
Paid-in capital |
|
|
8,647 |
|
|
|
8,702 |
|
Accumulated deficit |
|
|
(1,026 |
) |
|
|
(1,241 |
) |
Accumulated other comprehensive loss (defined benefit pension and post-retirement plans, net of tax: 2007 $403; 2006 $418) |
|
|
(404 |
) |
|
|
(418 |
) |
|
|
|
|
|
|
|
Total shareholders equity |
|
|
7,217 |
|
|
|
7,043 |
|
|
|
|
|
|
|
|
|
|
$ |
17,630 |
|
|
$ |
18,178 |
|
|
|
|
|
|
|
|
See Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1Summary of Significant Accounting Policies
Overview
The condensed consolidated financial statements (unaudited) include the accounts of Reynolds
American Inc., referred to as RAI, and its wholly owned subsidiaries. RAIs wholly owned
subsidiaries include its operating subsidiaries, R. J. Reynolds Tobacco Company; Lane, Limited,
referred to as Lane; Santa Fe Natural Tobacco Company, Inc., referred to as Santa Fe; R. J.
Reynolds Global Products, Inc., referred to as GPI; and Conwood Company, LLC, Conwood Sales Co.,
LLC, Scott Tobacco LLC and Rosswil LLC, collectively referred to as Conwood.
RAI was created to facilitate the July 30, 2004, transactions to combine the U.S. assets,
liabilities and operations of Brown & Williamson Holdings, Inc., referred to as B&W, an indirect,
wholly owned subsidiary of British American Tobacco p.l.c., referred to as BAT, with R. J. Reynolds
Tobacco Company, a wholly owned operating subsidiary of R.J. Reynolds Tobacco Holdings, Inc.,
referred to as RJR. As a result of the business combination, B&W owns approximately 42% of RAIs
outstanding common stock. Also, as part of the combination transactions, RAI acquired from an
indirect subsidiary of BAT the capital stock of a subsidiary 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.
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. References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco
Company, a New Jersey corporation.
On May 31, 2006, RAI, through its newly formed subsidiary, Conwood Holdings, Inc., acquired
Conwood, in a $3.5 billion stock acquisition. 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 RAI debt securities and available cash and was treated as a purchase of the
Conwood net assets by RAI for financial accounting purposes. The condensed consolidated financial
statements (unaudited) of RAI include the results of the Conwood operations subsequent to May 31,
2006.
Beginning January 1, 2007, the management and distribution of Lanes cigarette brands, DUNHILL
and STATE EXPRESS 555, were transferred to RJR Tobacco, and the distribution of Lanes remaining
products was transferred to Conwood.
Basis of Presentation
The accompanying interim condensed consolidated financial statements (unaudited) have been
prepared in accordance with accounting principles generally accepted in the United States of
America, referred to as GAAP, for interim financial information and, in managements opinion,
contain all adjustments, consisting only of normal recurring items, necessary for a fair
presentation of the results for the periods presented. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. For interim
reporting purposes, certain costs and expenses are charged to operations in proportion to the
estimated total annual amount expected to be incurred primarily based on sales volumes. The
results for the interim period ended June 30, 2007, are not necessarily indicative of the results
that may be expected for the year ending December 31, 2007.
6
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
The equity method is used to account for investments in businesses that RAI does not control,
but has the ability to significantly influence operating and financial policies. The cost method
is used to account for investments in which RAI does not have the ability to significantly
influence operating and financial policies. RAI has no investments in entities greater than 20%
for which it accounts by the cost method, and has no investments in entities greater than 50% for
which it accounts by the equity method. All material intercompany balances have been eliminated.
The condensed consolidated financial statements (unaudited) should be read in conjunction with
the consolidated financial statements and related footnotes, which appear in RAIs Annual Report on
Form 10-K for the year ended December 31, 2006. Certain reclassifications were made to conform
prior years financial statements to the current presentation. All dollar amounts, other than per
share amounts, are presented in millions, except for amounts set forth in note 9 and as otherwise
noted. All share and per share amounts reflect the two-for-one split of RAIs common stock on
August 14, 2006.
Master Settlement Agreement and Federal Tobacco Buyout Expenses
Cost of products sold includes the following components for the Master Settlement Agreement,
referred to as the MSA, and other state settlements and federal tobacco buyout expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months |
|
|
For The Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Settlement |
|
$ |
751 |
|
|
$ |
705 |
|
|
$ |
1,425 |
|
|
$ |
1,327 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout |
|
$ |
72 |
|
|
$ |
69 |
|
|
$ |
142 |
|
|
$ |
135 |
|
Federal quota tobacco stock liquidation
assessment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense |
|
$ |
72 |
|
|
$ |
69 |
|
|
$ |
142 |
|
|
$ |
126 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For additional information, see Governmental Health-Care Cost Recovery Cases MSA and Other
State Settlement Agreements and Tobacco Buyout Legislation in note 9.
Intangible Assets
The changes in the carrying amount of trademarks during the six months ended June 30, 2007,
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, 2007 |
|
$ |
1,859 |
|
|
$ |
47 |
|
|
$ |
155 |
|
|
$ |
25 |
|
|
$ |
1,390 |
|
|
$ |
3 |
|
|
$ |
3,479 |
|
Amortization expense |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
(4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2007 |
|
$ |
1,859 |
|
|
$ |
44 |
|
|
$ |
155 |
|
|
$ |
25 |
|
|
$ |
1,390 |
|
|
$ |
2 |
|
|
$ |
3,475 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the carrying amount of other intangibles during the six months ended June
30, 2007, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
|
Lane |
|
|
GPI |
|
|
|
|
|
|
Indefinite |
|
|
Finite |
|
|
Indefinite |
|
|
Indefinite |
|
|
|
|
|
|
Life |
|
|
Life |
|
|
Life |
|
|
Life |
|
|
Consolidated |
|
Balance as of January 1, 2007 |
|
$ |
20 |
|
|
$ |
116 |
|
|
$ |
35 |
|
|
$ |
44 |
|
|
$ |
215 |
|
Balance transfer |
|
|
35 |
|
|
|
|
|
|
|
(35 |
) |
|
|
|
|
|
|
|
|
Amortization expense |
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2007 |
|
$ |
55 |
|
|
$ |
108 |
|
|
$ |
|
|
|
$ |
44 |
|
|
$ |
207 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Concurrent with the transfer of the management and distribution of DUNHILL and STATE EXPRESS
555 cigarette brands to RJR Tobacco from Lane on January 1, 2007, a $35 million indefinite-lived
intangible asset was transferred to RJR Tobacco from Lane.
7
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
There were no changes in the carrying amounts of goodwill during the six months ended June 30,
2007.
Indefinite-lived intangibles include acquired distribution agreements of RJR Tobacco and
acquired distribution rights of GPI. Details of finite-lived intangible assets as of June 30,
2007, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
Gross |
|
|
Amortization |
|
|
Net |
|
Consumer database |
|
$ |
3 |
|
|
$ |
3 |
|
|
$ |
|
|
Customer contracts |
|
|
16 |
|
|
|
16 |
|
|
|
|
|
Contract manufacturing |
|
|
151 |
|
|
|
44 |
|
|
|
107 |
|
Technology-based |
|
|
3 |
|
|
|
2 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Total other intangibles |
|
|
173 |
|
|
|
65 |
|
|
|
108 |
|
Trademarks |
|
|
86 |
|
|
|
40 |
|
|
|
46 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
259 |
|
|
$ |
105 |
|
|
$ |
154 |
|
|
|
|
|
|
|
|
|
|
|
As of
June 30, 2007, the estimated remaining amortization associated with finite-lived
intangible assets was expected to be expensed as follows:
|
|
|
|
|
Year |
|
Amount |
|
Remainder of 2007 |
|
$ |
11 |
|
2008 |
|
|
21 |
|
2009 |
|
|
21 |
|
2010 |
|
|
18 |
|
2011 |
|
|
19 |
|
2012 |
|
|
19 |
|
Thereafter |
|
|
45 |
|
|
|
|
|
|
|
$ |
154 |
|
|
|
|
|
Pension and Postretirement
Recognized gains or losses include changes in the amount of either the benefit obligation or
the market-related value of plan assets resulting from actual experience differing from that
assumed or from changes in assumptions. The minimum amortization of unrecognized gains or losses,
as described in Statement of Financial Accounting Standards, referred to as SFAS, No. 87,
Employers Accounting for Pensions, is included in pension expense. Prior service costs, which
are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis
over the average remaining service period for active employees. The market-related value of plan
assets recognizes changes in fair value in a systematic and rational manner over five years.
The components of the total benefit are set forth below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months Ended |
|
|
For The Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
Pension Benefits |
|
|
Benefits |
|
|
Pension Benefits |
|
|
Benefits |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Service cost |
|
$ |
10 |
|
|
$ |
11 |
|
|
$ |
2 |
|
|
$ |
2 |
|
|
$ |
20 |
|
|
$ |
20 |
|
|
$ |
3 |
|
|
$ |
3 |
|
Interest cost |
|
|
79 |
|
|
|
78 |
|
|
|
23 |
|
|
|
22 |
|
|
|
157 |
|
|
|
154 |
|
|
|
46 |
|
|
|
44 |
|
Expected return on plan assets |
|
|
(109 |
) |
|
|
(93 |
) |
|
|
(7 |
) |
|
|
(7 |
) |
|
|
(218 |
) |
|
|
(184 |
) |
|
|
(14 |
) |
|
|
(14 |
) |
Amortization of prior service cost |
|
|
1 |
|
|
|
1 |
|
|
|
(3 |
) |
|
|
(3 |
) |
|
|
1 |
|
|
|
1 |
|
|
|
(6 |
) |
|
|
(6 |
) |
Amortization of net loss |
|
|
11 |
|
|
|
18 |
|
|
|
5 |
|
|
|
7 |
|
|
|
21 |
|
|
|
35 |
|
|
|
11 |
|
|
|
13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost |
|
|
(8 |
) |
|
|
15 |
|
|
|
20 |
|
|
|
21 |
|
|
|
(19 |
) |
|
|
26 |
|
|
|
40 |
|
|
|
40 |
|
Curtailment/special benefits |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total benefit cost |
|
$ |
(8 |
) |
|
$ |
17 |
|
|
$ |
20 |
|
|
$ |
21 |
|
|
$ |
(19 |
) |
|
$ |
28 |
|
|
$ |
40 |
|
|
$ |
40 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Employer contributions
RAI disclosed in its financial statements for the year ended December 31, 2006, that it
expected to contribute $300 million to its pension plans in 2007. Of this amount, RAI contributed
$292 million to its pension plans during the first six months of 2007.
Recently Adopted Accounting Pronouncements
Effective January 1, 2007, RAI adopted Financial Accounting Standards Board, referred to as
FASB, 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. RAIs adoption of
FIN No. 48 resulted in a cumulative adjustment to retained earnings as of January 1, 2007, of $5
million.
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 currently is assessing the impact of SFAS No.
157 on its consolidated financial position and results of operations.
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. RAI does not expect to
elect to measure any eligible financial instruments at fair value upon adoption of SFAS No. 159 on
January 1, 2008. Accordingly, RAI does not expect the adoption of SFAS No. 159 to have a material
impact on its financial position, results of operations or cash flows.
Note 2Restructuring and Asset Impairment Charges
2004 B&W Business Combination Restructuring Costs
The components of the 2004 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 |
|
Utilized in 2007 |
|
|
(1 |
) |
|
|
(3 |
) |
|
|
(4 |
) |
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2007 |
|
$ |
|
|
|
$ |
17 |
|
|
$ |
17 |
|
|
|
|
|
|
|
|
|
|
|
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 payments to approximately 2,450 former B&W
employees in operations, sales and corporate functions, which were significantly completed by
mid-year 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
9
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
As of June 30, 2007, $239 million of the accrued amount had been paid. In the condensed
consolidated balance sheet (unaudited) as of June 30, 2007, $6 million is included in other current
liabilities and $11 million is included in other noncurrent liabilities.
Note 3Income Per Share
The components of the calculation of income per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Income from continuing operations |
|
$ |
324 |
|
|
$ |
367 |
|
|
$ |
652 |
|
|
$ |
647 |
|
Extraordinary item gain on acquisition |
|
|
1 |
|
|
|
9 |
|
|
|
1 |
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
325 |
|
|
$ |
376 |
|
|
$ |
653 |
|
|
$ |
721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares, in thousands1 |
|
|
294,154 |
|
|
|
295,029 |
|
|
|
294,596 |
|
|
|
294,991 |
|
Effect of dilutive potential shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options |
|
|
248 |
|
|
|
286 |
|
|
|
251 |
|
|
|
308 |
|
Restricted stock |
|
|
222 |
|
|
|
45 |
|
|
|
194 |
|
|
|
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares, in thousands |
|
|
294,624 |
|
|
|
295,360 |
|
|
|
295,041 |
|
|
|
295,322 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Outstanding contingently issuable restricted stock of 0.8 million shares
and 0.5 million shares for the three-month periods, and 0.7 million shares and 0.3 million
shares for the six-month periods ended June 30, 2007 and 2006, respectively, were excluded
from the basic share calculation, as the related vesting provisions had not been met. |
Note 4Inventories
The major components of inventories were as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Leaf tobacco |
|
$ |
827 |
|
|
$ |
938 |
|
Raw materials |
|
|
44 |
|
|
|
44 |
|
Work in process |
|
|
54 |
|
|
|
54 |
|
Finished products |
|
|
174 |
|
|
|
156 |
|
Other |
|
|
25 |
|
|
|
26 |
|
|
|
|
|
|
|
|
Total |
|
|
1,124 |
|
|
|
1,218 |
|
Less LIFO allowance |
|
|
68 |
|
|
|
63 |
|
|
|
|
|
|
|
|
|
|
$ |
1,056 |
|
|
$ |
1,155 |
|
|
|
|
|
|
|
|
RAI recorded $1 million of expense from expected LIFO layer liquidations for the six-month
period ended June 30, 2007. Such expense for the quarter ended
June 30, 2007, was less than $1
million. RAI will perform its annual LIFO inventory valuation at December 31, 2007, and interim
periods represent an estimate of the expected annual valuation.
10
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 5Income Taxes
In the first quarter of 2007, RAI recorded a cumulative effect for a change in accounting
principle of $5 million concerning a decrease of reserves related to uncertain tax positions. This
change was accounted for as an increase to the opening balance of retained earnings. After the
cumulative effect decrease, RAI had approximately $174 million of gross unrecognized tax benefits.
Of this total, approximately $100 million, net of federal benefit on state issues and deposits,
represents the amount of unrecognized tax benefits that would affect the effective income tax rate
if recognized in future periods. Additionally, the gross unrecognized tax benefits included $59
million of accrued interest and penalties.
In its adoption of FIN No. 48, RAI has elected, consistent with its past accounting practice,
to classify interest and penalties related to its uncertain tax position as tax expense. RAI
accrued $59 million of gross interest and penalties as of January 1, 2007.
Pursuant to FIN No. 48, the total net amount of unrecognized tax benefits as of June 30, 2007,
that, if recognized, would affect the tax rate, was $105 million. Of this amount, $45 million,
represents net interest and penalties.
For the three-month and six-month periods ended June 30, 2007, the gross amounts of increases
in unrecognized tax benefits as a result of tax positions taken during prior years were $3 million
and $6 million, respectively. The gross amounts of increases as a result of tax positions taken
during the current year were $3 million and $7 million for
the three months and six months, respectively. The gross amount of
decreases in the unrecognized tax benefits relating to settlements
with taxing authorities were $1 million and $2 million for
the three months and six months ended June 30, 2007, respectively. There was no reduction of
unrecognized tax benefits as a result of a lapse of the applicable statute of limitations.
Included in the income tax expense for the three-month and six-month periods ended June 30,
2007, were approximately $4 million and $8 million, respectively, of additional tax, interest, net
of federal benefit, and penalties associated with uncertain tax positions. Of these amounts, $2
million and $4 million for the three and six month periods, respectively, relate to net interest
and penalties.
It is expected that the amount of unrecognized tax benefits will change in the next 12 months.
However, RAI does not expect the change to have a significant impact on its results of operations
or financial position.
The provision for income taxes in the second quarter of 2007 was $191 million, or an effective
rate of 37.1%, compared with $223 million, or an effective rate of 37.8%, in the second quarter of
2006. The provision for income taxes for the first half of 2007 was $387 million, or an effective
rate of 37.2%, compared with $390 million, or an effective rate of 37.6%, in the first half of
2006. The 2006 provision was impacted by the nondeductibility of certain expenditures relating to
ballot initiatives, state taxes and other nondeductible items, partially offset by the resolution
of certain prior years tax matters that resulted in a reduction of income tax expense of $9
million.
The effective rate exceeds the federal statutory rate of 35% primarily due to the impact of
state taxes and certain other nondeductible items, offset by the estimated domestic production
credit of the American Jobs Creation Act enacted on October 22, 2004.
RAI and its subsidiaries are subject to income taxes in the United States, certain foreign
jurisdictions and multiple state jurisdictions. The Internal Revenue Service completed its
examination and issued an assessment for the years 2002 and 2003. RAI filed a protest in 2006.
Discussions with the IRS during the first quarter of 2007 indicate that a resolution is expected by
the end of the year. The IRS adjustments have been reflected in the FIN No. 48 liability balance.
Overpayments for the prior IRS audits are available to cover any additional tax and interest that
may be due as the result of the 2002-2003 protest resolution. There are no additional IRS
examinations scheduled at this time.
For years through 1999, substantially all material state income tax matters have been
concluded and the federal audit adjustments for years prior to 2002 have been reported to the
states.
RAI recorded favorable tax matter resolution adjustments of $1 million and $9 million in the
second quarter of 2007 and 2006, respectively, and $1 million and $74 million, in the first
six months of 2007 and 2006, respectively, to
11
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
the gain related to the acquisition of RJRs former parent, Nabisco Group Holdings Corp., referred
to as NGH. Including these adjustments, the net after-tax gain on the acquisition of NGH was $1.8
billion.
Note 6Borrowing Arrangements
On June 28, 2007, RAI entered into a Fifth Amended and Restated Credit Agreement, which
provides for a five-year, $550 million senior secured revolving credit facility, which may be
increased to $900 million at the discretion of the lenders upon the request of RAI. The credit
agreement amends and restates RAIs prior credit agreement dated May 31, 2006.
The prior credit agreement provided for a five-year, $550 million senior secured revolving
credit facility, which could be increased to $800 million at the discretion of the lenders upon the
request of RAI and a six-year, $1.55 billion senior secured term loan. On June 21, 2007, RAI
prepaid in full, using available cash and the net proceeds of a notes offering as described in note
7 below, the $1.54 billion principal amount outstanding under such term loan, plus accrued interest
thereon.
The amended credit agreement contains 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. These
covenants in the amended credit agreement are subject to a number of qualifications and exceptions.
The maturity date of the amended credit agreement is June 28, 2012, which date may be extended in
two separate one year increments.
The amended credit agreement contains customary events of default, including upon a change in
control, that could result in the acceleration of all amounts and cancellation of all commitments
outstanding under the amended credit agreement.
RAI is able to use the revolving credit facility under the amended credit agreement for
borrowings and issuances of letters of credit at its option. Issuances of letters of credit reduce
availability under such revolving credit facility. As of June 30, 2007, there were no borrowings,
and $24 million of letters of credit outstanding, under the amended credit agreement.
Under the terms of the amended credit agreement, RAI is required to pay a commitment fee of
between 0.25% and 1.0% per annum on the unused portion of the revolving credit facility.
Borrowings under the amended credit agreement bear interest, at the option of RAI, at a rate
equal to an applicable margin plus:
|
|
|
the reference rate, which is the higher of (1) the federal funds effective rate
from time to time plus 0.5% and (2) 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. |
Certain of RAIs subsidiaries, including its material domestic subsidiaries, referred to as
the Guarantors, have guaranteed RAIs obligations under the amended credit agreement.
RAI has pledged substantially all of its assets, including the stock of its direct
subsidiaries, to secure its obligations under the amended credit agreement. In addition, the
Guarantors generally have pledged substantially all of their assets to secure their guarantees of
RAIs obligations under the amended credit agreement, including the stock, indebtedness and other
obligations held by or owing to such Guarantor of a subsidiary. However, the pledge of RJR and its
direct and indirect subsidiary Guarantors is limited to the stock of RJRs direct, wholly owned
subsidiary, RJR Tobacco, and RAIs direct, wholly owned subsidiaries, Lane and Santa Fe, have
pledged substantially all of their personal property, but no real property.
12
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Under the terms of the amended credit agreement, at such time, if any, as RAI has obtained a
corporate credit rating of investment grade with not worse than stable outlooks from each of
Moodys and S&P, the security for the amended credit agreement will, generally, be released
automatically.
Pursuant to the amended credit agreement, in the event of RAIs exposure under any hedging
arrangement with a lender, RAIs obligations under such hedging arrangement will be guaranteed by
the same entities and secured by the same assets as under the amended credit agreement.
As of June 30, 2007, Moodys corporate credit rating of RAI was Ba1, positive outlook, and
S&Ps rating was BB+, 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 lowering of, such ratings
would not have a material adverse impact on RAIs cash flows.
Note 7Long-Term Debt
Long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
RJR 8.50% 9.25% unsecured notes, due 2007 to 2013 |
|
$ |
89 |
|
|
$ |
89 |
|
RJR 6.5% 7.875% guaranteed, unsecured notes, due 2007 to 2015 |
|
|
69 |
|
|
|
163 |
|
|
|
|
|
|
|
|
Total RJR debt |
|
|
158 |
|
|
|
252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAI 6.5% 7.875% guaranteed, secured notes, due 2007 to 2037 |
|
|
3,870 |
|
|
|
2,939 |
|
RAI floating rate, guaranteed, secured, notes, due 2011 |
|
|
400 |
|
|
|
|
|
RAI floating rate, guaranteed, secured, term loan, due 2012 |
|
|
|
|
|
|
1,542 |
|
|
|
|
|
|
|
|
Total RAI debt |
|
|
4,270 |
|
|
|
4,481 |
|
|
|
|
|
|
|
|
Total debt |
|
|
4,428 |
|
|
|
4,733 |
|
Current maturities of long-term debt |
|
|
(29 |
) |
|
|
(344 |
) |
|
|
|
|
|
|
|
|
|
$ |
4,399 |
|
|
$ |
4,389 |
|
|
|
|
|
|
|
|
On June 21, 2007, RAI completed the sale of $1.55 billion in aggregate principal amount of
senior, secured notes, consisting of $400 million of floating rate notes due June 15, 2011, $700
million of 6.75% notes due June 15, 2017, and $450 million of 7.25% notes due June 15, 2037. These
notes were sold under RAIs shelf registration statement filed with the SEC on June 18, 2007. The
net proceeds from the offering, together with available cash, were used to prepay in full the
principal balance of $1.54 billion of a term loan, together with accrued interest.
In February 2007, $48 million of RJR notes were exchanged for RAI notes. In June 2007, $46
million of RJR notes matured and were repaid.
The Guarantors of RAIs amended credit agreement also guarantee RAIs senior secured notes.
RAIs senior secured notes are secured by a pledge of the stock, indebtedness and other obligations
of RJR Tobacco owned by or owed to RAI or any restricted subsidiary. Such notes also are secured
by any principal property of RAI and any Guarantor that is a restricted subsidiary. Santa Fe and
Lane are excluded from the definition of restricted subsidiary. These assets constitute a portion
of the security for the obligations of RAI and the Guarantors under the amended credit agreement.
If these assets are no longer pledged as security for the obligations of RAI and the Guarantors
under the amended credit agreement, 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 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.
RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed
by their indebtedness at June 30, 2007.
13
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 8Financial Instruments
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.
Swaps existed on the following principal amount of debt:
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
RJR 6.5% unsecured notes, due 2007 |
|
$ |
|
|
|
$ |
63 |
|
RJR 7.25% unsecured notes, due 2012 |
|
|
57 |
|
|
|
82 |
|
|
|
|
|
|
|
|
Total swapped RJR debt |
|
|
57 |
|
|
|
145 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAI 6.5% secured notes, due 2007 |
|
|
|
|
|
|
237 |
|
RAI 7.25% secured notes, due 2012 |
|
|
393 |
|
|
|
368 |
|
RAI 7.625% secured notes, due 2016 |
|
|
450 |
|
|
|
|
|
RAI 6.75% secured notes, due 2017 |
|
|
700 |
|
|
|
|
|
|
|
|
|
|
|
|
Total swapped RAI debt |
|
|
1,543 |
|
|
|
605 |
|
|
|
|
|
|
|
|
Total swapped debt |
|
$ |
1,600 |
|
|
$ |
750 |
|
|
|
|
|
|
|
|
In February 2007, $42 million of RJR notes with swap agreements were exchanged for RAI notes
with the associated swaps assigned to RAI. In June 2007, swaps related to $254 million of RAI debt
and $46 million of RJR debt were settled.
On June 21, 2007, RAI entered into swap agreements with respect to $450 million and $700
million of notes with fixed rates of 7.625% and 6.75%, due in 2016 and 2017, respectively.
Including the impact of swaps, as of June 30, 2007, the average interest rate on RAIs consolidated
$4.4 billion long-term debt was 7.04%.
The interest rate swaps notional amounts and termination dates match those of the
corresponding outstanding notes. As of June 30, 2007, 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 $4 million and $15 million at June 30, 2007 and
December 31, 2006, respectively, included in other assets and deferred charges and was 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 certain
interest rate swaps may require full collateralization with cash or securities.
Note 9Commitments 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 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. 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 term
judgment or final judgment refers to the final decision of the court resolving the dispute and
determining the rights and obligations of the
14
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 certain settlements entered into by RJR
Tobacco and B&W 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 GAAP, RAI and its subsidiaries, including RJR Tobacco and Conwood, as
applicable, record any loss concerning 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, 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 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. 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
15
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
claims brought against them continue to be dismissed at or before trial. 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.
No liability for pending smoking and health tobacco litigation was recorded in RAIs condensed
consolidated balance sheet (unaudited) as of June 30, 2007. RJR has liabilities totaling $94
million that were recorded in 1999 in connection with certain indemnification claims asserted by
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, referred to as Northern Brands. 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.
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 or its affiliates and indemnitees. 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. Although RJR Tobacco
and certain of its affiliates and indemnitees 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. RJR Tobacco and its affiliates, including RAI, believe that the
same legal principles that have resulted in dismissal of health-care cost recovery cases either at
the trial court level or on appeal should compel dismissal of the similar pending cases.
The
pending 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. These claims were dismissed, and the
only claim remaining in the case involves alleged violations of civil provisions of the federal
Racketeer Influenced and Corrupt Organizations Act, referred to as RICO. Under this statute, the
federal government sought disgorgement of profits from the defendants in the amount of $280
billion. Reversing 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 trial 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
16
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
As
with the claims that were resolved by the MSA and other state
settlement agreements, the other cases settled by RJR Tobacco can be distinguished from existing cases
pending against RJR Tobacco and its affiliates and indemnitees. The original Broin case, discussed
below under Litigation Affecting the Cigarette Industry Class-Action Suits, was settled in
the middle of trial during negotiations concerning a possible nation-wide settlement of claims
similar to those underlying the MSA and other state settlement agreements.
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 few antitrust cases pending against RJR Tobacco and B&W involve
different types of plaintiffs and different theories of recovery under the antitrust laws.
Finally, as discussed under Litigation Affecting the Cigarette Industry MSA Enforcement
and Validity, RJR Tobacco and B&W each has settled certain 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 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 condensed consolidated balance sheet (unaudited) as of June 30,
2007.
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 any particular 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 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. 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 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 indemnitees, 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.
17
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 second quarter of 2007, 27 tobacco-related cases were served against RJR Tobacco or
its affiliates or indemnitees. On June 30, 2007, there were 1,185 cases (including 871 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, as compared with 1,272 on June 30,
2006, and 1,371 on June 30, 2005, pending against RJR Tobacco or its affiliates or indemnitees.
As of July 13, 2007, 1,214 tobacco-related cases were pending against RJR Tobacco or its
affiliates or indemnitees: 1,209 in the United States; one in Puerto Rico; three in Canada; and one
in Israel. Of the 1,209 total U.S. cases, 29 cases are pending against B&W that are not also
pending against RJR Tobacco. The U.S. case number does not include the 2,623 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 July 13,
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 July 13, 2007:
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
West Virginia |
|
|
876 |
* |
Florida |
|
|
109 |
** |
Maryland |
|
|
36 |
|
Mississippi |
|
|
27 |
|
Missouri |
|
|
26 |
|
New York |
|
|
26 |
|
Louisiana |
|
|
16 |
|
California |
|
|
13 |
|
Illinois |
|
|
7 |
|
New Jersey |
|
|
4 |
|
Alabama |
|
|
3 |
|
Tennessee |
|
|
3 |
|
District of Columbia |
|
|
3 |
|
Georgia |
|
|
3 |
|
Connecticut |
|
|
3 |
|
Pennsylvania |
|
|
3 |
|
Ohio |
|
|
3 |
|
Delaware |
|
|
2 |
|
Minnesota |
|
|
2 |
|
Michigan |
|
|
2 |
|
North Carolina |
|
|
2 |
|
South Dakota |
|
|
2 |
|
Vermont |
|
|
2 |
|
Massachusetts |
|
|
2 |
|
Kentucky |
|
|
2 |
|
Oregon |
|
|
2 |
|
18
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
Kansas |
|
|
2 |
|
New Mexico |
|
|
2 |
|
South Carolina |
|
|
2 |
|
Arizona |
|
|
2 |
|
Washington |
|
|
2 |
|
Indiana |
|
|
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 |
|
Mariana Islands |
|
|
1 |
|
Maine |
|
|
1 |
|
Rhode Island |
|
|
1 |
|
Wisconsin |
|
|
1 |
|
Oklahoma |
|
|
1 |
|
Wyoming |
|
|
1 |
|
Alaska |
|
|
1 |
|
Virginia |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,209 |
|
|
|
|
|
|
|
|
|
* |
|
871 of the 876 cases are pending as a consolidated action. |
|
** |
|
41 of the 109 cases are pending as Engle Progeny Cases, as defined below. |
Of the 1,209 pending U.S. cases, 59 are pending in federal court, 1,149 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 July 13, 2007, compared with the number of cases
pending against RJR Tobacco, its affiliates or indemnitees as of April 13, 2007, as reported in
RAIs Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007, filed with the SEC
on May 4, 2007, and a cross-reference to the discussion of each case type.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in |
|
|
|
|
RJR Tobaccos |
|
Number of |
|
|
|
|
Case Numbers as of |
|
Cases Since |
|
|
Case Type |
|
July 13, 2007 |
|
April 13, 2007 |
|
Page Reference |
Individual Smoking and Health |
|
|
1,079 |
|
|
|
-28 |
* |
|
|
24 |
|
Engle Progeny |
|
|
41 |
|
|
|
* |
|
|
|
26 |
|
Flight Attendant ETS (Broin II) |
|
|
2,623 |
|
|
No Change |
|
|
26 |
|
Class-Action |
|
|
19 |
|
|
|
-3 |
|
|
|
26 |
|
Governmental Health-Care Cost Recovery |
|
|
1 |
|
|
No Change |
|
|
33 |
|
Other Health-Care Cost Recovery and
Aggregated Claims |
|
|
3 |
|
|
No Change |
|
|
36 |
|
Master Settlement Agreement-Enforcement
and Validity |
|
|
53 |
|
|
|
+5 |
|
|
|
36 |
|
Antitrust |
|
|
4 |
|
|
No Change |
|
|
38 |
|
Other Litigation |
|
|
9 |
|
|
|
-3 |
|
|
|
40 |
|
|
|
|
* |
|
The Engle Progeny Cases have been separated from the Individual Smoking and Health cases for
reporting purposes. |
19
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Three pending cases against RJR Tobacco and B&W have attracted significant media attention:
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 reversal 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.
After subsequent motions were resolved, the Florida Supreme Court issued its mandate on January 11,
2007, thus beginning a one-year period in which former class members may file individual lawsuits.
Lawsuits by individuals requesting the benefit of the Engle ruling, whether filed before or after
the January 11, 2007 mandate, are referred to as Engle Progeny Cases. On May 21, 2007, the
defendants, including RJR Tobacco, filed a petition for writ of certiorari in the U.S. Supreme
Court.
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
certain 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 U.S. Court of Appeals for the Second Circuit granted the defendants motions
to stay the district court proceedings and for review of the class certification ruling. Oral
argument occurred on July 10, 2007. A decision is pending.
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:
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 and $2.7 billion in 2006 and 2005, respectively. RJR Tobacco estimates
its payments will be approximately $2.6 billion in 2007 and will be approximately $2.8 billion each
year 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. The following table lists the trial schedule, as of July 13, 2007, for RJR Tobacco or
its affiliates and indemnitees through June 30, 2008.
20
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
Trial Date |
|
Case Name/Type |
|
Defendant(s) |
|
Jurisdiction |
September 17, 2007
|
|
Hausrath v. Philip Morris USA, Inc.
[Individual]
|
|
B&W
|
|
NY Supreme Court
Erie County
(Buffalo, NY) |
|
|
|
|
|
|
|
October 10, 2007
|
|
Standish v. American Tobacco Co.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Supreme Court
Bronx County
(Bronx, NY) |
|
|
|
|
|
|
|
October 29, 2007
|
|
Menchini v. Philip Morris, Inc.
[Broin II/ETS]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
11th Judicial Circuit
Miami-Dade County
(Miami, FL) |
|
|
|
|
|
|
|
January 7, 2008
|
|
Brown v. R.J. Reynolds Tobacco Co.
[Individual (Engle III)]
|
|
RJR Tobacco
|
|
U.S. District Court
Southern District
(Miami, FL) |
|
|
|
|
|
|
|
January 14, 2008
|
|
Williams v. Brown & Williamson
Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
City of St. Louis
(St. Louis, MO) |
|
|
|
|
|
|
|
February 19, 2008
|
|
Smith v. R.J. Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
U.S. District Court
Eastern District
(New Orleans, LA) |
|
|
|
|
|
|
|
March 17, 2008
|
|
Coy v. Philip Morris, Inc.
[Individual]
|
|
RJR Tobacco, B&W
|
|
U.S. District Court
Southern District
(Miami, FL) |
|
|
|
|
|
|
|
March 17, 2008
|
|
In re: Tobacco Litigation (Individual Personal Injury Cases)
[Individual/Consolidated]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Ohio County
(Wheeling, WV) |
|
|
|
|
|
|
|
March 24, 2008
|
|
Falconer v. R.J. Reynolds Tobacco
Co.
[Individual]
|
|
RJR Tobacco
|
|
Circuit Court
Jackson County
(Kansas City, MO) |
Trial Results. From January 1, 1999 through July 13, 2007, 53 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 July 13, 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.
One case was tried in the first half of 2007 in which RJR Tobacco was a defendant. In Whiteley
v. R.J. Reynolds Tobacco Co., an individual smoker case in California state court, jury selection
began in January 2007. On May 2, 2007, the jury awarded the plaintiff $2.46 million in
compensatory damages jointly against RJR Tobacco and Philip Morris. On May 9, 2007, the jury
returned a punitive damages verdict award of $250,000 against RJR Tobacco only. RJR Tobacco
intends to file appropriate post-trial motions and, if necessary, appeal.
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 July 13, 2007, in
which verdicts have been returned in favor of the plaintiffs and against RJR Tobacco or B&W, or
both.
21
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
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 May 21, 2007,
the defendants,
including RJR
Tobacco, filed a
petition for writ
of certiorari in
the U.S. Supreme
Court. |
|
|
|
|
|
|
|
|
|
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
January 2, 2007,
the defendants
moved to set aside
the June 11, 2002,
verdict 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
motions occurred on
March 15, 2007. A
decision is
pending. |
22
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
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
Council for Tobacco
Research and
$500,000 to the
Tobacco Institute.
On June 26,
2007, final
judgment was
entered in the
amount of
approximately $6.8
million (including
interest and
costs). The
defendants filed a
notice of appeal on
July 3, 2007.
Pursuant to its
agreement to
indemnify B&W, RJR
Tobacco posted a
supersedeas bond in
the amount of
$8.018 million on
July 5, 2007. |
|
|
|
|
|
|
|
|
|
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 any
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. The
defendants filed an
application for
writ of certiorari
with the Louisiana
Supreme Court on
April 2, 2007. |
23
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
February 2, 2005
|
|
Smith v. Brown &
Williamson Tobacco
Corp.
[Individual]
|
|
Circuit Court,
Jackson County
(Independence, MO)
|
|
$2 million in
compensatory
damages (reduced to
$500,000 because of
jurys findings
that the plaintiff
was 75% at fault);
$20 million in
punitive damages.
|
|
On June 1, 2005,
B&W filed its
notice of appeal.
On July 31, 2007, the Missouri Court of Appeals reversed the
punitive damages award, ordered a new trial on punitive damages and
transferred the case to the Missouri Supreme Court. The Missouri
Supreme Court may review the entire case. |
|
|
|
|
|
|
|
|
|
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. |
|
|
|
|
|
|
|
|
|
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, to
reimburse the U.S.
Department of
Justice appropriate
costs associated
with the lawsuit,
and to 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. In May
2007, the court of
appeals issued a
briefing schedule
that extends
through May 19,
2008. |
|
|
|
|
|
|
|
|
|
May 2, 2007
|
|
Whiteley v. R.J.
Reynolds Tobacco Co.
[Individual]
|
|
Superior Court,
San Francisco County,
(San Francisco, CA)
|
|
$2.46 million in
compensatory
damages against RJR
Tobacco and Philip
Morris; $250,000
punitive damages
against RJR Tobacco
only.
|
|
RJR
Tobacco filed its
motion for judgment
notwithstanding the
verdict or, in the
alternative, for a
new trial on
July 31, 2007. |
Individual Smoking and Health Cases
As of July 13, 2007, 1,079 individual cases, including 871 individual smoker cases in West
Virginia state court in a consolidated action, were pending in the United States against RJR
Tobacco, B&W, as its indemnitee, or both. This category of cases includes smoking and health cases
alleging personal injury brought by or on behalf of individual plaintiffs, but does not include the
Broin II cases discussed below. A total of 1,113 of the individual cases are brought
by or on behalf of individual smokers or their survivors, while the remaining seven 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 during the period from January 1, 2007 to July 13,
2007, or remained on appeal as of July 13, 2007.
On March 20, 2000, in Whiteley v. Raybestos-Manhattan, Inc. (a case filed in April 1999 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
24
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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, alleging
that use of the defendants products, along with exposure to asbestos, caused Mrs. Whiteley to
develop lung cancer and ultimately die, and the case name became Whiteley v. R. J. Reynolds Tobacco
Co. The jury awarded the plaintiff $2.46 million in compensatory damages jointly against RJR
Tobacco and Philip Morris on May 2, 2007, and returned a punitive damages verdict award of $250,000
against RJR Tobacco on May 9, 2007. RJR Tobacco filed its motion for judgment notwithstanding the
verdict or, in the alternative, for a new trial on July 31, 2007, and if necessary, RJR Tobacco
will appeal.
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 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 occurred on May 16, 2007. A decision is pending.
On December 18, 2003, in Frankson v. Brown & Williamson Tobacco Corp. (a case filed in August
2000 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 (other manufacturers were dismissed before
trial). The plaintiff, Gladys Frankson, alleged that Mr. Frankson became physically and
psychologically addicted to nicotine, was unable to cease smoking, developed lung cancer and 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, assigning $6 million to B&W,
$2 million to American Tobacco, a predecessor company to B&W, and $6 million 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.
After all post-trial motions (and appeals therefrom) were denied, judgment was entered in
favor of the plaintiffs for $175,000 in compensatory damages (the original jury award reduced by
50%) and $5 million in punitive damages (the amount to which the plaintiff stipulated). On June
26, 2007, final judgment was entered in the amount of approximately $6.8 million (including
interest and costs). The defendants filed a notice of appeal to the Appellate Division, New York
Supreme Court, Second Department on July 3, 2007. Pursuant to its agreement to indemnify B&W, RJR
Tobacco posted a supersedeas bond in the amount of $8.018 million on July 5, 2007.
On February 1, 2005, a jury returned a split verdict in Smith v. Brown & Williamson Tobacco
Corp. (a case filed in May 2003 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
negligence (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 and $20 million in punitive 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. B&W appealed to the Missouri Court of Appeals and on
July 31, 2007, the court affirmed the compensatory damages
award, and reversed the award for and ordered a new trial on punitive
damages. The case was also transferred to the Missouri Supreme Court,
which may review the entire case.
On March 18, 2005, in Rose v. Brown & Williamson Tobacco Corp. (a case filed in December 1996
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, chronic obstructive pulmonary disease and other smoking related conditions
and/or diseases. Oral argument on B&Ws appeal in the Appellate Division, New York Supreme Court, First
Department occurred on
25
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
Engle Progeny Cases
Pursuant to the Florida Supreme Courts July 6, 2006 ruling in Engle v. R.J. Reynolds Tobacco
Co., former class members have one-year from January 11, 2007 in which to file individual lawsuits.
In addition, some individuals who filed suit prior to January 11, 2007 and who claim they meet the
conditions in Engle are also attempting to avail themselves of the Engle ruling. Lawsuits by
individuals requesting the benefit of the Engle ruling, whether filed before or after the January
11, 2007 mandate, are referred to as Engle Progeny Cases. As of July 13, 2007, RJR Tobacco has
been served and is currently a defendant in 41 Engle Progeny Cases. For further information on the
Engle case, see Class-Action Suits Engle Case, below.
Broin II Cases
As of July 13, 2007, there were 2,623 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 by exposure to ETS
in aircraft cabins (i.e., specific causation). Below is a description of the Broin II cases against
RJR Tobacco and B&W that went to trial or were decided during the period from January 1, 2007 to
July 13, 2007, or remained on appeal or were otherwise pending as of July 13, 2007.
In Janoff v. Philip Morris, Inc. (a case filed in February 2000 in Circuit Court, Miami-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. On July 6, 2007,
the plaintiff asked the trial court to set the case for trial.
In Swaty v. Philip Morris, Inc. (a case filed in September 2000 in Circuit Court, Miami-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 July 13, 2007, 19 class-action cases were pending in the United States
against RJR Tobacco or its affiliates or indemnitees. 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 state-wide, 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 in state or federal courts in California, Florida, Illinois, Louisiana,
Minnesota, Missouri, New York, Oregon, Washington, West Virginia and the District of Columbia. All
pending class-action cases are discussed below.
26
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
The pending class-actions against RJR Tobacco or its affiliates or indemnitees include nine
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, Minnesota, Missouri and New York. 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.
On February 10, 2003, in Simms v. Philip Morris, Inc. (a case filed in May 2001 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 under-age 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 under-age, 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 in District Court, Orleans Parish,
Louisiana), the trial court certified 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 March 2, 2007, the defendants application for rehearing and
clarification was denied. The defendants filed an application for writ of certiorari with the
Louisiana Supreme Court on April 2, 2007.
In addition to the Scott case, one other medical monitoring class-action remains pending
against RJR Tobacco, B&W, and other cigarette manufacturers. In Lowe v. Philip Morris, Inc. (a case
filed in November 2001 in Circuit Court, Multnomah County, Oregon), a judge dismissed the complaint
on November 4, 2003, for failure to state a claim in an action seeking creation of a
court-supervised program of medical monitoring, smoking cessation and education, and recovery of
attorneys fees. On September 6, 2006, the Court of Appeals affirmed the trial courts dismissal.
On
27
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
March 20, 2007, the Oregon Supreme Court granted the plaintiffs petition for review. Oral
argument is scheduled for September 5, 2007.
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, Miami-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. 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 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 former class members to avail themselves of
those findings under certain conditions 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 citizen residents who suffered or died from smoking-related
illnesses that manifested themselves on or before November 21, 1996 and that were caused by an
addiction to cigarettes. 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 decision denied
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
Engle jurys finding on express warranty were preserved for use by eligible plaintiffs. The court
also denied the plaintiffs motion and confirmed that the class was limited to those individuals
who developed alleged smoking-related illnesses that manifested themselves on or before November
21, 1996. The court
issued its mandate on January 11, 2007, which began the one-year period for former class
members to file individual lawsuits. RAI anticipates individual case filings in Florida will
increase as a result of the Engle decision. For further information on the individual cases, see
Engle Progeny Cases above.
On April 17, 2007, RJR Tobaccos motions for discharge of RJR Tobaccos and B&Ws civil
supersedeas bonds related to the punitive damages award were granted. During the second quarter of
2007, RJR Tobacco received the full amount of the $100 million cash collateral that it had posted.
On May 21, 2007, the defendants, including RJR Tobacco, filed a petition for writ of certiorari
in the U.S. Supreme Court.
28
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Prior to the Florida Supreme Court ruling on July 6, 2006, RJR Tobacco and/or B&W were 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,
Miami-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 motions occurred on March 15,
2007. A decision is pending.
California Business and Professions Code Cases. On November 30, 2000, in Daniels v. Philip
Morris Cos., Inc. (a case filed in April 1998 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 and 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. Oral argument occurred on June 6, 2007. A decision is pending.
On April 11, 2001, in Brown v. American Tobacco Co., Inc. (a case filed in June 1997 in
Superior Court, San Diego County, California), the same judge as 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 complete. Oral argument has not been
scheduled.
Lights Cases. As noted above, lights class-action cases are pending against RJR Tobacco
or B&W in Illinois (2), Missouri (2), Minnesota (2), Florida (2) and New York (1). The classes in
these cases generally seek to recover $50,000 to $75,000 per class member for compensatory and
punitive damages, injunctive and other forms of relief, and attorneys fees and costs from RJR
Tobacco and/or B&W. In general, the plaintiffs allege that RJR Tobacco or B&W made false and
misleading claims that lights cigarettes were lower in tar and nicotine and /or were less
hazardous or less mutagenic than other cigarettes. The cases typically are filed pursuant to state
consumer protection and related statutes.
In Turner v. R. J. Reynolds Tobacco Co. (a case filed in February 2000 in Circuit Court,
Madison County, Illinois), a judge certified a class on November 14, 2001. On June 6, 2003, RJR
Tobacco filed a motion to stay the case
29
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
In Howard v. Brown & Williamson Tobacco Corp. (another case filed in February 2000 in Circuit
Court, Madison County, Illinois), a judge certified a class on December 18, 2001. 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. 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 December 18, 2006, the defendants filed a motion to dismiss
and for entry of final judgment with the circuit court, 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. The mandate from the
Illinois Fifth District Court of Appeals issued March 14, 2007. Oral argument on the plaintiffs
motion to vacate occurred on May 2, 2007. A decision is pending. In the event RJR Tobacco and its
affiliates or indemnitees 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 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. 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 November 16, 2006,
the U.S. Court of Appeals for the Second Circuit granted the defendants motions to stay the
district court proceedings and for review of the class certification ruling. Oral argument occurred
on July 10, 2007. A decision is pending.
A lights class-action case is pending against each of RJR Tobacco and B&W in Missouri. In
Collora v. R. J. Reynolds Tobacco Co. (a case filed in May 2000 in Circuit Court, St. Louis County,
Missouri), a judge in St. Louis certified a class on December 31, 2003. On April 9, 2007, the
court granted the plaintiffs 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 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. On October 25, 2005, the plaintiffs filed a motion to
remand, which was granted on March 17, 2006. As discussed in the prior paragraph, this case and
certain other cases have been reassigned 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 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,
30
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
2005, RJR Tobacco and RJR filed a motion for summary judgment based on federal preemption. On
July 6, 2007, the court granted the defendants motion for summary judgment and dismissed the case
with prejudice.
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. 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 14, 2007, the U.S. Court of Appeals
for the Fifth Circuit reversed the judgment and remanded the case with directions to dismiss all
claims with prejudice. On April 2, 2007, final judgment was entered in favor of B&W, and the case
was dismissed 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. 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. On February 28, 2007, the Eighth Circuit remanded
the case to the Minnesota Court of Appeals. Briefing is complete. Oral argument has not been
scheduled.
In Thompson v. R. J. Reynolds Tobacco Co. (a case filed in February 2003 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. 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 in Superior Court,
King County, Washington), the plaintiffs motion for class certification was denied on April 21,
2006. 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 March 1, 2007, the plaintiffs petition for review with the Washington Supreme Court
was denied. The plaintiffs motion to modify the ruling of the Washington Supreme Court was denied
on June 5, 2007. On June 19, 2007, the parties stipulated to a dismissal with
prejudice. On June 27, 2007, the court dismissed the case with prejudice.
Rios v. R. J. Reynolds Tobacco Co. (a case filed in February 2002 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.
Finally, in Rivera v. Brown & Williamson Tobacco Corp. (a case filed in October 2006 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 answered the complaint on November 22, 2006.
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 case 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 the class,
which in no event will be greater than $75,000 per each class member, 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 the courts ruling on the motion to dismiss. In its
ruling, the court 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. A hearing is
scheduled for September 6, 2007.
Young v. American Tobacco Co., Inc. (a case filed in November 1997 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
31
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 above under Medical Monitoring and Smoking Cessation Cases.
In Parsons v. A C & S, Inc. (a case filed in February 1998 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 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, in Espinosa v. Philip Morris USA, Inc., a class-action complaint was filed against
certain cigarette manufacturers, including RJR Tobacco, and their parents, including RAI, in
December 2006, in the Circuit Court for Cook County, Illinois. The plaintiffs allege that the
defendants have 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. The plaintiffs
motion to remand was denied on March 26, 2007. The defendants motion to dismiss the complaint was
granted on June 18, 2007.
Broin Settlement. RJR Tobacco, B&W and other cigarette manufacturer defendants settled Broin
v. Philip Morris, Inc. in October 1997. This case had been brought in Florida state court on behalf
of flight attendants alleged to suffer 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 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. 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.
32
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
Effective on November 12, 1999, the MSA settled all the health-care cost recovery actions brought
by, or on behalf of, the settling jurisdictions and released 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 2005 and beyond:
Unadjusted Original Participating Manufacturers Settlement Payment Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2011 and |
|
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
|
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 Payments1 |
|
|
7,004 |
|
|
|
7,004 |
|
|
|
7,004 |
|
|
|
7,143 |
|
|
|
7,143 |
|
|
|
7,143 |
|
|
|
7,143 |
|
Additional Annual Payments (through 2017)1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
861 |
|
|
|
861 |
|
|
|
861 |
|
|
|
861 |
|
Base Foundation Funding |
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Growers Trust (through 2010) 2 |
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
|
|
500 |
|
|
|
295 |
|
|
|
295 |
|
|
|
|
|
Offset by federal tobacco buyout 2 |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(295 |
) |
|
|
(295 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
8,389 |
|
|
$ |
8,389 |
|
|
$ |
8,389 |
|
|
$ |
9,389 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. |
RAIs Operating Subsidiaries Settlement Expenses and Payment Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2011 and |
|
|
2005 |
|
2006 |
|
2007 |
|
2008 |
|
2009 |
|
2010 |
|
thereafter |
Settlement expenses |
|
$ |
2,600 |
|
|
$ |
2,611 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement cash payments |
|
$ |
2,732 |
|
|
$ |
2,631 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected settlement expenses |
|
|
|
|
|
|
|
|
|
|
>$2,850 |
|
|
|
>$2,800 |
|
|
|
>$2,800 |
|
|
|
>$2,800 |
|
|
|
>$2,800 |
|
Projected settlement cash payments |
|
|
|
|
|
|
|
|
|
|
>$2,600 |
|
|
|
>$2,850 |
|
|
|
>$2,800 |
|
|
|
>$2,800 |
|
|
|
>$2,800 |
|
33
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 care to smokers who 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 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. 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, 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 defendants motion for clarification was granted
in part and denied in part on March 16, 2007. The defendants motion as to the meaning and
applicability of the general injunctive relief of the August 17, 2006 order was denied. The
request for clarification as to the scope of the provisions in the order
prohibiting the use of descriptors and requiring corrective statements at retail point of sale
was granted. The court also ruled that the provisions prohibiting the use of express or implied
health messages or descriptors do apply to the actions of the defendants taken outside of the
United States. The defendants filed amended notices of appeal on March 29, 2007 and March 30,
2007. In May 2007, the court of appeals issued a briefing schedule that extends through May 19,
2008.
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)
34
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
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.
No such cases currently are pending against RJR Tobacco and its affiliates or indemnitees 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 because Louisiana was 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 alleged 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 motions to dismiss both cases. 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. 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.
On November 12, 1998, the government of British Columbia enacted legislation creating a civil
cause of action permitting the government to recover 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 reasonably could 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. On April 5,
2007, the Supreme Court dismissed RJR Tobaccos application. The case is in the preliminary
stages.
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
35
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 of Israel. A hearing occurred on March 28, 2005, and a decision is
pending.
Other Health-Care Cost Recovery and Aggregated Claims Cases
Health-care cost recovery cases have been brought by a variety of plaintiffs. 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 July 13, 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.
Native American Tribe Cases. As of July 13, 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 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.
Hospital Cases. As of July 13, 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 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. The plaintiff appealed to the U.S. Court of Appeals for the First Circuit. Oral argument
occurred on March 6, 2007. A decision is pending.
MSA-Enforcement and Validity
As of July 13, 2007, there were 53 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
36
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 appealed to
the U.S. Court of Appeals for the Ninth Circuit. Oral argument occurred on February 15, 2007. A
decision is pending.
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 intended 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. On April 25, 2007, the court denied the State of Vermonts motion
to strike defendants demand for trial by jury. The case is scheduled to be trial ready by
February 1, 2008.
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 an 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.
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 for a given year is available. An independent auditor
designated under the MSA must determine that the participating manufacturers have experienced a
market share loss beyond a triggering threshold to those manufacturers that do not participate in
the MSA, referred to as NPMs, and a firm of independent economic consultants must find that the
disadvantages of the MSA were a significant factor contributing to the 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 these
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. On March 28, 2007, the independent auditor issued revised calculations
that reduced RJR Tobaccos share of the NPM Adjustment for 2003 to approximately $615 million. On
April 19, 2007, RJR Tobacco instructed the independent auditor to release to the settling states
approximately $32 million from the disputed payments account.
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 a single, nation-wide arbitration
before a panel of three former federal judges. Following RJR Tobaccos payment of a portion of its
2006 MSA payment into the disputed funds escrow account, 37 of the settling states filed legal
proceedings in their respective MSA courts seeking declaratory orders that they diligently enforced
their Qualifying Statutes during 2003 and/or orders
37
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
compelling RJR Tobacco and the other participating manufacturers that placed money in the
disputed payments account to pay the disputed amounts to the settling states. In response, RJR
Tobacco has moved to compel arbitration as provided in 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 participating manufacturers would assume that these settling states would
not object to the required arbitration. All but one of these settling states responded that they
would not agree to submit the dispute to arbitration and would oppose any effort to compel
arbitration of the dispute. The participating manufacturers, including RJR Tobacco, have filed
motions to compel arbitration in the MSA courts of all of these settling states, except certain of
the territories.
As of July 13, 2007, 44 out of 45 courts that had addressed the question whether disputes
concerning the 2003 NPM Adjustment are arbitrable had ruled that arbitration is required under the
MSA.
During 2006, proceedings were initiated with respect to an NPM Adjustment for 2004. The MSA
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 issued a final, non-appealable
determination that the disadvantages of the MSA were a significant factor contributing to the
2004 market share loss. On April 16, 2007, RJR Tobacco placed approximately $561 million of its
2007 MSA payment into the disputed payments account. That amount represented RJR Tobaccos share
of the 2004 NPM Adjustment as calculated by the MSA independent auditor.
On October 12, 2006, the State of New York sent a 30-day notice, signed by 26 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. As of
July 13, 2007, only the State of Ohio has filed an action pursuant to this notice.
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. As of July 13, 2007, all of the federal and state
court cases on behalf of indirect purchasers have been dismissed, except for two state court cases
pending in Kansas and in New Mexico.
In Smith v. Philip Morris Cos., Inc. (a case filed in February 2000, and 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 in District Court, Rio
Arriba County, New Mexico), the court granted class certification on May 14, 2003 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 June 30, 2006, the court granted the defendants motion for summary
judgment. On August 14, 2006, the plaintiff appealed to the New Mexico Court of Appeals. Briefing
is underway.
38
Notes to Condensed Consolidated Financial Statements (Unaudited) (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 an initial requirement of 55 million pounds
for B&W (the amount changes each year pursuant to the settlement agreement).
On April 22, 2004, RJR Tobacco and the plaintiffs settled, which settlement the court approved
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
35 million pounds (exclusive of the pounds it must purchase as the successor to B&W) of domestic
green leaf tobacco for the next ten 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.
By opinion dated December 6, 2004, the U.S. Court of Appeals for the Fourth Circuit held that
the April 2004 settlement between RJR Tobacco and the plaintiffs triggered a Most Favored Nations
Clause in the earlier May 2003 settlement between B&W and other defendants. The Most Favored
Nations Clause reduces the number of pounds RJR Tobacco, as successor to B&W, is obligated to
purchase. By order dated August 4, 2005, the U.S. District Court for the Middle District of North
Carolina ruled that, pursuant to the Most Favored Nations Clause, the defendants to the May 2003
settlement are entitled to a reduction in their green leaf purchase commitment for any remaining
whole years, commencing after the date of the courts order, in the amount of 67.81 percent. This
ruling applies to the minimum number of pounds RJR Tobacco, as successor to B&W, is required to
purchase each year and reduces that amount by 67.81 percent each year for all future years.
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 allegedly 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. 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, and the plaintiffs filed a notice
of appeal of the summary judgment and dismissal.
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 several months after the granting of summary judgment in RJR Tobaccos favor, and
those plaintiffs thereafter 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. On February 27, 2007, the U.S. Court of Appeals
for the Sixth Circuit affirmed the trial courts decision granting RJR Tobaccos motion for summary
judgment. Twelve of the plaintiffs filed a petition for writ of certiorari in the U.S. Supreme
Court on May 29, 2007; the remaining eight plaintiffs did not join in the petition.
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 case was removed to federal court on
January 26, 2006. On September 28, 2006, the court granted the plaintiffs motion to remand the
case back to the
39
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
state court. 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. The
court has not set a hearing date on the preliminary injunction.
Other Litigation and Developments
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 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.
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 did not
perfect its appeal until May 8, 2007. A hearing on the appeal is set for October 29, 2007.
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. On May 30, 2007, the court
announced its decision to issue an order committing two of the accused, JTI-MC and Edward
Lang, to stand trial on the charges filed in February 2003 and discharging the other six
accused. JTI-MC and Mr. Lang have separately filed papers seeking an order quashing the
order committing them to stand trial, and the government has filed papers seeking an order
quashing the order discharging six of the accused.
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.
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.
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
40
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
extended to May 30, 2008. 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. Pursuant to a court-imposed deadline, 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.
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.
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
incurred arising out of a Southern District of New York grand jury investigation, 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. In
the interim, RJR and RJR Tobacco are paying defense costs and
expenses in connection with certain of the Canadian litigation
described above. In addition, RJR has liabilities of
$94 million that were recorded in 1999 in connection with
certain of the indemnification claims asserted by JTI. For further information on the
JTI indemnification claims, see Other Contingencies and Guarantees below.
On May 15, 2007, RAI was served with a subpoena issued by the U.S. District Court for the
Middle District of North Carolina. The subpoena seeks documents relating primarily to the business
of RJR-TI regarding the manufacture and sale of Canadian brand cigarettes during the period 1990
through 1996. The subpoena was issued at the request of Canada pursuant to a Mutual Legal
Assistance Treaty between the United States and Canada.
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 U.S. Court of
Appeals for the Second Circuit and then by the Supreme Court of the dismissal of their August 2001
complaint. The U.S. 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.
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
41
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 May 14, 2007, the plaintiffs filed a
petition for writ of certiorari in the U.S. Supreme Court.
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 sought: 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 pre-judgment 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 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. On June 26, 2007, the court ruled that Stars patents
are unenforceable due to inequitable conduct by Star and its representatives in the U.S. Patent &
Trademark Office. On June 26, 2007, the court also entered final judgment in favor of RJR Tobacco
and against Star, dismissing all of Stars claims with prejudice. On June 27, 2007, Star filed a
notice of appeal. On July 9, 2007, RJR Tobacco filed a bill of costs seeking reimbursement of its
recoverable costs as the prevailing party, and a motion seeking reimbursement of its attorneys
fees and excess costs incurred in defending Stars lawsuit. The trial court has deferred that
motion pending the appeal.
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 an 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 has settled with all of the 20 defendants, and the
case has been dismissed.
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, which was dismissed on May
23, 2007. 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 July 13, 2007, Conwood was a defendant in eight 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 claims and
defendants, and this litigation has been dormant.
42
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Pursuant to a second amended complaint filed in September 2006, 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. There is not presently a punitive damages
demand in this case, though the plaintiff retains the right to seek leave of court to add such a
demand later. 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 December 14, 2004, the U.S. Court of Appeals for the Fourth Circuit 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. 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. On March 7, 2007, the court granted the plaintiff leave to file
an amended complaint and denied all pending motions as moot, including the plaintiffs motion to
name as additional defendants the six committee members. On April 6, 2007, the defendants moved to
dismiss the amended complaint. On May 31, 2007, the court granted the motion in part and denied it in part,
dismissing all claims against the RJR Employee Benefits Committee and the RJR Pension Investment
Committee. The remaining defendants, RJR and
43
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
RJR Tobacco, filed their answer and affirmative
defenses on June 14, 2007. On June 28, 2007, the plaintiff filed a motion to amend the complaint
to add as parties defendant the six members of the RJR Pension Investment Committee and the RJR
Employee Benefits Committee. The defendants filed their opposition to
this motion on July 23, 2007.
Employment Litigation
On March 19, 2007, in Marshall v. R.J. Reynolds Tobacco Co., the plaintiff filed a class
action complaint against R.J. Reynolds Tobacco Company in the U.S. District Court for the Western
District of Missouri alleging violations of the Fair Labor Standards Act. The allegations include
failure to keep accurate records of all hours worked by RJR Tobaccos employees and failure to pay
wages and overtime compensation to non-exempt retail representatives. The lawsuit is currently in
its preliminary stages.
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 2002, R. J. Reynolds Tobacco C. V., an indirect wholly owned subsidiary of RAI and referred
to as RJRTCV, and an affiliate of Gallaher Group Plc, referred to as Gallaher, formed a joint
venture, with each party owning a 50% membership interest. The joint venture, R. J.
Reynolds-Gallaher International Sarl, markets American-blend cigarettes primarily in Italy, France
and Spain.
On April 18, 2007, an affiliate of Japan Tobacco Inc. acquired Gallaher, and Gallaher
subsequently notified RJRTCV that the acquisition constituted a change of control of Gallaher
within the meaning of the joint venture agreement, wherein RJRTCV may elect to terminate the joint
venture prior to its expiration date. On May 15, 2007, RJRTCV notified the other member of the
joint venture that RJRTCV had exercised its termination right, effective November 30, 2007. Unless
the members agree otherwise, the joint venture will no longer conduct any business and will be
liquidated following its termination.
Upon a
termination of the joint venture, the value of generally all of the trademarks each
joint venture member or its affiliate has licensed to the joint venture will be calculated. The
party whose licensed trademarks have the greater value will be required to pay the other party an
amount equal to one-half of the difference between the value of the parties respective trademarks.
RJRTCV believes that the current value of the trademarks licensed to the joint venture by
Gallahers affiliate is materially greater than that of the trademarks licensed to the joint
venture by RJRTCVs affiliate. The value of the trademarks and the resulting termination amount are
not yet known, and will be determined in accordance with the valuation procedures set forth in the
joint venture agreement as described in RAIs Current Report on
Form 8-K, filed with the SEC on May 21, 2007. In accordance
with the terms of the joint venture agreement, the termination amount
shall be determined no later than July 2008, whereupon 40% of such
amount shall be paid within 60 days of the final determination, and
the remainder shall be paid in six equal annual installments.
44
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 $2 million and $4
million during the first six months of 2007 and 2006, respectively, for funds to be reimbursed to
BAT for costs and expenses incurred arising out of certain 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:
|
|
|
any liabilities, costs and expenses arising out of the imposition or assessment
of any tax with respect to the international tobacco business arising prior to the
sale, other than as reflected on the closing balance sheet; |
|
|
|
|
any liabilities, costs and expenses that JTI or any of its affiliates,
including the acquired entities, may incur after the sale with respect to any of RJRs
or RJR Tobaccos employee benefit and welfare plans; and |
|
|
|
|
any liabilities, costs and expenses incurred by JTI or any of its affiliates
arising out of certain activities of Northern Brands. |
As described above in Litigation Affecting the Cigarette Industry Other Litigation and
Developments, RJR Tobacco has received several claims for indemnification from JTI. 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 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 6 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 June 30, 2007, RAI and its subsidiaries had approximately 7,400 full-time employees and
approximately 200 part-time employees. The 7,400 full-time employees include approximately 5,800
RJR Tobacco employees and 800 Conwood employees. No employees of RAI or its subsidiaries are
unionized.
45
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 10Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Total |
|
|
|
|
|
|
Common |
|
|
Paid-In |
|
|
Accumulated |
|
|
Comprehensive |
|
|
Shareholders |
|
|
Comprehensive |
|
|
|
Stock |
|
|
Capital |
|
|
Deficit |
|
|
Loss |
|
|
Equity |
|
|
Income |
|
Balance as of December 31,
2006 |
|
$ |
|
|
|
$ |
8,702 |
|
|
$ |
(1,241 |
) |
|
$ |
(418 |
) |
|
$ |
7,043 |
|
|
|
|
|
Cumulative effect of
adoption of FIN No. 48 |
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted balance as of
January 1, 2007 |
|
|
|
|
|
|
8,702 |
|
|
|
(1,236 |
) |
|
|
(418 |
) |
|
|
7,048 |
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
653 |
|
|
|
|
|
|
|
653 |
|
|
$ |
653 |
|
Retirement benefits FAS 158,
net of $12 million tax
expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15 |
|
|
|
15 |
|
|
|
15 |
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
667 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends $0.75 per share |
|
|
|
|
|
|
|
|
|
|
(443 |
) |
|
|
|
|
|
|
(443 |
) |
|
|
|
|
Restricted stock amortization |
|
|
|
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
4 |
|
|
|
|
|
Stock repurchased |
|
|
|
|
|
|
(60 |
) |
|
|
|
|
|
|
|
|
|
|
(60 |
) |
|
|
|
|
Excess tax benefit on
stock-based compensation
plans |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2007 |
|
$ |
|
|
|
$ |
8,647 |
|
|
$ |
(1,026 |
) |
|
$ |
(404 |
) |
|
$ |
7,217 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On February 6, 2007, the Board of Directors of RAI authorized the repurchase of up to $75
million of outstanding shares of RAI common stock to offset the dilution from restricted stock
grants and the exercise of previously granted options under the Reynolds American Inc. Long-Term
Incentive Plan, referred to as the LTIP. During March 2007, RAI repurchased 984,000 shares of its
common stock at an average per share price of $60.65 for a total of $60 million. Due to RAIs
incorporation in North Carolina, which does not recognize treasury shares, the shares repurchased
are cancelled at the time of repurchase.
On February 6, 2007, the Board of Directors of RAI approved a grant, to key employees of RAI
and its subsidiaries, of shares of restricted RAI common stock under the LTIP, effective March 6,
2007. The 373,082 restricted shares were granted based on the per share closing price of RAI
common stock on March 6, 2007, of $59.50. The shares of the restricted RAI common stock generally
will vest on March 6, 2010. Compensation expense includes the vesting period elapsed. Dividends
on shares of outstanding restricted stock, which are paid concurrently with dividends on
outstanding unrestricted shares of stock, are recognized as a reduction of equity.
On February 6, 2007 and May 11, 2007, RAIs board of directors declared a quarterly cash
dividend of $0.75 per common share, or $3.00 on an annualized basis.
On May 11, 2007, the shareholders of RAI approved an amendment to RAIs amended and restated
articles of incorporation increasing the number of authorized shares of RAIs common stock, par
value $.0001 per share, from 400,000,000 to 800,000,000.
Note 11Segment 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,
PALL MALL, DORAL, WINSTON and SALEM, are currently six of the ten best-selling brands of cigarettes
in the United States. Those brands, and its other brands, including MISTY and CAPRI, are
manufactured in a variety of styles and marketed in the United States. RJR Tobacco also manages
contract manufacturing of cigarettes and tobacco products through arrangements with BAT affiliates.
As of January 1, 2007, the management and distribution of the DUNHILL and STATE EXPRESS 555
cigarette brands were transferred from Lane to RJR Tobacco.
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. Beginning January 1,
46
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
2007, Conwood began
distribution of a variety of tobacco products manufactured by Lane, including WINCHESTER and
CAPTAIN BLACK little cigars, and BUGLER roll-your-own tobacco.
The disclosures classified as All Other include the total assets and results of operations of
Santa Fe, GPI and the R.J. Reynolds-Gallaher International Sarl joint venture. The financial
condition and results of operations of these operating segments do not meet the materiality
criteria to be reportable.
Beginning in 2007, the practice of allocating certain corporate expenses for segment reporting
was discontinued. The amounts presented for prior periods have been reclassified to reflect the
current segment composition.
Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL
AMERICAN SPIRIT brand. Santa Fe markets its products in the United States, and has a small, but
growing, international tobacco business. On January 1, 2007, GPI began managing the international
businesses of Conwood and Santa Fe. GPI also manufactures and exports tobacco products to
U.S. territories, U.S. duty-free shops and U.S. overseas military bases and manages a contract
manufacturing business.
Segment Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Net sales: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
2,061 |
|
|
$ |
2,111 |
|
|
$ |
3,960 |
|
|
$ |
3,945 |
|
Conwood |
|
|
174 |
|
|
|
72 |
|
|
|
329 |
|
|
|
100 |
|
All Other |
|
|
113 |
|
|
|
108 |
|
|
|
207 |
|
|
|
206 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net sales |
|
$ |
2,348 |
|
|
$ |
2,291 |
|
|
$ |
4,496 |
|
|
$ |
4,251 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
496 |
|
|
$ |
564 |
|
|
$ |
984 |
|
|
$ |
983 |
|
Conwood |
|
|
90 |
|
|
|
32 |
|
|
|
170 |
|
|
|
37 |
|
All Other |
|
|
35 |
|
|
|
39 |
|
|
|
70 |
|
|
|
78 |
|
Corporate expense |
|
|
(26 |
) |
|
|
(19 |
) |
|
|
(55 |
) |
|
|
(36 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income |
|
$ |
595 |
|
|
$ |
616 |
|
|
$ |
1,169 |
|
|
$ |
1,062 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation to income before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
595 |
|
|
$ |
616 |
|
|
$ |
1,169 |
|
|
$ |
1,062 |
|
Interest and debt expense |
|
|
87 |
|
|
|
52 |
|
|
|
176 |
|
|
|
87 |
|
Interest income |
|
|
(23 |
) |
|
|
(23 |
) |
|
|
(61 |
) |
|
|
(59 |
) |
Other expense, net |
|
|
16 |
|
|
|
(3 |
) |
|
|
15 |
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before
income taxes |
|
$ |
515 |
|
|
$ |
590 |
|
|
$ |
1,039 |
|
|
$ |
1,037 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Assets: |
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
15,085 |
|
|
$ |
14,955 |
|
Conwood |
|
|
4,552 |
|
|
|
4,578 |
|
All Other |
|
|
1,028 |
|
|
|
996 |
|
Corporate |
|
|
17,066 |
|
|
|
17,818 |
|
Elimination adjustments |
|
|
(20,101 |
) |
|
|
(20,169 |
) |
|
|
|
|
|
|
|
Consolidated assets |
|
$ |
17,630 |
|
|
$ |
18,178 |
|
|
|
|
|
|
|
|
Note 12Related 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.
47
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
|
2007 |
|
2006 |
Balances: |
|
|
|
|
|
|
|
|
Accounts receivable, related party |
|
$ |
48 |
|
|
$ |
62 |
|
Due to related party |
|
|
9 |
|
|
|
9 |
|
Deferred revenue, related party |
|
|
39 |
|
|
|
62 |
|
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
2006 |
Transactions
for the six months ended June 30: |
|
|
|
|
|
|
|
|
Net sales, related party |
|
$ |
251 |
|
|
$ |
266 |
|
Research and development services billed to related parties |
|
|
1 |
|
|
|
2 |
|
BAT related legal indemnification expenses |
|
|
2 |
|
|
|
4 |
|
Purchases from related parties |
|
|
5 |
|
|
|
4 |
|
RAIs operating subsidiaries have entered into various transactions with affiliates of BAT.
RAIs operating subsidiaries sell contract-manufactured cigarettes, processed strip leaf, pipe
tobacco and little cigars to BAT affiliates. For 2007, 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 the six-month period ended June
30, 2007, net sales to BAT affiliates were $251 million, primarily cigarettes, representing 6% of
RAIs total net sales.
RJR Tobacco recorded $39 million of deferred sales revenue relating to leaf sold to BAT
affiliates that had not been delivered as of June 30, 2007, 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.
RAIs operating subsidiaries also purchase unprocessed leaf at market prices, and import
cigarettes at prices not to exceed manufacturing costs plus 10%, from BAT affiliates. Royalty
expense is paid to BAT affiliates that own the trademarks to imported brands of cigarettes and pipe
tobacco. The royalty rates vary, although none is in excess of 10% of the local sales price.
During the first six months of 2007, the aggregate purchases for leaf and cigarettes were $5
million and royalty expenses were less than $1 million.
In the first half of 2007, RJR Tobacco recorded $2 million in selling, general and
administrative expenses for funds to be reimbursed to BAT. These funds will be paid in connection
with the indemnification of B&W and its affiliates for costs and expenses related to certain
tobacco-related litigation in the United States. For additional information relating to this
indemnification, see note 9.
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. During the first six months of 2007, $2 million was billed to BAT related to
secondees.
At June 30, 2007, $9 million of accounts payable is included in due to related party in the
condensed consolidated balance sheet (unaudited), primarily relating to cigarette purchases and the
litigation reimbursement accrual.
Note 13RAI 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 $4.3 billion guaranteed, secured notes.
RAIs direct, wholly owned subsidiaries and certain of its indirectly owned subsidiaries have fully
and unconditionally, and jointly and severally, guaranteed these notes. The following condensed
consolidating financial statements include: the accounts and activities
of RAI, the parent issuer; RJR, RJR Tobacco, Conwood, Conwood Holdings, Inc., Santa Fe, Lane,
GPI, RJR Acquisition Corp., and certain of RJR Tobaccos other subsidiaries, the guarantors; other
indirect subsidiaries of RAI that are not guarantors; and elimination adjustments.
48
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Three Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
2,218 |
|
|
$ |
31 |
|
|
$ |
(22 |
) |
|
$ |
2,227 |
|
Net sales, related party |
|
|
|
|
|
|
121 |
|
|
|
|
|
|
|
|
|
|
|
121 |
|
Cost of products sold |
|
|
|
|
|
|
1,349 |
|
|
|
16 |
|
|
|
(22 |
) |
|
|
1,343 |
|
Selling, general and administrative expenses |
|
|
14 |
|
|
|
375 |
|
|
|
14 |
|
|
|
1 |
|
|
|
404 |
|
Amortization expense |
|
|
|
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(14 |
) |
|
|
609 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
595 |
|
Interest and debt expense |
|
|
84 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
87 |
|
Interest income |
|
|
(1 |
) |
|
|
(22 |
) |
|
|
|
|
|
|
|
|
|
|
(23 |
) |
Intercompany interest (income) expense |
|
|
(30 |
) |
|
|
29 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
10 |
|
|
|
|
|
Other (income) expense, net |
|
|
20 |
|
|
|
(1 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(87 |
) |
|
|
610 |
|
|
|
3 |
|
|
|
(11 |
) |
|
|
515 |
|
Provision for (benefit from) income taxes |
|
|
(28 |
) |
|
|
219 |
|
|
|
|
|
|
|
|
|
|
|
191 |
|
Equity income from subsidiaries |
|
|
384 |
|
|
|
3 |
|
|
|
|
|
|
|
(387 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
325 |
|
|
|
394 |
|
|
|
3 |
|
|
|
(398 |
) |
|
|
324 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
325 |
|
|
$ |
395 |
|
|
$ |
3 |
|
|
$ |
(398 |
) |
|
$ |
325 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
2,165 |
|
|
$ |
21 |
|
|
$ |
(16 |
) |
|
$ |
2,170 |
|
Net sales, related party |
|
|
|
|
|
|
121 |
|
|
|
|
|
|
|
|
|
|
|
121 |
|
Cost of products sold |
|
|
|
|
|
|
1,285 |
|
|
|
7 |
|
|
|
(16 |
) |
|
|
1,276 |
|
Selling, general and administrative expenses |
|
|
8 |
|
|
|
375 |
|
|
|
9 |
|
|
|
|
|
|
|
392 |
|
Amortization expense |
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(8 |
) |
|
|
619 |
|
|
|
5 |
|
|
|
|
|
|
|
616 |
|
Interest and debt expense |
|
|
22 |
|
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
52 |
|
Interest income |
|
|
(1 |
) |
|
|
(22 |
) |
|
|
|
|
|
|
|
|
|
|
(23 |
) |
Intercompany interest (income) expense |
|
|
(15 |
) |
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
10 |
|
|
|
|
|
Other (income) expense, net |
|
|
3 |
|
|
|
(2 |
) |
|
|
(4 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(17 |
) |
|
|
608 |
|
|
|
9 |
|
|
|
(10 |
) |
|
|
590 |
|
Provision for (benefit from) income taxes |
|
|
(5 |
) |
|
|
227 |
|
|
|
1 |
|
|
|
|
|
|
|
223 |
|
Equity income from subsidiaries |
|
|
388 |
|
|
|
8 |
|
|
|
|
|
|
|
(396 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
376 |
|
|
|
389 |
|
|
|
8 |
|
|
|
(406 |
) |
|
|
367 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
376 |
|
|
$ |
398 |
|
|
$ |
8 |
|
|
$ |
(406 |
) |
|
$ |
376 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Six Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
4,234 |
|
|
$ |
47 |
|
|
$ |
(36 |
) |
|
$ |
4,245 |
|
Net sales, related party |
|
|
|
|
|
|
251 |
|
|
|
|
|
|
|
|
|
|
|
251 |
|
Cost of products sold |
|
|
|
|
|
|
2,537 |
|
|
|
17 |
|
|
|
(36 |
) |
|
|
2,518 |
|
Selling, general and administrative expenses |
|
|
29 |
|
|
|
744 |
|
|
|
23 |
|
|
|
1 |
|
|
|
797 |
|
Amortization expense |
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(29 |
) |
|
|
1,192 |
|
|
|
7 |
|
|
|
(1 |
) |
|
|
1,169 |
|
Interest and debt expense |
|
|
168 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
176 |
|
Interest income |
|
|
(2 |
) |
|
|
(58 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(61 |
) |
Intercompany interest (income) expense |
|
|
(62 |
) |
|
|
60 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
21 |
|
|
|
|
|
Other (income) expense, net |
|
|
22 |
|
|
|
(2 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(155 |
) |
|
|
1,205 |
|
|
|
11 |
|
|
|
(22 |
) |
|
|
1,039 |
|
Provision for (benefit from) income taxes |
|
|
(51 |
) |
|
|
437 |
|
|
|
1 |
|
|
|
|
|
|
|
387 |
|
Equity income from subsidiaries |
|
|
757 |
|
|
|
10 |
|
|
|
|
|
|
|
(767 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
653 |
|
|
|
778 |
|
|
|
10 |
|
|
|
(789 |
) |
|
|
652 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
653 |
|
|
$ |
779 |
|
|
$ |
10 |
|
|
$ |
(789 |
) |
|
$ |
653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
3,974 |
|
|
$ |
44 |
|
|
$ |
(33 |
) |
|
$ |
3,985 |
|
Net sales, related party |
|
|
|
|
|
|
266 |
|
|
|
|
|
|
|
|
|
|
|
266 |
|
Cost of products sold |
|
|
|
|
|
|
2,460 |
|
|
|
14 |
|
|
|
(33 |
) |
|
|
2,441 |
|
Selling, general and administrative expenses |
|
|
14 |
|
|
|
703 |
|
|
|
17 |
|
|
|
|
|
|
|
734 |
|
Amortization expense |
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(14 |
) |
|
|
1,063 |
|
|
|
13 |
|
|
|
|
|
|
|
1,062 |
|
Interest and debt expense |
|
|
22 |
|
|
|
65 |
|
|
|
|
|
|
|
|
|
|
|
87 |
|
Interest income |
|
|
(1 |
) |
|
|
(58 |
) |
|
|
|
|
|
|
|
|
|
|
(59 |
) |
Intercompany interest (income) expense |
|
|
(8 |
) |
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
21 |
|
|
|
|
|
Other (income) expense, net |
|
|
3 |
|
|
|
(1 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(30 |
) |
|
|
1,070 |
|
|
|
18 |
|
|
|
(21 |
) |
|
|
1,037 |
|
Provision for (benefit from) income taxes |
|
|
(9 |
) |
|
|
397 |
|
|
|
2 |
|
|
|
|
|
|
|
390 |
|
Equity income from subsidiaries |
|
|
742 |
|
|
|
16 |
|
|
|
|
|
|
|
(758 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
721 |
|
|
|
689 |
|
|
|
16 |
|
|
|
(779 |
) |
|
|
647 |
|
Extraordinary item gain on acquisition |
|
|
|
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
721 |
|
|
$ |
763 |
|
|
$ |
16 |
|
|
$ |
(779 |
) |
|
$ |
721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Cash Flows
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Six Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) operating activities |
|
$ |
402 |
|
|
$ |
(190 |
) |
|
$ |
8 |
|
|
$ |
(76 |
) |
|
$ |
144 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments |
|
|
|
|
|
|
(3,001 |
) |
|
|
|
|
|
|
|
|
|
|
(3,001 |
) |
Proceeds from sale of short-term investments |
|
|
|
|
|
|
3,451 |
|
|
|
|
|
|
|
|
|
|
|
3,451 |
|
Capital expenditures |
|
|
(5 |
) |
|
|
(51 |
) |
|
|
(4 |
) |
|
|
|
|
|
|
(60 |
) |
Distributions from (investment in) equity
investments |
|
|
|
|
|
|
(1 |
) |
|
|
10 |
|
|
|
|
|
|
|
9 |
|
Other, net |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
Intercompany notes receivable |
|
|
20 |
|
|
|
(308 |
) |
|
|
|
|
|
|
288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from investing activities |
|
|
15 |
|
|
|
89 |
|
|
|
6 |
|
|
|
288 |
|
|
|
398 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(444 |
) |
|
|
(55 |
) |
|
|
|
|
|
|
55 |
|
|
|
(444 |
) |
Dividends paid on preferred stock |
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Repurchase of common stock |
|
|
(60 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(60 |
) |
Excess tax benefit from stock-based
compensation |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Repayments of long-term debt |
|
|
(254 |
) |
|
|
(46 |
) |
|
|
|
|
|
|
|
|
|
|
(300 |
) |
Repayments of term loan |
|
|
(1,542 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,542 |
) |
Issuance of
long-term debt |
|
|
1,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,547 |
|
Deferred debt issuance cost |
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
Intercompany notes payable |
|
|
297 |
|
|
|
(20 |
) |
|
|
11 |
|
|
|
(288 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in)financing
activities |
|
|
(490 |
) |
|
|
(121 |
) |
|
|
11 |
|
|
|
(212 |
) |
|
|
(812 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(73 |
) |
|
|
(222 |
) |
|
|
25 |
|
|
|
|
|
|
|
(270 |
) |
Cash and cash equivalents at beginning of period |
|
|
296 |
|
|
|
1,065 |
|
|
|
72 |
|
|
|
|
|
|
|
1,433 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
223 |
|
|
$ |
843 |
|
|
$ |
97 |
|
|
$ |
|
|
|
$ |
1,163 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) operating activities |
|
$ |
787 |
|
|
$ |
(68 |
) |
|
$ |
16 |
|
|
$ |
(632 |
) |
|
$ |
103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments |
|
|
|
|
|
|
(2,966 |
) |
|
|
|
|
|
|
|
|
|
|
(2,966 |
) |
Proceeds from sale of short-term investments |
|
|
|
|
|
|
3,621 |
|
|
|
|
|
|
|
|
|
|
|
3,621 |
|
Capital expenditures |
|
|
|
|
|
|
(71 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
(73 |
) |
Distributions from equity investments |
|
|
|
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
8 |
|
Proceeds from the sale of businesses |
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
3 |
|
Business acquisition |
|
|
|
|
|
|
(3,517 |
) |
|
|
|
|
|
|
|
|
|
|
(3,517 |
) |
Intercompany notes receivable |
|
|
(3,168 |
) |
|
|
9 |
|
|
|
|
|
|
|
3,159 |
|
|
|
|
|
Net intercompany investments |
|
|
(381 |
) |
|
|
381 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other, net |
|
|
(2 |
) |
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
(3,551 |
) |
|
|
(2,535 |
) |
|
|
6 |
|
|
|
3,159 |
|
|
|
(2,921 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(368 |
) |
|
|
(611 |
) |
|
|
|
|
|
|
611 |
|
|
|
(368 |
) |
Dividends paid on preferred stock |
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Proceeds from exercise of stock options |
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3 |
|
Excess tax benefit from stock-based
compensation |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Repayment of long-term debt |
|
|
|
|
|
|
(190 |
) |
|
|
|
|
|
|
|
|
|
|
(190 |
) |
Issuance of long-term debt |
|
|
1,641 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641 |
|
Principal borrowings under term loan |
|
|
1,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,550 |
|
Deferred debt issuance costs |
|
|
(48 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(48 |
) |
Intercompany notes payable |
|
|
(9 |
) |
|
|
3,168 |
|
|
|
|
|
|
|
(3,159 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from financing
activities |
|
|
2,750 |
|
|
|
2,367 |
|
|
|
|
|
|
|
(2,527 |
) |
|
|
2,590 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(14 |
) |
|
|
(236 |
) |
|
|
22 |
|
|
|
|
|
|
|
(228 |
) |
Cash and cash equivalents at beginning of period |
|
|
227 |
|
|
|
1,076 |
|
|
|
30 |
|
|
|
|
|
|
|
1,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
213 |
|
|
$ |
840 |
|
|
$ |
52 |
|
|
$ |
|
|
|
$ |
1,105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
223 |
|
|
$ |
843 |
|
|
$ |
97 |
|
|
$ |
|
|
|
$ |
1,163 |
|
Short-term investments |
|
|
|
|
|
|
843 |
|
|
|
|
|
|
|
|
|
|
|
843 |
|
Accounts and other receivables, net |
|
|
5 |
|
|
|
95 |
|
|
|
10 |
|
|
|
|
|
|
|
110 |
|
Accounts receivable, related party |
|
|
|
|
|
|
48 |
|
|
|
|
|
|
|
|
|
|
|
48 |
|
Inventories |
|
|
|
|
|
|
1,027 |
|
|
|
30 |
|
|
|
(1 |
) |
|
|
1,056 |
|
Deferred income taxes |
|
|
5 |
|
|
|
830 |
|
|
|
|
|
|
|
|
|
|
|
835 |
|
Prepaid expenses and other current assets |
|
|
1 |
|
|
|
123 |
|
|
|
1 |
|
|
|
(6 |
) |
|
|
119 |
|
Short-term intercompany notes and interest
receivable |
|
|
82 |
|
|
|
112 |
|
|
|
|
|
|
|
(194 |
) |
|
|
|
|
Other intercompany receivables |
|
|
463 |
|
|
|
|
|
|
|
3 |
|
|
|
(466 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
779 |
|
|
|
3,921 |
|
|
|
141 |
|
|
|
(667 |
) |
|
|
4,174 |
|
Property, plant and equipment, net |
|
|
5 |
|
|
|
1,039 |
|
|
|
20 |
|
|
|
|
|
|
|
1,064 |
|
Trademarks, net |
|
|
|
|
|
|
3,475 |
|
|
|
|
|
|
|
|
|
|
|
3,475 |
|
Goodwill |
|
|
|
|
|
|
8,167 |
|
|
|
8 |
|
|
|
|
|
|
|
8,175 |
|
Other intangibles, net |
|
|
|
|
|
|
207 |
|
|
|
|
|
|
|
|
|
|
|
207 |
|
Long-term intercompany notes |
|
|
2,140 |
|
|
|
768 |
|
|
|
|
|
|
|
(2,908 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
10,001 |
|
|
|
82 |
|
|
|
|
|
|
|
(10,083 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
79 |
|
|
|
448 |
|
|
|
34 |
|
|
|
(26 |
) |
|
|
535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
13,004 |
|
|
$ |
18,107 |
|
|
$ |
203 |
|
|
$ |
(13,684 |
) |
|
$ |
17,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related accruals |
|
$ |
|
|
|
$ |
1,584 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
1,584 |
|
Accounts payable and other accrued
liabilities |
|
|
644 |
|
|
|
1,029 |
|
|
|
24 |
|
|
|
(6 |
) |
|
|
1,691 |
|
Due to related party |
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
9 |
|
Deferred revenue, related party |
|
|
|
|
|
|
39 |
|
|
|
|
|
|
|
|
|
|
|
39 |
|
Current maturities of long-term debt |
|
|
|
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
29 |
|
Short-term intercompany notes and interest
payables |
|
|
29 |
|
|
|
82 |
|
|
|
83 |
|
|
|
(194 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
467 |
|
|
|
|
|
|
|
(467 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
673 |
|
|
|
3,239 |
|
|
|
107 |
|
|
|
(667 |
) |
|
|
3,352 |
|
Intercompany notes and interest payable |
|
|
768 |
|
|
|
2,140 |
|
|
|
|
|
|
|
(2,908 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,270 |
|
|
|
129 |
|
|
|
|
|
|
|
|
|
|
|
4,399 |
|
Deferred income taxes |
|
|
|
|
|
|
1,113 |
|
|
|
|
|
|
|
(26 |
) |
|
|
1,087 |
|
Long-term retirement benefits (less
current portion) |
|
|
43 |
|
|
|
1,114 |
|
|
|
14 |
|
|
|
|
|
|
|
1,171 |
|
Other noncurrent liabilities |
|
|
33 |
|
|
|
370 |
|
|
|
1 |
|
|
|
|
|
|
|
404 |
|
Shareholders equity |
|
|
7,217 |
|
|
|
10,002 |
|
|
|
81 |
|
|
|
(10,083 |
) |
|
|
7,217 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
13,004 |
|
|
$ |
18,107 |
|
|
$ |
203 |
|
|
$ |
(13,684 |
) |
|
$ |
17,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
296 |
|
|
$ |
1,065 |
|
|
$ |
72 |
|
|
$ |
|
|
|
$ |
1,433 |
|
Short-term investments |
|
|
|
|
|
|
1,293 |
|
|
|
|
|
|
|
|
|
|
|
1,293 |
|
Accounts and other receivables, net |
|
|
4 |
|
|
|
98 |
|
|
|
5 |
|
|
|
|
|
|
|
107 |
|
Accounts receivable, related party |
|
|
|
|
|
|
59 |
|
|
|
3 |
|
|
|
|
|
|
|
62 |
|
Inventories |
|
|
|
|
|
|
1,135 |
|
|
|
20 |
|
|
|
|
|
|
|
1,155 |
|
Deferred income taxes |
|
|
3 |
|
|
|
790 |
|
|
|
|
|
|
|
|
|
|
|
793 |
|
Prepaid expenses and other current assets |
|
|
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 |
|
52
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
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 |
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 14RJR 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 $69 million unsecured notes. RAI and
certain of its direct or indirect, wholly owned subsidiaries, have fully and unconditionally, and
jointly and severally, guaranteed these notes. The following condensed consolidating financial
statements include: the accounts and activities of RAI, the parent guarantor; RJR, the issuer of
the debt securities; RJR Tobacco, RJR Acquisition Corp. and certain of RJRs other subsidiaries,
the other guarantors; other subsidiaries of RAI and RJR, including Santa Fe, Lane and Conwood, that
are not guarantors; and elimination adjustments. GPI was added as a guarantor in September 2006.
Comparative information for 2006 represents the guarantor subsidiaries during those periods.
54
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Three Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,006 |
|
|
$ |
262 |
|
|
$ |
(41 |
) |
|
$ |
2,227 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
116 |
|
|
|
5 |
|
|
|
|
|
|
|
121 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
1,289 |
|
|
|
95 |
|
|
|
(41 |
) |
|
|
1,343 |
|
Selling, general and administrative expenses |
|
|
14 |
|
|
|
|
|
|
|
332 |
|
|
|
58 |
|
|
|
|
|
|
|
404 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
1 |
|
|
|
|
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(14 |
) |
|
|
|
|
|
|
496 |
|
|
|
113 |
|
|
|
|
|
|
|
595 |
|
Interest and debt expense |
|
|
84 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87 |
|
Interest income |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(18 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
(23 |
) |
Intercompany interest (income) expense |
|
|
(30 |
) |
|
|
(1 |
) |
|
|
(18 |
) |
|
|
49 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
10 |
|
|
|
|
|
Other (income) expense, net |
|
|
20 |
|
|
|
(1 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(87 |
) |
|
|
10 |
|
|
|
532 |
|
|
|
70 |
|
|
|
(10 |
) |
|
|
515 |
|
Provision for (benefit from) income taxes |
|
|
(28 |
) |
|
|
|
|
|
|
192 |
|
|
|
27 |
|
|
|
|
|
|
|
191 |
|
Equity income from subsidiaries |
|
|
384 |
|
|
|
343 |
|
|
|
4 |
|
|
|
|
|
|
|
(731 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
325 |
|
|
|
353 |
|
|
|
344 |
|
|
|
43 |
|
|
|
(741 |
) |
|
|
324 |
|
Extraordinary item-gain on acquisition |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
325 |
|
|
$ |
353 |
|
|
$ |
345 |
|
|
$ |
43 |
|
|
$ |
(741 |
) |
|
$ |
325 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,032 |
|
|
$ |
172 |
|
|
$ |
(34 |
) |
|
$ |
2,170 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
117 |
|
|
|
4 |
|
|
|
|
|
|
|
121 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
1,240 |
|
|
|
70 |
|
|
|
(34 |
) |
|
|
1,276 |
|
Selling, general and administrative expenses |
|
|
8 |
|
|
|
|
|
|
|
345 |
|
|
|
39 |
|
|
|
|
|
|
|
392 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(8 |
) |
|
|
|
|
|
|
557 |
|
|
|
67 |
|
|
|
|
|
|
|
616 |
|
Interest and debt expense |
|
|
22 |
|
|
|
28 |
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
52 |
|
Interest income |
|
|
(1 |
) |
|
|
(2 |
) |
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
(23 |
) |
Intercompany interest (income) expense |
|
|
(15 |
) |
|
|
1 |
|
|
|
(12 |
) |
|
|
26 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
10 |
|
|
|
|
|
Other (income) expense, net |
|
|
3 |
|
|
|
(2 |
) |
|
|
|
|
|
|
(4 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(17 |
) |
|
|
(15 |
) |
|
|
588 |
|
|
|
44 |
|
|
|
(10 |
) |
|
|
590 |
|
Provision for (benefit from) income taxes |
|
|
(5 |
) |
|
|
(15 |
) |
|
|
229 |
|
|
|
14 |
|
|
|
|
|
|
|
223 |
|
Equity income from subsidiaries |
|
|
388 |
|
|
|
376 |
|
|
|
4 |
|
|
|
|
|
|
|
(768 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
376 |
|
|
|
376 |
|
|
|
363 |
|
|
|
30 |
|
|
|
(778 |
) |
|
|
367 |
|
Extraordinary item-gain on acquisition |
|
|
|
|
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
376 |
|
|
$ |
376 |
|
|
$ |
372 |
|
|
$ |
30 |
|
|
$ |
(778 |
) |
|
$ |
376 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
55
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Six Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
3,833 |
|
|
$ |
477 |
|
|
$ |
(65 |
) |
|
$ |
4,245 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
243 |
|
|
|
8 |
|
|
|
|
|
|
|
251 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
2,425 |
|
|
|
158 |
|
|
|
(65 |
) |
|
|
2,518 |
|
Selling, general and administrative expenses |
|
|
29 |
|
|
|
|
|
|
|
655 |
|
|
|
113 |
|
|
|
|
|
|
|
797 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
1 |
|
|
|
|
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(29 |
) |
|
|
|
|
|
|
985 |
|
|
|
213 |
|
|
|
|
|
|
|
1,169 |
|
Interest and debt expense |
|
|
168 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
176 |
|
Interest income |
|
|
(2 |
) |
|
|
(4 |
) |
|
|
(49 |
) |
|
|
(6 |
) |
|
|
|
|
|
|
(61 |
) |
Intercompany interest (income) expense |
|
|
(62 |
) |
|
|
(2 |
) |
|
|
(33 |
) |
|
|
97 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Other (income) expense, net |
|
|
22 |
|
|
|
(2 |
) |
|
|
|
|
|
|
(5 |
) |
|
|
|
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(155 |
) |
|
|
21 |
|
|
|
1,067 |
|
|
|
127 |
|
|
|
(21 |
) |
|
|
1,039 |
|
Provision for (benefit from) income taxes |
|
|
(51 |
) |
|
|
|
|
|
|
393 |
|
|
|
45 |
|
|
|
|
|
|
|
387 |
|
Equity income from subsidiaries |
|
|
757 |
|
|
|
684 |
|
|
|
10 |
|
|
|
|
|
|
|
(1,451 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
653 |
|
|
|
705 |
|
|
|
684 |
|
|
|
82 |
|
|
|
(1,472 |
) |
|
|
652 |
|
Extraordinary item-gain on acquisition |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
653 |
|
|
$ |
705 |
|
|
$ |
685 |
|
|
$ |
82 |
|
|
$ |
(1,472 |
) |
|
$ |
653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
3,770 |
|
|
$ |
284 |
|
|
$ |
(69 |
) |
|
$ |
3,985 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
260 |
|
|
|
6 |
|
|
|
|
|
|
|
266 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
2,387 |
|
|
|
123 |
|
|
|
(69 |
) |
|
|
2,441 |
|
Selling, general and administrative expenses |
|
|
14 |
|
|
|
1 |
|
|
|
653 |
|
|
|
66 |
|
|
|
|
|
|
|
734 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(14 |
) |
|
|
(1 |
) |
|
|
976 |
|
|
|
101 |
|
|
|
|
|
|
|
1,062 |
|
Interest and debt expense |
|
|
22 |
|
|
|
60 |
|
|
|
1 |
|
|
|
4 |
|
|
|
|
|
|
|
87 |
|
Interest income |
|
|
(1 |
) |
|
|
(5 |
) |
|
|
(53 |
) |
|
|
|
|
|
|
|
|
|
|
(59 |
) |
Intercompany interest (income) expense |
|
|
(8 |
) |
|
|
1 |
|
|
|
(22 |
) |
|
|
29 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Other (income) expense, net |
|
|
3 |
|
|
|
(2 |
) |
|
|
1 |
|
|
|
(5 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(30 |
) |
|
|
(34 |
) |
|
|
1,049 |
|
|
|
73 |
|
|
|
(21 |
) |
|
|
1,037 |
|
Provision for (benefit from) income taxes |
|
|
(9 |
) |
|
|
(26 |
) |
|
|
403 |
|
|
|
22 |
|
|
|
|
|
|
|
390 |
|
Equity income from subsidiaries |
|
|
742 |
|
|
|
735 |
|
|
|
11 |
|
|
|
|
|
|
|
(1,488 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before extraordinary item |
|
|
721 |
|
|
|
727 |
|
|
|
657 |
|
|
|
51 |
|
|
|
(1,509 |
) |
|
|
647 |
|
Extraordinary item-gain on acquisition |
|
|
|
|
|
|
|
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
721 |
|
|
$ |
727 |
|
|
$ |
731 |
|
|
$ |
51 |
|
|
$ |
(1,509 |
) |
|
$ |
721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Statements of Cash Flows
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Six Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) operating activities |
|
$ |
402 |
|
|
$ |
184 |
|
|
$ |
(332 |
) |
|
$ |
105 |
|
|
$ |
(215 |
) |
|
$ |
144 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
(5 |
) |
|
|
|
|
|
|
(42 |
) |
|
|
(13 |
) |
|
|
|
|
|
|
(60 |
) |
Distribution from equity investees |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
10 |
|
|
|
|
|
|
|
9 |
|
Purchases of short-term investments |
|
|
|
|
|
|
(2 |
) |
|
|
(2,899 |
) |
|
|
(100 |
) |
|
|
|
|
|
|
(3,001 |
) |
Proceeds from short-term investments |
|
|
|
|
|
|
120 |
|
|
|
3,331 |
|
|
|
|
|
|
|
|
|
|
|
3,451 |
|
Net intercompany investments |
|
|
|
|
|
|
(260 |
) |
|
|
260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other, net |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1 |
) |
Intercompany notes receivable |
|
|
20 |
|
|
|
9 |
|
|
|
(346 |
) |
|
|
|
|
|
|
317 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
15 |
|
|
|
(134 |
) |
|
|
303 |
|
|
|
(103 |
) |
|
|
317 |
|
|
|
398 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(444 |
) |
|
|
|
|
|
|
(139 |
) |
|
|
(55 |
) |
|
|
194 |
|
|
|
(444 |
) |
Dividends paid on preferred stock |
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Repurchase of common stock |
|
|
(60 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(60 |
) |
Repayment of long-term debt |
|
|
(254 |
) |
|
|
(46 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(300 |
) |
Repayment of term loan |
|
|
(1,542 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,542 |
) |
Issuance of
long-term debt |
|
|
1,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,547 |
|
Deferred debt issuance cost |
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
Excess tax benefit from stock-based
compensation |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Intercompany notes payable |
|
|
297 |
|
|
|
|
|
|
|
1 |
|
|
|
19 |
|
|
|
(317 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing activities |
|
|
(490 |
) |
|
|
(46 |
) |
|
|
(138 |
) |
|
|
(36 |
) |
|
|
(102 |
) |
|
|
(812 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(73 |
) |
|
|
4 |
|
|
|
(167 |
) |
|
|
(34 |
) |
|
|
|
|
|
|
(270 |
) |
Cash and cash equivalents at beginning of period |
|
|
296 |
|
|
|
22 |
|
|
|
848 |
|
|
|
267 |
|
|
|
|
|
|
|
1,433 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
223 |
|
|
$ |
26 |
|
|
$ |
681 |
|
|
$ |
233 |
|
|
$ |
|
|
|
$ |
1,163 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) operating activities |
|
$ |
787 |
|
|
$ |
569 |
|
|
$ |
86 |
|
|
$ |
21 |
|
|
$ |
(1,360 |
) |
|
$ |
103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
|
|
|
|
|
|
|
|
(67 |
) |
|
|
(6 |
) |
|
|
|
|
|
|
(73 |
) |
Distribution from equity investees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
8 |
|
Purchases of short-term investments |
|
|
|
|
|
|
(3 |
) |
|
|
(2,963 |
) |
|
|
|
|
|
|
|
|
|
|
(2,966 |
) |
Proceeds from short-term investments |
|
|
|
|
|
|
|
|
|
|
3,621 |
|
|
|
|
|
|
|
|
|
|
|
3,621 |
|
Intercompany notes receivable |
|
|
(3,168 |
) |
|
|
(3,157 |
) |
|
|
7 |
|
|
|
|
|
|
|
6,318 |
|
|
|
|
|
Net intercompany investment |
|
|
(381 |
) |
|
|
219 |
|
|
|
(219 |
) |
|
|
381 |
|
|
|
|
|
|
|
|
|
Business acquisition |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,517 |
) |
|
|
|
|
|
|
(3,517 |
) |
Proceeds from sale of business |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
3 |
|
Other, net |
|
|
(2 |
) |
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
(3,551 |
) |
|
|
(2,941 |
) |
|
|
384 |
|
|
|
(3,131 |
) |
|
|
6,318 |
|
|
|
(2,921 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(368 |
) |
|
|
(611 |
) |
|
|
(728 |
) |
|
|
|
|
|
|
1,339 |
|
|
|
(368 |
) |
Dividends paid on preferred stock |
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21 |
|
|
|
|
|
Proceeds from exercise of stock options |
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3 |
|
Excess tax benefit from stock-based
compensation |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Repayments of long-term debt |
|
|
|
|
|
|
(190 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(190 |
) |
Issuance of long-term debt |
|
|
1,641 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641 |
|
Principal borrowings under term loan credit
facility |
|
|
1,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,550 |
|
Deferred debt issuance cost |
|
|
(48 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(48 |
) |
Intercompany notes payable |
|
|
(9 |
) |
|
|
3,169 |
|
|
|
(2 |
) |
|
|
3,160 |
|
|
|
(6,318 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
Net cash flows from (used in) financing
activities |
|
|
2,750 |
|
|
|
2,368 |
|
|
|
(730 |
) |
|
|
3,160 |
|
|
|
(4,958 |
) |
|
|
2,590 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(14 |
) |
|
|
(4 |
) |
|
|
(260 |
) |
|
|
50 |
|
|
|
|
|
|
|
(228 |
) |
Cash and cash equivalents at beginning of period |
|
|
227 |
|
|
|
33 |
|
|
|
1,043 |
|
|
|
30 |
|
|
|
|
|
|
|
1,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
213 |
|
|
$ |
29 |
|
|
$ |
783 |
|
|
$ |
80 |
|
|
$ |
|
|
|
$ |
1,105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
223 |
|
|
$ |
26 |
|
|
$ |
681 |
|
|
$ |
233 |
|
|
$ |
|
|
|
$ |
1,163 |
|
Short-term investments |
|
|
|
|
|
|
|
|
|
|
743 |
|
|
|
100 |
|
|
|
|
|
|
|
843 |
|
Accounts and other receivables, net |
|
|
5 |
|
|
|
3 |
|
|
|
72 |
|
|
|
30 |
|
|
|
|
|
|
|
110 |
|
Accounts receivable, related party |
|
|
|
|
|
|
|
|
|
|
42 |
|
|
|
6 |
|
|
|
|
|
|
|
48 |
|
Inventories |
|
|
|
|
|
|
|
|
|
|
816 |
|
|
|
241 |
|
|
|
(1 |
) |
|
|
1,056 |
|
Deferred income taxes |
|
|
5 |
|
|
|
|
|
|
|
808 |
|
|
|
22 |
|
|
|
|
|
|
|
835 |
|
Prepaid expenses and other current assets |
|
|
1 |
|
|
|
|
|
|
|
120 |
|
|
|
4 |
|
|
|
(6 |
) |
|
|
119 |
|
Short-term intercompany notes and
interest receivable |
|
|
82 |
|
|
|
101 |
|
|
|
444 |
|
|
|
|
|
|
|
(627 |
) |
|
|
|
|
Other intercompany receivables |
|
|
463 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(463 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
779 |
|
|
|
130 |
|
|
|
3,726 |
|
|
|
636 |
|
|
|
(1,097 |
) |
|
|
4,174 |
|
Property, plant and equipment, net |
|
|
5 |
|
|
|
|
|
|
|
946 |
|
|
|
113 |
|
|
|
|
|
|
|
1,064 |
|
Trademarks, net |
|
|
|
|
|
|
|
|
|
|
1,902 |
|
|
|
1,573 |
|
|
|
|
|
|
|
3,475 |
|
Goodwill |
|
|
|
|
|
|
|
|
|
|
5,303 |
|
|
|
2,872 |
|
|
|
|
|
|
|
8,175 |
|
Other intangibles, net |
|
|
|
|
|
|
|
|
|
|
207 |
|
|
|
|
|
|
|
|
|
|
|
207 |
|
Long-term intercompany notes |
|
|
2,140 |
|
|
|
234 |
|
|
|
810 |
|
|
|
|
|
|
|
(3,184 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
10,001 |
|
|
|
8,512 |
|
|
|
64 |
|
|
|
|
|
|
|
(18,577 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
79 |
|
|
|
31 |
|
|
|
418 |
|
|
|
36 |
|
|
|
(29 |
) |
|
|
535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
13,004 |
|
|
$ |
8,907 |
|
|
$ |
13,376 |
|
|
$ |
5,230 |
|
|
$ |
(22,887 |
) |
|
$ |
17,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement and related accruals |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,571 |
|
|
$ |
13 |
|
|
$ |
|
|
|
$ |
1,584 |
|
Accounts payable and other accrued liabilities |
|
|
644 |
|
|
|
6 |
|
|
|
968 |
|
|
|
79 |
|
|
|
(6 |
) |
|
|
1,691 |
|
Due to related party |
|
|
|
|
|
|
|
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
9 |
|
Deferred revenue, related party |
|
|
|
|
|
|
|
|
|
|
39 |
|
|
|
|
|
|
|
|
|
|
|
39 |
|
Current maturities of long-term debt |
|
|
|
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29 |
|
Short-term intercompany notes and interest
payable |
|
|
29 |
|
|
|
407 |
|
|
|
2 |
|
|
|
189 |
|
|
|
(627 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
39 |
|
|
|
420 |
|
|
|
5 |
|
|
|
(464 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
673 |
|
|
|
481 |
|
|
|
3,009 |
|
|
|
286 |
|
|
|
(1,097 |
) |
|
|
3,352 |
|
Intercompany notes |
|
|
768 |
|
|
|
|
|
|
|
3 |
|
|
|
2,413 |
|
|
|
(3,184 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,270 |
|
|
|
129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,399 |
|
Deferred income taxes |
|
|
|
|
|
|
|
|
|
|
542 |
|
|
|
574 |
|
|
|
(29 |
) |
|
|
1,087 |
|
Long-term retirement benefits (less current
portion) |
|
|
43 |
|
|
|
18 |
|
|
|
1,042 |
|
|
|
68 |
|
|
|
|
|
|
|
1,171 |
|
Other noncurrent liabilities |
|
|
33 |
|
|
|
91 |
|
|
|
269 |
|
|
|
11 |
|
|
|
|
|
|
|
404 |
|
Shareholders equity |
|
|
7,217 |
|
|
|
8,188 |
|
|
|
8,511 |
|
|
|
1,878 |
|
|
|
(18,577 |
) |
|
|
7,217 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
13,004 |
|
|
$ |
8,907 |
|
|
$ |
13,376 |
|
|
$ |
5,230 |
|
|
$ |
(22,887 |
) |
|
$ |
17,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
296 |
|
|
$ |
22 |
|
|
$ |
848 |
|
|
$ |
267 |
|
|
$ |
|
|
|
$ |
1,433 |
|
Short-term investments |
|
|
|
|
|
|
117 |
|
|
|
1,176 |
|
|
|
|
|
|
|
|
|
|
|
1,293 |
|
Accounts and other receivables, net |
|
|
4 |
|
|
|
3 |
|
|
|
70 |
|
|
|
30 |
|
|
|
|
|
|
|
107 |
|
Accounts receivable, related party |
|
|
|
|
|
|
|
|
|
|
51 |
|
|
|
11 |
|
|
|
|
|
|
|
62 |
|
Inventories |
|
|
|
|
|
|
|
|
|
|
910 |
|
|
|
246 |
|
|
|
(1 |
) |
|
|
1,155 |
|
Deferred income taxes |
|
|
3 |
|
|
|
1 |
|
|
|
768 |
|
|
|
21 |
|
|
|
|
|
|
|
793 |
|
Prepaid expenses and other current assets |
|
|
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 |
|
59
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Non-Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
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 |
|
|
472 |
|
|
|
|
|
|
|
4 |
|
|
|
2,400 |
|
|
|
(2,876 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,229 |
|
|
|
160 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,389 |
|
Deferred income taxes |
|
|
|
|
|
|
|
|
|
|
605 |
|
|
|
588 |
|
|
|
(26 |
) |
|
|
1,167 |
|
Long-term retirement benefits (less current
portion) |
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
60
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
The following is a discussion and analysis of RAIs business, initiatives, critical accounting
policies and its consolidated 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
compares the second quarter of 2007 with the second quarter of 2006 and the first six months of
2007 with the first six months of 2006. Disclosures related to liquidity and financial condition
complete managements discussion and analysis. You should read this discussion and analysis of
RAIs consolidated financial condition and results of operations in conjunction with the financial
information included in the condensed consolidated financial statements (unaudited).
Overview and Initiatives
RAIs operating subsidiaries include RJR Tobacco, Conwood, Santa Fe 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, PALL MALL, DORAL,
WINSTON and SALEM, are currently six of the ten best-selling brands of cigarettes in the United
States. Those brands, and its other brands, including 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 contract manufacturing of cigarettes and other tobacco products through
arrangements with BAT affiliates. Beginning January 1, 2007, the management and distribution of
DUNHILL and STATE EXPRESS 555 cigarette brands were transferred to RJR Tobacco from Lane.
RAIs other reportable 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. Beginning January 1, 2007, Conwood
began to distribute a variety of tobacco products manufactured by Lane, including WINCHESTER and
CAPTAIN BLACK little cigars, and BUGLER roll-your-own tobacco.
The disclosures classified as All Other include the total assets and results of operations of
Santa Fe and GPI. Santa Fe manufactures and markets cigarettes and other tobacco products under
the NATURAL AMERICAN SPIRIT brand. GPI manufactures and exports cigarettes to U.S. territories,
U.S. duty-free shops and U.S. overseas military bases, manages a contract manufacturing business
and, as of January 1, 2007, manages the international businesses of Conwood and Santa Fe.
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 RJR Tobaccos products if, and when,
wholesale and retail tobacco distributors adjust the timing of their 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.
61
RJR Tobaccos refined brand portfolio strategy took effect at the beginning of 2007, and
modified the three categories of brands to growth, support and non-support. The growth brands
consist of 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 consist of 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 consist of 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
Conwood offers a range of differentiated smokeless tobacco products to adult consumers.
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. The moist snuff category is
divided into premium and price-value brands. GRIZZLY, the nations largest price-value brand, led
to Conwoods increased share of the smokeless market. KODIAK is Conwoods leading premium brand.
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 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.
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. RAI is
combining 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.
Critical Accounting Policies
GAAP requires estimates and assumptions to be made that affect the reported amounts in RAIs
condensed consolidated financial statements and accompanying notes. Some of these estimates
require difficult, subjective and/or complex judgments about matters that are inherently uncertain,
and as a result, actual results could differ from those estimates. Due to the estimation processes
involved, the following summarized accounting policies 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 condensed consolidated financial statements (unaudited).
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 9 to condensed consolidated financial statements (unaudited), 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. Unfavorable judgments have been returned in a
number of tobacco-related cases and state enforcement actions. RJR Tobacco has paid approximately
$26 million since January 1, 2005, related to such unfavorable judgments, including pre-acquisition
contingencies related to the B&W business combination.
62
RAI and its subsidiaries believe, however, that they have valid bases for appeals in their
pending cases and have valid defenses to all actions, and they 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. No liability for pending
smoking and health tobacco litigation or smokeless tobacco litigation was recorded in RAIs
condensed consolidated financial statements (unaudited) as of June 30, 2007. As discussed in more
detail in note 9 to condensed consolidated financial statements (unaudited), 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 note 9 to condensed consolidated financial statements (unaudited), RJR
Tobacco, Santa Fe and Lane are participants in the MSA, and RJR Tobacco is a participant in other
state settlement agreements related to governmental health-care cost recovery actions. Their
obligations and the related expense charges under the MSA and other 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 CasesMSA and
Other State Settlement Agreements and MSAEnforcement and Validity in note 9 to condensed
consolidated financial statements (unaudited).
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. FIN No. 48, Accounting for Uncertainty in
Income Taxes, clarifies SFAS No. 109 by providing guidance for consistent reporting of uncertain
income tax positions recognized in a companys financial statements.
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 may cause
the effective rate to be adjusted. Additional tax, interest, and penalties associated with
uncertain tax positions are recognized in tax expense in each reporting period.
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 condensed
consolidated balance sheet (unaudited) will be realized. To the extent a deferred tax liability is
established under SFAS No. 109, it is recorded, tracked and, once it becomes currently due and
payable, paid to the taxing authorities.
The financial statements 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.
63
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
% |
|
|
|
2007 |
|
|
2006 |
|
|
Change |
|
|
2007 |
|
|
2006 |
|
|
Change |
|
Net sales:1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
2,061 |
|
|
$ |
2,111 |
|
|
|
(2.4 |
)% |
|
$ |
3,960 |
|
|
$ |
3,945 |
|
|
|
0.4 |
% |
Conwood |
|
|
174 |
|
|
|
72 |
|
|
NM3 |
|
|
329 |
|
|
|
100 |
|
|
NM3 |
All other |
|
|
113 |
|
|
|
108 |
|
|
|
4.6 |
% |
|
|
207 |
|
|
|
206 |
|
|
|
0.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
2,348 |
|
|
|
2,291 |
|
|
|
2.5 |
% |
|
|
4,496 |
|
|
|
4,251 |
|
|
|
5.8 |
% |
Cost of products sold1, 2 |
|
|
1,343 |
|
|
|
1,276 |
|
|
|
5.3 |
% |
|
|
2,518 |
|
|
|
2,441 |
|
|
|
3.2 |
% |
Selling, general and administrative expenses |
|
|
404 |
|
|
|
392 |
|
|
|
3.1 |
% |
|
|
797 |
|
|
|
734 |
|
|
|
8.6 |
% |
Amortization expense |
|
|
6 |
|
|
|
7 |
|
|
|
(14.3 |
)% |
|
|
12 |
|
|
|
14 |
|
|
|
(14.3 |
)% |
Operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
|
496 |
|
|
|
564 |
|
|
|
(12.1) |
% |
|
|
984 |
|
|
|
983 |
|
|
|
0.1 |
% |
Conwood |
|
|
90 |
|
|
|
32 |
|
|
NM3 |
|
|
170 |
|
|
|
37 |
|
|
NM3 |
All other |
|
|
35 |
|
|
|
39 |
|
|
|
(10.3 |
)% |
|
|
70 |
|
|
|
78 |
|
|
|
(10.3 |
)% |
Corporate expense |
|
|
(26 |
) |
|
|
(19 |
) |
|
|
36.8 |
% |
|
|
(55 |
) |
|
|
(36 |
) |
|
|
52.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
595 |
|
|
$ |
616 |
|
|
|
(3.4 |
)% |
|
$ |
1,169 |
|
|
$ |
1,062 |
|
|
|
10.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 Excludes excise taxes of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
492 |
|
|
$ |
532 |
|
|
|
|
|
|
$ |
940 |
|
|
$ |
997 |
|
|
|
|
|
Conwood |
|
|
5 |
|
|
|
3 |
|
|
|
|
|
|
|
9 |
|
|
|
4 |
|
|
|
|
|
All other |
|
|
32 |
|
|
|
34 |
|
|
|
|
|
|
|
74 |
|
|
|
68 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
529 |
|
|
$ |
569 |
|
|
|
|
|
|
$ |
1,023 |
|
|
$ |
1,069 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
See below for further information related to MSA settlement and federal
tobacco buyout expense included in cost of products sold. |
|
3 |
|
Percent change is not meaningful. |
RJR Tobacco
Net Sales
RJR Tobaccos net sales for the second quarter of 2007 decreased $50 million from the
comparable prior-year quarter, primarily due to a decrease in total volume of $157 million
partially offset by higher pricing and lower discounting. For the first six months of 2007, RJR
Tobaccos net sales increased $15 million due to higher pricing coupled with lower discounting,
mostly offset by a $219 million decrease in volume. The volume declines in the comparative periods
were primarily due to inventory builds at wholesale during the second quarter of 2006 in
preparation for an RJR Tobacco system conversion on June 30, 2006. 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.
Domestic shipment volume, in billions of units for RJR Tobacco and the industry, were as
follows1:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
Six Months Ended June 30, |
|
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
Growth brands: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter |
|
|
6.6 |
|
|
|
6.3 |
|
|
|
5.4 |
% |
|
|
12.2 |
|
|
|
11.6 |
|
|
|
5.1 |
% |
KOOL |
|
|
3.0 |
|
|
|
3.1 |
|
|
|
(4.8 |
)% |
|
|
5.6 |
|
|
|
5.9 |
|
|
|
(4.9 |
)% |
PALL MALL |
|
|
1.9 |
|
|
|
1.8 |
|
|
|
3.1 |
% |
|
|
3.5 |
|
|
|
3.3 |
|
|
|
7.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11.4 |
|
|
|
11.2 |
|
|
|
2.2 |
% |
|
|
21.4 |
|
|
|
20.8 |
|
|
|
2.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support brands |
|
|
10.7 |
|
|
|
11.8 |
|
|
|
(9.7 |
)% |
|
|
20.7 |
|
|
|
22.3 |
|
|
|
(7.0 |
)% |
Non-support brands |
|
|
3.8 |
|
|
|
5.0 |
|
|
|
(22.6 |
)% |
|
|
7.5 |
|
|
|
9.5 |
|
|
|
(20.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
26.0 |
|
|
|
28.0 |
|
|
|
(7.2 |
)% |
|
|
49.6 |
|
|
|
52.6 |
|
|
|
(5.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
Six Months Ended June 30, |
|
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
Total premium |
|
|
16.3 |
|
|
|
17.1 |
|
|
|
(5.1 |
)% |
|
|
30.9 |
|
|
|
32.2 |
|
|
|
(3.8 |
)% |
Total value |
|
|
9.7 |
|
|
|
10.8 |
|
|
|
(10.5 |
)% |
|
|
18.7 |
|
|
|
20.4 |
|
|
|
(8.6 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
26.0 |
|
|
|
28.0 |
|
|
|
(7.2 |
)% |
|
|
49.6 |
|
|
|
52.6 |
|
|
|
(5.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry2: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium |
|
|
68.0 |
|
|
|
70.0 |
|
|
|
(2.9 |
)% |
|
|
128.8 |
|
|
|
133.7 |
|
|
|
(3.7 |
)% |
Value |
|
|
25.1 |
|
|
|
27.1 |
|
|
|
(7.6 |
)% |
|
|
47.5 |
|
|
|
52.0 |
|
|
|
(8.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
93.1 |
|
|
|
97.1 |
|
|
|
(4.2 |
)% |
|
|
176.2 |
|
|
|
185.6 |
|
|
|
(5.1 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 Management Science Associates, Inc.,
referred to as MSAi. Prior year amounts have been restated to reflect current
methodology. |
RJR Tobaccos total domestic shipment volume decreased 7.2% and 5.7% in the second
quarter and first six months of 2007, respectively, compared with prior-year periods. This
decrease reflects the second quarter 2006 wholesale inventory build of approximately 1 billion
units in preparation of RJR Tobaccos SAP enterprise business system conversion along with declines
in current consumption, or current retail sales to consumers. RJR Tobaccos full-year 2007
shipment volume decline is expected to be approximately 4%. The expected overall
domestic industry consumption decline is approximately 3%.
Shipments in the premium tier increased to 62.6% of RJR Tobaccos total domestic shipments
during the second quarter of 2007 compared with 61.2% in the prior-year quarter. For the first six
months, premium tier shipments as a percentage of total shipments were 62.4% in 2007 and 61.2% in
2006. These increases were driven by CAMEL with the introduction of CAMEL No. 9 and CAMEL
Signature during the first half of 2007. The domestic industrys premium shipments increased to
73.1% for the three months ended June 30, 2007, from 72.1% of total shipments for the three months
ended June 30, 2006. For the first six months, premium tier shipments as a percentage of total
shipments were 73.1% in 2007 and 72.0% in 2006.
The shares of RJR Tobacco as a percentage of total share of U.S. retail cigarette sales
according to data1 from Information Resources, Inc./Capstone Research Inc., collectively
referred to as IRI, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended2 |
|
|
|
|
|
|
June 30, |
|
March 31, |
|
Share Point |
|
June 30, |
|
Share Point |
|
|
2007 |
|
2007 |
|
Change |
|
2006 |
|
Change |
Growth brands: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter |
|
|
7.82 |
% |
|
|
7.39 |
% |
|
|
0.43 |
|
|
|
7.34 |
% |
|
|
0.49 |
|
KOOL |
|
|
3.07 |
% |
|
|
3.20 |
% |
|
|
(0.13 |
) |
|
|
3.11 |
% |
|
|
(0.03 |
) |
PALL MALL |
|
|
2.09 |
% |
|
|
2.04 |
% |
|
|
0.05 |
|
|
|
1.92 |
% |
|
|
0.18 |
|
Total growth brands |
|
|
12.99 |
% |
|
|
12.63 |
% |
|
|
0.36 |
|
|
|
12.36 |
% |
|
|
0.63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support brands |
|
|
11.67 |
% |
|
|
11.99 |
% |
|
|
(0.32 |
) |
|
|
12.10 |
% |
|
|
(0.43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-support brands |
|
|
4.49 |
% |
|
|
4.79 |
% |
|
|
(0.30 |
) |
|
|
5.33 |
% |
|
|
(0.84 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
29.14 |
% |
|
|
29.41 |
% |
|
|
(0.27 |
) |
|
|
29.79 |
% |
|
|
(0.64 |
) |
|
|
|
1 |
|
Retail share of U.S. cigarette sales data is included in this document because
it is used by RJR Tobacco primarily as an indicator of the relative performance of industry
participants and brands and market trends. You should not rely on the market share data
reported by IRI as being a precise measurement of actual market share because IRI is not able
to effectively track all volume. Moreover, you should be aware that in a product market
experiencing overall declining consumption, a particular product can experience increasing
market share relative to competing products, yet still be subject to declining consumption
volumes. |
|
2 |
|
Amounts presented in this table are rounded on an individual basis and,
accordingly, may not sum on an aggregate basis. |
The retail share of market of CAMELs filtered styles increased 0.43 share points in the
second quarter of 2007 from the prior quarter and 0.49 share points from the second quarter of
2006. CAMEL continues to focus on brand innovation particularly in the menthol category. In
February 2007, CAMEL introduced CAMEL No. 9 in regular and
65
menthol styles designed to appeal to adult female smokers. CAMEL No. 9 has been well received
and currently has a market share of almost a half point. KOOLs
market share in the second quarter of
2007 was relatively stable compared with the prior quarter and prior-year period. KOOL has been
providing innovative products such as KOOL XL, the smoother and wider cigarette introduced in late
2006 and, most recently, a milder style KOOL XL Blue. Both KOOL XL and KOOL XL Blue will be
expanded to national distribution during 2007. PALL MALLs market share continues to grow, gaining
0.05 share points in the second quarter of 2007 over the first quarter of 2007 and 0.18 share points
over the comparable quarter of 2006. PALL MALL offers a longer-lasting cigarette with a premium
heritage at a less-than-premium price. During the second quarter of 2007, PALL MALL ultra lights
were available in a bright, distinctive packaging design.
The combined share of market of RJR Tobaccos growth brands during the first half of 2007
showed improvement over the comparative prior-year period. However, as expected, the decline in
share of support and non-support brands more than offset the gains on the growth brands.
Operating Income
RJR Tobaccos operating income for the second quarter of 2007 decreased $68 million to $496
million, or 24.1% of net sales, from $564 million, or 26.7% of net sales, in the comparable
prior-year quarter. For the first six months, operating income was stable at $984 million, or
24.8% of net sales, in 2007 compared with $983 million, or 24.9% of net sales, in 2006. Increased
MSA settlement payments and volume declines were partially offset by improvements in pricing,
product mix, productivity and pension expense during 2007.
RJR Tobaccos MSA settlement and federal tobacco buyout expenses, included in cost of products
sold, are detailed in the schedule below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months |
|
|
For The Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Settlement |
|
$ |
743 |
|
|
$ |
699 |
|
|
$ |
1,410 |
|
|
$ |
1,315 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tobacco quota buyout |
|
|
70 |
|
|
|
66 |
|
|
|
138 |
|
|
|
131 |
|
Federal quota tobacco stock liquidation
assessment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total quota buyout expense |
|
$ |
70 |
|
|
$ |
66 |
|
|
$ |
138 |
|
|
$ |
122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MSA and other state settlement expenses are expected to be approximately $2.9 billion in 2007,
subject to adjustment for changes in volume and other factors, and the federal tobacco quota buyout
is expected to be approximately $260 million in 2007. For additional information, see
Governmental Health-Care Cost Recovery Cases MSA and Other State Settlement Agreements in note
9 to condensed consolidated financial statements (unaudited) and -Governmental Activity below.
Selling, general and administrative expenses include the costs of litigating and administering
product liability claims, as well as other legal expenses. For the quarters ended June 30, 2007
and 2006, RJR Tobaccos product liability defense costs were $23 million and $30 million,
respectively. For the six-month periods ended June 30, 2007 and 2006, RJR Tobaccos product
liability defense costs were $51 million and $57 million, respectively.
Product liability cases generally include the following types of smoking and health related
cases:
|
|
|
Individual Smoking and Health; |
|
|
|
|
Engle Progeny; |
|
|
|
|
Flight Attendant ETS (Broin II); |
|
|
|
|
Class Actions; |
|
|
|
|
Governmental Health-Care Cost Recovery; and |
66
|
|
|
Other Health-Care Cost Recovery and Aggregated Claims. |
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 ResearchU.S.A. |
Numerous factors affect the amount of product liability defense costs. The most important
factors are the number of cases pending and the number of cases in trial or in preparation for
trial (that is, with active discovery and motions practice). See Litigation Affecting the
Cigarette IndustryOverview in note 9 to condensed consolidated financial statements (unaudited)
for detailed information regarding the number and type of cases pending, and Litigation Affecting
the Cigarette IndustryScheduled Trials in note 9 for detailed information regarding the number
and nature of cases in trial and scheduled for trial through June 30, 2008.
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
IndustryEngle Progeny Cases and Litigation Affecting the Cigarette IndustryClass Action
SuitsEngle Case in note 9 to the condensed consolidated financial statements (unaudited) 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
Net Sales
Conwoods net sales for the second quarter and first half of 2007 were $174 million and $329
million, respectively, compared with $72 million and $100 million in the second quarter and first
half of 2006, respectively. The Conwood acquisition occurred on May 31, 2006, and consequently,
the RAI condensed consolidated statements of income (unaudited) include only the results of
operations of Conwood subsequent to May 31, 2006. Additionally, for segment reporting purposes,
comparative results of Lane operations that were transferred to
Conwood on January 1, 2007, have been reclassified.
The shares of Conwoods moist snuff products and volume discussion presented below include
periods prior to the acquisition by RAI for enhanced analysis. The shipment volume, in millions of
cans, for Conwood was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
For the Six Months Ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
June 30, |
|
|
|
June 30, |
|
June 30, |
|
|
|
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
KODIAK |
|
|
14.2 |
|
|
|
14.9 |
|
|
|
(5.2 |
)% |
|
|
27.0 |
|
|
|
28.7 |
|
|
|
(5.9 |
)% |
Other |
|
|
0.9 |
|
|
|
0.9 |
|
|
|
(6.3 |
)% |
|
|
1.6 |
|
|
|
1.8 |
|
|
|
(9.3 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15.0 |
|
|
|
15.9 |
|
|
|
(5.3 |
)% |
|
|
28.6 |
|
|
|
30.5 |
|
|
|
(6.1 |
)% |
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
For the Six Months Ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
June 30, |
|
|
|
June 30, |
|
June 30, |
|
|
|
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
Price-value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GRIZZLY |
|
|
59.2 |
|
|
|
50.6 |
|
|
|
17.1 |
% |
|
|
113.5 |
|
|
|
95.2 |
|
|
|
19.2 |
% |
Other |
|
|
0.4 |
|
|
|
0.8 |
|
|
|
(45.6 |
)% |
|
|
1.0 |
|
|
|
1.6 |
|
|
|
(36.5 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59.7 |
|
|
|
51.4 |
|
|
|
16.1 |
% |
|
|
114.5 |
|
|
|
96.9 |
|
|
|
18.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total moist snuff |
|
|
74.7 |
|
|
|
67.2 |
|
|
|
11.1 |
% |
|
|
143.2 |
|
|
|
127.3 |
|
|
|
12.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 data1 processed by MSAi, were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
March 31, |
|
Share Point |
|
June 30, |
|
Share Point |
|
|
2007 |
|
2007 |
|
Change |
|
2006 |
|
Change |
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
KODIAK |
|
|
4.61 |
% |
|
|
4.55 |
% |
|
|
0.06 |
|
|
|
5.23 |
% |
|
|
(0.62 |
) |
Other |
|
|
0.29 |
% |
|
|
0.30 |
% |
|
|
(0.01 |
) |
|
|
0.35 |
% |
|
|
(0.05 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.90 |
% |
|
|
4.85 |
% |
|
|
0.05 |
|
|
|
5.58 |
% |
|
|
(0.68 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Price-value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GRIZZLY |
|
|
20.64 |
% |
|
|
20.57 |
% |
|
|
(0.07 |
) |
|
|
18.74 |
% |
|
|
1.90 |
|
Other |
|
|
0.19 |
% |
|
|
0.22 |
% |
|
|
(0.03 |
) |
|
|
0.26 |
% |
|
|
(0.07 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20.83 |
% |
|
|
20.79 |
% |
|
|
0.04 |
|
|
|
19.00 |
% |
|
|
1.83 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total moist snuff |
|
|
25.73 |
% |
|
|
25.64 |
% |
|
|
0.09 |
|
|
|
24.58 |
% |
|
|
1.15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 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. |
GRIZZLY, Conwoods leading price-value moist snuff brand, had a share position of 20.64%
of the moist snuff market in the second quarter of 2007: an increase
of 0.07 points from the prior quarter and up 1.90 points from the second quarter of 2006. In the second quarter of 2007, Conwood
completed its national roll-out of GRIZZLY Long-Cut Natural. The retail market share of KODIAK,
Conwoods leading premium moist snuff brand, was adversely impacted in the second quarter of 2007
compared with the prior-year period by competitive discounting and timing of competitive
promotional shipments. KODIAK experienced modest growth in retail market share from the prior
quarter due to the timing of promotions.
Operating Income
Conwoods operating income for the second quarter of 2007 increased to $90 million, or 51.7%
of net sales, from $32 million, or 44.4% of net sales, in the comparable prior-year quarter.
Operating income for the first six months of 2007 was $170 million, or 51.7% of net sales, compared
with $37 million, or 37.0% of net sales, for the first six months of 2006.
RAI Consolidated
Interest and debt expense was $87 million during the three-month period, and $176 million for
the six months, ended June 30, 2007, an increase of $35 million and $89 million, respectively, from
the comparable prior-year periods. These increases from the prior-year periods are primarily due
to higher debt balances, resulting from the debt incurred by RAI to fund the Conwood acquisition in
May 2006.
Other expense (income) net was expense of $16 million for the second quarter of 2007 and
expense of $15 million for the six months ended June 30, 2007, primarily due to the expensing of
unamortized debt fees associated with
68
the term loan that RAI pre-paid in full in June 2007. For each of the comparable periods for
2006, other income was $3 million consisting primarily of foreign exchange gain.
Provision for income taxes was $191 million, or an effective rate of 37.1% in the second
quarter of 2007 compared with $223 million or 37.8% in the second quarter of 2006. The provision
for income taxes for the first half of 2007 was $387 million, or an effective rate of 37.2%,
compared with $390 million, or an effective rate of 37.6%, in the first half of 2006. The
effective tax rates exceeded the federal statutory rate of 35% primarily due to the impact of state
taxes and certain non-deductible items, offset by the estimated domestic production credit of the
American Jobs Creation Act, enacted on October 22, 2004. The 2006 provision was impacted by the
nondeductibility of certain expenditures relating to ballot initiatives, state taxes and other
nondeductible items, partially offset by the resolution of certain prior years tax matters that
resulted in a reduction of income tax expense of $9 million.
Extraordinary items included a gain of $1 million in the second quarter of 2007 and $9 million
for the second quarter of 2006, related to the 2000 acquisition of RJRs former parent, NGH,
primarily from settlement of tax matters. Including this adjustment, the net after-tax gain on the
acquisition of NGH was $1.8 billion. Year-to-date extraordinary gains attributable to the
aforementioned tax matters were $1 million in 2007 and $74 million in 2006.
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.
The following contractual obligations have changed from those reported in RAIs 2006 Annual
Report on Form 10-K filed on February 27, 2007 and are updated as of June 30, 2007 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
Less than 1 |
|
|
1-3 Years |
|
|
4-5 Years |
|
|
|
|
|
|
Total |
|
|
Year-2007 |
|
|
2008-2009 |
|
|
2010-2011 |
|
|
Thereafter |
|
RAI Credit Facilities(1) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Long term notes, exclusive of interest (1) |
|
|
4,428 |
|
|
|
29 |
|
|
|
199 |
|
|
|
699 |
|
|
|
3,501 |
|
Interest
payments related to long-term notes and RAI Credit Facility(1) |
|
|
2,973 |
|
|
|
156 |
|
|
|
614 |
|
|
|
563 |
|
|
|
1,640 |
|
Purchase obligations(2) |
|
|
1,266 |
|
|
|
246 |
|
|
|
386 |
|
|
|
213 |
|
|
|
421 |
|
Gross unrecognized tax benefits (3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash obligations |
|
$ |
8,667 |
|
|
$ |
431 |
|
|
$ |
1,199 |
|
|
$ |
1,475 |
|
|
$ |
5,562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
For more information about RAIs long-term notes and
credit facilities, see Debt below and notes 6 and 7
to condensed consolidated financial statements
(unaudited). |
|
(2) |
|
Purchase obligations include commitments to acquire
tobacco leaf. The major component 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 9 to condensed consolidated financial
statements (unaudited) for additional information on the
DeLoach case. |
|
(3) |
|
Gross unrecognized tax benefits of $158 million relate to the adoption of FIN No.
48. For more information, see note 5 to condensed
consolidated financial statements (unaudited). Due to
inherent uncertainties regarding the timing of the payment
of these amounts, RAI cannot reasonably estimate the
payment period. |
69
Cash Flows
Net cash flows from operating activities were $144 million in the first six months of 2007,
compared with net cash flows from operating activities of $103 million in the first six months of
2006. This change is primarily due to advanced collections on certain accounts receivables by
customers who elected RJR Tobaccos terms in April 2007. Net cash flows for the first half of 2007
also benefited from the classification of certain book overdrafts as accounts payable, reflecting
changes in certain banking arrangements. Partially offsetting the increases were higher pension
funding, as well as an increase in accrued income tax in 2007 due to
a change in the timing of tax payments.
Net cash flows from investing activities were $398 million in the first six months of 2007,
compared with net cash flows used in investing activities of $2.9 billion in the prior-year period.
This change is primarily driven by the acquisition of Conwood in 2006.
Net cash flows used in financing activities were $812 million in the first six months of 2007,
compared with net cash flows provided by financing activities of $2.6 billion in the prior-year
period. This change is due to prior year RAI debt issuance and term
loan indebtedness.
Stock Repurchases
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 and the exercise of previously granted options under the LTIP. Due to RAIs incorporation
in North Carolina, which does not recognize treasury shares, the shares repurchased are cancelled
at the time of repurchase. RAI also 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 LTIP. During the first six months of 2007, RAI repurchased and
cancelled 989,825 shares of its common stock at an aggregate cost of $60 million.
Dividends
On May 11, 2007, RAIs Board of Directors declared a quarterly cash dividend of $0.75 per
common share. The dividend was paid on July 2, 2007, to shareholders of record as of June 11,
2007.
On July 24, 2007, the RAI Board of Directors declared a quarterly cash dividend of $0.85 per
common share, a more than 13% increase. The dividend will be paid on October 1, 2007, to shareholders of record as of
September 10, 2007. On an annualized basis, the increased dividend rate is $3.40 per common share.
The dividend reflects RAIs dividend 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 cash capital expenditures were $60 million for the first six
months of 2007, compared with $73 million for the first six months of 2006. The decrease in 2007
is primarily due to 2006 expenditures related to the implementation of an SAP enterprise business
system and the purchase of a previously leased aircraft. RAIs operating subsidiaries plan to
spend an additional $130 million to $140 million for capital expenditures during the remainder of
2007, funded primarily by cash flows from operations. The majority of capital spending will be
done in the RJR Tobacco segment. In addition, capital expenditures planned for 2007 include the
expansion of a Conwood manufacturing facility expected to be completed in 2008. 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 June 30, 2007.
Debt
Credit Facility
On June 28, 2007, RAI entered into a Fifth Amended and Restated Credit Agreement, which
provides for a five-year, $550 million senior secured revolving credit facility, which may be
increased to $900 million at the discretion of the lenders upon the request of RAI. The credit
agreement amends and restates RAIs prior agreement dated May 31, 2006.
70
RAI is able to use the revolving credit facility for borrowings and issuances of letters of
credit, at its option. RAI is required to pay a commitment fee ranging from 0.25% to 1.00% per
annum on the unused portion of the revolving credit facility. Borrowings under the RAI credit
facility 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. At June 30, 2007, RAI had $24 million
in letters of credit outstanding under its revolving credit facility. No borrowings were
outstanding, and the remaining $526 million of the revolving credit facility was available for
borrowing.
The RAI credit facility has 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.
RAIs material domestic subsidiaries guarantee RAIs obligations under the credit facility.
These guarantors also generally have pledged substantially all of their assets to secure these
obligations. RAI has pledged substantially all of its assets, including the stock of its direct
subsidiaries, to secure its obligations under the credit facility. The collateral for the credit
facility generally will be released automatically in certain circumstances, including at such time,
if any, as RAI obtains an investment grade corporate credit rating with not worse than stable
outlooks by each of Moodys and S&P. See note 7 to the condensed consolidated financial
statements (unaudited) for additional information related to RAIs credit facility.
Long-Term Debt
As of June 30, 2007, RAI had outstanding senior secured notes in the aggregate principal
amount of $4.3 billion with maturity dates ranging from 2009 to 2037. As of June 30, 2007, RJR had
outstanding unsecured notes in the aggregate principal amount of $158 million, with maturity dates
ranging from 2007 to 2015. For more information regarding RAIs and RJRs long-term debt, see note
7 to the condensed consolidated financial statements (unaudited).
On June 21, 2007, RAI completed the sale of $1.55 billion in aggregate principal amount of
senior, secured notes, consisting of $400 million of floating rate notes due June 15, 2011, $700
million of 6.75% notes due June 15, 2017 and $450 million of 7.25% notes due June 15, 2037. These
notes were sold under RAIs shelf registration statement filed with the SEC on June 18, 2007. The
net proceeds from the offering, together with available cash, were used to prepay in full the
principal balance of $1.54 billion of a term loan, together with accrued and unpaid interest, which
indebtedness was incurred in connection with the Conwood acquisition.
In June 2007, $46 million of RJR notes matured and were paid off leaving $158 million of RJR
notes outstanding as of June 30, 2007.
The Guarantors of RAIs amended credit agreement also guarantee RAIs senior secured notes.
RAIs senior secured notes are secured by a pledge of the stock, indebtedness and other obligations
of RJR Tobacco owned by or owed to RAI or any restricted subsidiary, as defined in the indenture
governing the notes. Such notes also are secured by any principal property of RAI and any
Guarantor that is a restricted subsidiary. Santa Fe and Lane are excluded from the definition of
restricted subsidiary. These assets constitute a portion of the security for the obligations of
RAI and the Guarantors under the amended credit agreement. If these assets are no longer pledged
as security for the obligations of RAI and the Guarantors under the amended credit agreement, 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 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.
As of June 30, 2007, Moodys corporate credit rating of RAI was Ba1, positive outlook, and
S&Ps rating was BB+, 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 lowering of, such ratings
would not have a material adverse impact on RAIs cash flows.
At its option, RAI and RJR, as applicable, may redeem any or all of their outstanding fixed
rate notes, in whole or in part at any time, subject to the payment of a make-whole premium. The
floating rate notes are redeemable at par after 18 months.
71
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
certain 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 June 30, 2007.
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:
|
|
|
significantly increase their taxes on tobacco products; |
|
|
|
|
restrict displays, advertising and sampling of tobacco products; |
|
|
|
|
establish ignition propensity standards for cigarettes; |
|
|
|
|
raise the minimum age to possess or purchase tobacco products; |
|
|
|
|
restrict or ban the use of certain flavorings in tobacco products; |
|
|
|
|
require the disclosure of ingredients used in the manufacture of tobacco products; |
|
|
|
|
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; |
|
|
|
|
impose restrictions on smoking in public and private areas; and |
|
|
|
|
restrict the sale of tobacco products directly to consumers or other unlicensed
recipients, including over the Internet. |
In addition, during 2007, the U.S. Congress is considering regulation of the manufacture and
sale of tobacco products by the FDA, and a further increase in the federal excise tax on cigarettes
and other tobacco products. The U.S. Congress also may consider legislation regarding:
|
|
|
regulation of environmental tobacco smoke; |
|
|
|
|
additional warnings on tobacco packaging and advertising; |
|
|
|
|
reduction or elimination of the tax deductibility of advertising expenses; |
|
|
|
|
implementation of a national standard for fire-safe cigarettes; |
|
|
|
|
regulation of the retail sale of tobacco products over the Internet and in other
non-face-to-face retail transactions, such as by mail order and telephone; and |
|
|
|
|
banning of the delivery of tobacco products by the U.S. Postal Service. |
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 U.S. Senate Health, Education, Labor and
Pensions Committee approved the FDA regulation bill on August 1,
2007. 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
regulations 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. At this time, RAI does not know whether FDA
regulation over tobacco products will be approved by the balance of
Congress or signed into law by the President.
72
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 currently $0.39. The U.S. Senate Finance Committee has approved
an excise tax per pack increase on cigarettes of $0.61 and proportional increases on other tobacco
products to fund expansion of the State Childrens Health Insurance Program, referred to as SCHIP.
The U.S. House of Representatives has
approved its version of SCHIP, which
included an excise tax per pack increase on cigarettes of $0.45 and proportional increases on other
tobacco products. At this time, RAI does not know whether any excise
tax increase will be approved by the
balance of Congress and signed into law by the President. The
adoption of any such increase could have a material adverse effect on
the business or results of operations of RJR Tobacco.
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. As of June 30, 2007, the
weighted average state cigarette excise tax per pack, calculated on a 12-month rolling average
basis, was approximately $0.886, an increase compared with the 12-month rolling average of $0.778
as of June 30, 2006. As of August 1, 2007, six states have increased their excise tax per pack
this year. In addition, a number of other states are considering an increase in their excise
taxes. Certain city and county governments, such as New York and Chicago, also impose substantial
excise taxes on cigarettes sold in those jurisdictions.
Cigars are generally taxed on an ad valorem basis, ranging from 3% in North Carolina to 75% in
Alaska and Washington. Other states have unit-based tax schemes for cigars or tax little cigars the
same as cigarettes.
The federal excise tax on smokeless tobacco products 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, and the Commonwealth of
Pennsylvania, which currently levies no tax on other tobacco products, is considering one during
its current legislative session. As of June 30, 2007, 39 states taxed moist snuff, and 46 states
taxed chewing tobacco, on an ad valorem basis at rates that range from 3% in North Carolina to 90%
in Massachusetts. Other states have a unit tax or a weight based tax. Since the beginning of
2006, four states have changed their tax on moist snuff from an ad valorem tax to a weight-based
tax. In addition, legislation to convert from an ad valorem to a weight-based tax also has been
introduced in approximately 19 other states.
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. Both the CAPTAIN BLACK and WINCHESTER little cigar brands manufactured by Lane,
which are classified and sold as little cigars, 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 TTB now is
considering written comments that were received prior to the March 26, 2007 deadline.
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. As of July 13, 2007, 19 states in addition to New York
have enacted fire-safe legislation of their own, adopting the same testing standard set forth in
the OFPC regulations described above. 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.
In July, 2007, the State of Maine became the first state to enact a statute that prohibits the
sale of cigarettes and cigars that have a characterizing flavor. The legislation defines
characterizing flavor as a distinguishable taste or aroma that is imparted to tobacco or tobacco
smoke either prior to or during consumption, other than a taste or aroma from tobacco, menthol,
clove, coffee, nuts or peppers. On October 11, 2006, RJR Tobacco entered into an agreement with
the States Attorneys Generals whereby it agreed not to use fruit, candy or alcoholic terms in its
advertising or
73
packaging of cigarette products other than in adult-only facilities. In contrast to this
agreement, the Maine statute does not address the marketing or advertising, but focuses on the
content of the product. Similar legislation has been filed in other states.
Forty-two 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.
It is not possible to determine what additional federal, state or local legislation or
regulations relating to smoking, cigarettes or smokeless tobacco products will be enacted or to
predict the effect of such new legislation or regulations, but any new legislation or regulations
could have an adverse effect on RJR Tobacco, Conwood, the cigarette industry or the smokeless
tobacco industry, as the case may be.
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. 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 condensed consolidated financial statements (unaudited)
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
74
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 2002, R. J. Reynolds Tobacco C. V., an indirect wholly owned subsidiary of RAI and referred
to as RJRTCV, and an affiliate of Gallaher Group Plc, referred to as Gallaher, formed a joint
venture, with each party owning a 50% membership interest. The joint venture, R. J.
Reynolds-Gallaher International Sarl, markets American-blend cigarettes primarily in Italy, France
and Spain.
On April 18, 2007, an affiliate of Japan Tobacco Inc. acquired Gallaher, and Gallaher
subsequently notified RJRTCV that the acquisition constituted a change of control of Gallaher
within the meaning of the joint venture agreement, wherein RJRTCV may elect to terminate the joint
venture prior to its expiration date. On May 15, 2007, RJRTCV notified the other member of the
joint venture that RJRTCV had exercised its termination right, effective November 30, 2007. Unless
the members agree otherwise, the joint venture will no longer conduct any business and will be
liquidated following its termination.
Upon a termination of the joint venture, the value of generally all of the trademarks each
joint venture member or its affiliate has licensed to the joint venture will be calculated. The
party whose licensed trademarks have the greater value will be required to pay the other party an
amount equal to one-half of the difference between the value of the parties respective trademarks.
RJRTCV believes that the current value of the trademarks licensed to the joint venture by
Gallahers affiliate is materially greater than that of the trademarks licensed to the joint
venture by RJRTCVs affiliate. The value of the trademarks and the resulting termination amount are
not yet known, and will be determined in accordance with the valuation procedures set forth in the
parties agreement. Under certain circumstances, a dispute relating to the parties agreement may
be submitted to binding arbitration for resolution.
For information relating to other contingencies and guarantees of RAI, RJR and RJR Tobacco,
see Other Contingencies and Guarantees in note 9 to condensed consolidated financial statements
(unaudited).
Off-Balance Sheet Arrangements
RAI has no off-balance sheet arrangements that have or are reasonably likely to have a current
or future material effect on its financial position, results of operations, liquidity, capital
expenditures or capital resources.
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:
|
|
|
the substantial and increasing regulation and taxation of tobacco products; |
|
|
|
|
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; |
|
|
|
|
the substantial payment obligations and limitations on the advertising and
marketing of cigarettes under the MSA and other state settlement agreements; |
|
|
|
|
the continuing decline in volume in the domestic cigarette industry; |
|
|
|
|
concentration of a material amount of sales with a single customer or distributor; |
75
|
|
|
competition from other manufacturers, including any new entrants in the marketplace; |
|
|
|
|
increased promotional activities by competitors, including deep-discount cigarette brands; |
|
|
|
|
the success or failure of new product innovations and acquisitions; |
|
|
|
|
the responsiveness of both the trade and consumers to new products, marketing
strategies and promotional programs; |
|
|
|
|
the ability to achieve efficiencies in manufacturing and distribution
operations without negatively affecting sales; |
|
|
|
|
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; |
|
|
|
|
the effect of market conditions on foreign currency exchange rate risk,
interest rate risk and the return on corporate cash; |
|
|
|
|
any adverse effects resulting from dependence on certain single-source
suppliers, including supply interruption or quality issues; |
|
|
|
|
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; 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.
76
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact the consolidated financial position,
results of operations and cash flows due to adverse changes in financial market prices and rates.
RAI and its subsidiaries are exposed to interest rate risk directly related to their normal
investing and funding activities. In addition, RAI and its subsidiaries have exposure to foreign
currency exchange rate risk concerning obligations for, and service agreements related to, foreign
operations denominated in Euros, British pounds, Swiss francs and Japanese yen. 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 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 June 30, 2007,
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 |
|
$ |
191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
191 |
|
|
$ |
191 |
|
Average Interest Rate |
|
|
5.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.8 |
% |
|
|
|
|
Variable Rate |
|
$ |
1,815 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,815 |
|
|
$ |
1,815 |
|
Average Interest Rate |
|
|
5.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.2 |
% |
|
|
|
|
Debt |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Rate |
|
$ |
29 |
|
|
|
|
|
|
$ |
200 |
|
|
$ |
300 |
|
|
|
|
|
|
$ |
3,510 |
|
|
$ |
4,039 |
|
|
$ |
4,181 |
|
Average Interest Rate 2 |
|
|
8.7 |
% |
|
|
|
|
|
|
7.9 |
% |
|
|
6.5 |
% |
|
|
|
|
|
|
7.3 |
% |
|
|
7.3 |
% |
|
|
|
|
Variable Rate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
400 |
|
|
|
|
|
|
$ |
400 |
|
|
$ |
400 |
|
Average Interest Rate 2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.0 |
% |
|
|
|
|
|
|
6.0 |
% |
|
|
|
|
Swaps
Notional Amount 3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,600 |
|
|
$ |
1,600 |
|
|
$ |
4 |
|
Average Variable Interest Pay
Rate2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.9 |
% |
|
|
6.9 |
% |
|
|
|
|
Average Fixed Interest Receive
Rate2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7.1 |
% |
|
|
7.1 |
% |
|
|
|
|
|
|
|
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 $1.6 billion of fixed rate debt to variable rate debt. |
RAIs exposure to foreign currency transactions was not material to results of operations
for the six months ended June 30, 2007, 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 2 for additional information.
Item 4. Controls and Procedures
|
(a) |
|
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. |
|
|
(b) |
|
There have been no changes in RAIs internal controls over financial reporting that
occurred during the second quarter of 2007 that have materially affected, or are reasonably
likely to materially affect, RAIs internal controls over financial reporting. |
77
PART II Other Information
Item 1. Legal Proceedings
For a discussion of the litigation and legal proceedings pending against RJR Tobacco, Conwood
or their affiliates, including RAI and RJR, or indemnitees, including B&W, see note 9 to condensed
consolidated financial statements (unaudited) and Managements Discussion and Analysis of
Financial Condition and Results of Operations Liquidity and Financial Condition Litigation and
Settlements and Governmental Activity included in Part IFinancial Information.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
RAI conducts its business through its subsidiaries and is dependent on the earnings and cash
flows of its subsidiaries to satisfy its obligations and other cash needs. For more information,
see Managements Discussion and Analysis of Financial Condition and Results of
OperationsLiquidity and Financial Condition in Part I, Item 2. RAI believes that the provisions
of its credit facility and the guarantees of its credit facility, interest rate swaps and
guaranteed, secured notes will not impair its payment of quarterly dividends.
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 and the exercise of previously granted options under the LTIP. RAI also 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 LTIP.
The following table summarizes RAIs purchases of its common stock during the second quarter
of 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
Approximate Dollar |
|
|
|
|
|
|
|
|
|
|
Shares Purchased |
|
Value that May Yet |
|
|
Total Number |
|
Average Price |
|
as Part of Publicly |
|
Be Purchased Under |
|
|
of Shares |
|
Paid per |
|
Announced Plans |
|
the Plans or |
|
|
Purchased |
|
Share |
|
or Programs |
|
Programs |
April 1, 2007 to
April 30, 2007 |
|
|
61 |
|
|
$ |
62.41 |
|
|
|
|
|
|
$ |
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 1, 2007 to May
31, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 1, 2007 to
June 30, 2007 |
|
|
1,039 |
|
|
$ |
65.23 |
|
|
|
|
|
|
$ |
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter Total |
|
|
1,100 |
|
|
$ |
65.07 |
|
|
|
|
|
|
$ |
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders of RAI was held on May 11, 2007, in Winston-Salem, North
Carolina, at which the following matters were submitted to a vote of shareholders:
|
(a) |
|
Votes regarding the re-election of three Class III directors and one Class I director
were: |
|
|
|
|
|
|
|
|
|
|
|
For |
|
Withheld |
Class III |
|
|
|
|
|
|
|
|
Martin D. Feinstein |
|
|
242,345,853 |
|
|
|
7,512,477 |
|
Susan M. Ivey |
|
|
242,351,854 |
|
|
|
7,506,477 |
|
Neil R. Withington |
|
|
230,911,916 |
|
|
|
18,946,415 |
|
Class I |
|
|
|
|
|
|
|
|
John T. Chain, Jr. |
|
|
247,991,117 |
|
|
|
1,867,214 |
|
78
|
(b) |
|
Votes to approve an amendment to RAIs amended and restated articles of incorporation
increasing the number of authorized shares of RAIs common stock, par value $.0001 per
share, from 400,000,000 to 800,000,000 were: |
|
|
|
|
|
For |
|
Against |
|
Abstentions |
205,754,343
|
|
42,176,677
|
|
1,927,309 |
|
(c) |
|
Votes regarding ratification of appointment of KPMG LLP as independent auditors for
fiscal year 2007 were: |
|
|
|
|
|
For |
|
Against |
|
Abstentions |
248,053,615
|
|
800,123
|
|
1,004,590 |
Item 5.
Other Information
On July
12, 2007, the Board of Directors of RAI elected John J. Zillmer to
serve on RAIs Board as a Class I Director. Also on
July 12, 2007, RAIs Board elected Mr. Zillmer to
serve on the Boards Compensation Committee.
79
Item 6. Exhibits
(a) Exhibits
|
|
|
Exhibit |
|
|
Number |
|
Description |
|
|
|
1.1
|
|
Underwriting Agreement, dated June
18, 2007, by and among Reynolds
American Inc., as issuer, Reynolds
American Inc.s subsidiaries that
are guaranteeing the Notes and
Citigroup Global Markets Inc., J.P.
Morgan Securities Inc., Lehman
Brothers Inc. and Morgan Stanley &
Co. Incorporated, as representatives
of the several underwriters named
therein (incorporated by reference
to Exhibit 1.1 to Reynolds American
Inc.s Form 8-K, filed June 22,
2007). |
|
|
|
3.1
|
|
Articles of Amendment of Amended
and Restated Articles of Incorporation of Reynolds American Inc. |
|
|
|
4.1
|
|
Form of Reynolds American Inc.
Floating Rate Senior Secured Note
due 2011 (incorporated by reference
to Exhibit 4.1 to Reynolds American
Inc.s Form 8-K, filed June 22,
2007). |
|
|
|
4.2
|
|
Form of Reynolds American Inc.
6.750% Senior Secured Note due 2017
(incorporated by reference to
Exhibit 4.2 to Reynolds American
Inc.s Form 8-K, filed June 22,
2007). |
|
|
|
4.3
|
|
Form of Reynolds American Inc.
7.250% Senior Secured Note due 2037
(incorporated by reference to
Exhibit 4.3 to Reynolds American
Inc.s Form 8-K, filed June 22,
2007). |
|
|
|
10.1
|
|
Fifth Amended and Restated Credit
Agreement, dated as of June 28,
2007, 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, filed July 3,
2007). |
|
|
|
10.2
|
|
Third Amended and Restated Pledge
Agreement, dated as of June 28,
2007, among Reynolds American Inc.,
certain of its subsidiaries as
pledgors and JPMorgan Chase Bank,
N.A. as collateral agent and pledgee
(incorporated by reference to
Exhibit 10.2 to Reynolds American
Inc.s Form 8-K, filed July 3,
2007). |
|
|
|
10.3
|
|
Third Amended and Restated Security
Agreement, dated as of June 28,
2007, among Reynolds American Inc.,
certain of its subsidiaries as
assignors and JPMorgan Chase Bank,
N.A. as collateral agent and
assignee (incorporated by reference
to Exhibit 10.3 to Reynolds American
Inc.s Form 8-K, filed July 3,
2007). |
|
|
|
10.4
|
|
Sixth Amended and Restated
Subsidiary Guaranty, dated as of
June 28, 2007, 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, filed July 3,
2007). |
|
|
|
10.5
|
|
Amended and Restated (effective as
of May 10, 2007) Reynolds American
Inc. Annual Incentive Award Plan. |
|
|
|
10.6
|
|
Amended and Restated (effective as
of May 11, 2007) Reynolds American
Inc. Long-Term Incentive Plan. |
|
|
|
10.7
|
|
Amended and Restated (effective as
of July 12, 2007) Deferred
Compensation Plan for Directors of
Reynolds American Inc. |
|
|
|
10.8
|
|
Amended and Restated (effective as
of July 12, 2007) Equity Incentive
Award Plan for Directors of Reynolds
American Inc. |
|
|
|
10.9
|
|
April 30, 2007 Amendments to the
Contract Manufacturing Agreement,
dated July 30, 2004, by and between
RJ Reynolds Tobacco Company and
BATUS Japan, Inc. |
|
|
|
10.10
|
|
June 12, 2007 Amendments to the
Contract Manufacturing Agreement, dated July 30, 2004, by and
between RJ Reynolds Tobacco Company and BATUS Japan, Inc. |
|
|
|
10.11
|
|
Form of Deed of Trust, Security
Agreement, Assignment of Leases, Rents and Profits, Financing
Statement and Fixture Filing (Tennessee), dated as of October 2,
2006, by Conwood Company, L.P., as the Trustor, to Richard F. Warren,
as Trustee, for the benefit of JPMorgan Chase Bank, N.A., as
Administrative Agent and Collateral Agent, as the Beneficiary for the
benefit of the Secured Creditors. |
|
|
|
31.1
|
|
Certification of Chief Executive
Officer relating to RAIs Quarterly
Report on Form 10-Q for the quarter
ended June 30, 2007. |
|
|
|
31.2
|
|
Certification of Chief Financial
Officer relating to RAIs Quarterly
Report on Form 10-Q for the quarter
ended June 30, 2007. |
|
|
|
32.1
|
|
Certification of Chief Executive
Officer and Chief Financial Officer
relating to RAIs Quarterly Report
on Form 10-Q for the quarter ended
June 30, 2007, pursuant to Section
18 U.S.C. §1350, adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002. |
80
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
REYNOLDS AMERICAN INC.
(Registrant)
|
|
|
/s/ Dianne M. Neal
|
|
|
Dianne M. Neal |
|
|
Executive Vice President and
Chief Financial Officer |
|
|
Date:
August 2, 2007
81