FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2009
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 1-32258
Reynolds American Inc.
(Exact name of registrant as specified in its charter)
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North Carolina
(State or other jurisdiction of incorporation or organization)
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20-0546644
(I.R.S. Employer Identification Number) |
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 has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company
in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ |
Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company 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: 291,327,583 shares of common stock, par value $.0001 per share, as
of April 9, 2009
Part I Financial Information
Item 1. Financial Statements
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
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For the Three Months |
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Ended March 31, |
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2009 |
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2008 |
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Net sales(1) |
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$ |
1,832 |
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$ |
1,944 |
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Net sales, related party |
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89 |
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113 |
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Net sales |
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1,921 |
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2,057 |
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Costs and expenses: |
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Cost of products sold(1)(2)(3) |
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998 |
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1,164 |
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Selling, general and administrative expenses |
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365 |
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382 |
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Amortization expense |
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8 |
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5 |
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Trademark impairment charge |
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453 |
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Operating income |
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97 |
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506 |
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Interest and debt expense |
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66 |
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72 |
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Interest income |
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(5 |
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(22 |
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Gain on termination of joint venture |
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(328 |
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Other (income) expense, net |
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19 |
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(12 |
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Income before income taxes |
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17 |
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796 |
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Provision for income taxes |
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9 |
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291 |
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Net income |
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$ |
8 |
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$ |
505 |
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Basic income per share: |
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Net income |
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$ |
0.03 |
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$ |
1.71 |
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Diluted income per share: |
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Net income |
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$ |
0.03 |
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$ |
1.71 |
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Dividends declared per share |
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$ |
0.85 |
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$ |
0.85 |
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(1) |
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Excludes excise taxes of $410 million and $437 million for the three
months ended March 31, 2009 and 2008, respectively. |
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(2) |
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Includes Master Settlement Agreement and other state settlement
agreements, collectively referred to as the MSA, expense of $578
million and $654 million for the three months ended March 31, 2009 and
2008, respectively. |
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(3) |
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Includes federal tobacco quota buyout expenses of $52 million and $63
million for the three months ended March 31, 2009 and 2008,
respectively. |
See Notes to Condensed Consolidated Financial Statements (Unaudited)
3
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
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For the Three Months |
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Ended March 31, |
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2009 |
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2008 |
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Cash flows from (used in) operating activities: |
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Net income |
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$ |
8 |
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$ |
505 |
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Adjustments to reconcile to net cash flows from (used in)
continuing operating activities: |
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Depreciation and amortization |
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38 |
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33 |
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Gain on termination of joint venture |
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(328 |
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Restructuring charges, net of cash payments |
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(9 |
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(1 |
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Trademark impairment charge |
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453 |
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Deferred income tax expense |
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(198 |
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143 |
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Tobacco settlement accruals |
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580 |
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646 |
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Other, net |
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(9 |
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(120 |
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Net cash flows from operating activities |
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863 |
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878 |
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Cash flows from (used in) investing activities: |
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Proceeds from settlement of short-term investments |
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13 |
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2 |
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Capital expenditures |
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(27 |
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(39 |
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Other, net |
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2 |
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1 |
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Net cash flows used in investing activities |
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(12 |
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(36 |
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Cash flows from (used in) financing activities: |
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Dividends paid on common stock |
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(248 |
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(251 |
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Other, net |
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(4 |
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Net cash flows used in financing activities |
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(252 |
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(251 |
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Effect of exchange rate changes on cash and cash equivalents |
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(8 |
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Net change in cash and cash equivalents |
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591 |
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591 |
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Cash and cash equivalents at beginning of period |
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2,578 |
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2,215 |
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Cash and cash equivalents at end of period |
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$ |
3,169 |
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$ |
2,806 |
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Income taxes paid, net of refunds |
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$ |
10 |
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$ |
56 |
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Interest paid |
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$ |
23 |
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$ |
26 |
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See Notes to Condensed Consolidated Financial Statements (Unaudited)
4
REYNOLDS AMERICAN INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
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March 31, |
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December 31, |
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2009 |
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2008 |
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(Unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
3,169 |
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$ |
2,578 |
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Short-term investments |
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10 |
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23 |
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Accounts receivable, net of allowance (2009 $1; 2008 $1) |
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84 |
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84 |
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Accounts receivable, related party |
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64 |
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91 |
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Notes receivable |
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35 |
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35 |
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Other receivables |
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28 |
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37 |
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Inventories |
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1,215 |
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1,170 |
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Deferred income taxes, net |
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851 |
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838 |
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Prepaid expenses and other |
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204 |
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163 |
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Total current assets |
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5,660 |
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5,019 |
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Property, plant and equipment, net of accumulated depreciation (2009
$1,579; 2008 $1,549) |
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1,025 |
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1,031 |
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Trademarks and other intangible assets, net of accumulated
amortization (2009 $627; 2008 $619) |
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2,809 |
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3,270 |
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Goodwill |
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8,174 |
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8,174 |
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Other assets and deferred charges |
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621 |
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660 |
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$ |
18,289 |
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$ |
18,154 |
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Liabilities and shareholders equity |
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Current liabilities: |
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Accounts payable |
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$ |
123 |
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$ |
206 |
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Tobacco settlement accruals |
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2,897 |
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2,321 |
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Due to related party |
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1 |
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3 |
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Deferred revenue, related party |
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34 |
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50 |
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Current maturities of long-term debt |
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200 |
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200 |
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Other current liabilities |
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1,240 |
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1,143 |
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Total current liabilities |
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4,495 |
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3,923 |
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Long-term debt (less current maturities) |
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4,460 |
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4,486 |
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Deferred income taxes, net |
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97 |
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282 |
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Long-term retirement benefits (less current portion) |
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2,844 |
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2,836 |
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Other noncurrent liabilities |
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391 |
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390 |
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Commitments and contingencies: |
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Shareholders equity: |
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Common stock (shares issued: 2009 291,327,583; 2008 291,450,762) |
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Paid-in capital |
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8,475 |
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8,463 |
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Accumulated deficit |
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(772 |
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(531 |
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Accumulated other comprehensive loss (Defined benefit pension and
post-retirement plans: 2009 $(1,628) and 2008 $(1,643), net of
tax) |
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(1,701 |
) |
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(1,695 |
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Total shareholders equity |
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6,002 |
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6,237 |
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$ |
18,289 |
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$ |
18,154 |
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See Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 Business and Summary 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 operating subsidiaries. RAIs wholly owned
subsidiaries include R. J. Reynolds Tobacco Company; Santa Fe Natural Tobacco Company, Inc.,
referred to as Santa Fe; Lane, Limited, referred to as Lane; Conwood Holdings, Inc.; and Conwood
Company, LLC and Rosswil LLC, collectively referred to as the Conwood companies.
RAI was incorporated as a holding company in the state of North Carolina on January 5, 2004,
and its common stock is listed on the NYSE under the symbol RAI. RAI was created to facilitate
the Brown & Williamson Holdings, Inc., referred to as B&W, business combination with R. J. Reynolds
Tobacco Company on July 30, 2004.
References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco Company, a
New Jersey corporation and a wholly owned subsidiary of R.J. Reynolds Tobacco Holdings, Inc.,
referred to as RJR. References to RJR Tobacco on and subsequent to July 30, 2004, relate to the
combined U.S. assets, liabilities and operations of B&W and R. J. Reynolds Tobacco Company, a North
Carolina corporation.
RAIs reportable operating segments are RJR Tobacco and Conwood. The RJR Tobacco segment
consists of the primary operations of R. J. Reynolds Tobacco Company. The Conwood segment consists
of Conwood Holdings, Inc., the primary operations of the Conwood companies and Lane. RAIs wholly
owned subsidiary, Santa Fe, among others, is included in All Other. The segments were identified
based on how RAIs chief operating decision maker allocates resources and assesses performance.
Some of RAIs wholly owned operating subsidiaries have entered into intercompany agreements for
products or services with other RAI operating subsidiaries. As a result, certain activities of an
operating subsidiary may be included in a different segment of RAI.
RAIs operating subsidiaries primarily conduct their business in the United States.
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 March 31, 2009, are not necessarily indicative of the results
that may be expected for the year ending December 31, 2009.
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, 2008. 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 10 and as otherwise
noted.
6
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Pension and Postretirement
Recognized gains or losses are annual changes in the amount of either the benefit obligation
or the market-related value of plan assets resulting from experience different from that assumed or
from changes in assumptions. The minimum amortization of unrecognized gains or losses, as described
in Statement of Financial Accounting Standards, referred to as SFAS, No. 87, Employers Accounting
for Pensions, was included in pension expense, and as described in SFAS No. 106, Employers
Accounting for Postretirement Benefits other than Pensions, was included in the postretirement
benefit cost. Prior service costs, which are changes in benefit obligations due to plan amendments,
are amortized on a straight-line basis over the average remaining service period for active
employees. The market-related value of plan assets recognizes changes in fair value in a systematic
and rational manner over five years.
The components of the pension benefits and the postretirement benefits are set forth below:
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For The Three Months Ended March 31, |
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Postretirement |
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Pension Benefits |
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Benefits |
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2009 |
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2008 |
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2009 |
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2008 |
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Service cost |
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$ |
8 |
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$ |
10 |
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$ |
1 |
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$ |
1 |
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Interest cost |
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78 |
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80 |
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21 |
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23 |
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Expected return on plan assets |
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(83 |
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(113 |
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(6 |
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(6 |
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Amortization of prior service cost (credit) |
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1 |
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5 |
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(6 |
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5 |
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Amortization of net loss (income) |
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24 |
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5 |
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(3 |
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Total
benefit cost (income) |
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$ |
28 |
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$ |
(18 |
) |
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$ |
15 |
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$ |
20 |
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Employer Contributions
RAI disclosed in its financial statements for the year ended December 31, 2008, that it
expected to contribute a minimum of $50 million to its pension plans in 2009. As of March 31,
2009, RAI expected to contribute $60 million to its pension plans in 2009, of which $3 million was
contributed during the first three months of 2009.
Recently Adopted Accounting Pronouncements
Effective January 1, 2009, RAI adopted SFAS No. 157, Fair Value Measurements, for
nonfinancial assets and nonfinancial liabilities. 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 disclosure about fair value measurements. SFAS No. 157 also establishes a fair
value hierarchy that distinguishes between independent and observable inputs and unobservable
inputs based on the best information available. The adoption of SFAS No. 157 on nonfinancial assets
and nonfinancial liabilities did not have a material impact on RAIs consolidated results of
operations, cash flows or financial position.
Effective January 1, 2009, RAI adopted Financial Accounting Standards Board, referred to as
FASB, Staff Position, referred to as FSP, No. EITF 03-6-1, Determining Whether Instruments Granted
in Share-Based Payment Transactions Are Participating Securities. FSP No. EITF 03-6-1 addresses
whether instruments granted in share-based payment transactions are participating securities prior
to vesting and, therefore, need to be included in the earnings allocation in computing earnings per
share. As a result, unvested restricted shares outstanding under the RAI Long-Term Incentive Plan,
referred to as the LTIP, are included in basic EPS calculations. All prior-period earnings per
share have been adjusted retrospectively to conform to the provisions of this FSP, which reduced
basic net income per share for the first quarter of 2008 by $0.01 from $1.72 per share to $1.71 per
share.
Effective January 1, 2009, RAI adopted SFAS No. 161, Disclosures about Derivative Instruments
and Hedging Activities-an amendment of FASB Statement No. 133. SFAS No. 161 seeks qualitative
disclosures about the objectives and strategies for using derivatives; quantitative data about the
fair value of, and gains and losses on,
7
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
derivative contracts; and details of credit-risk-related contingent features in hedged
positions. SFAS No. 161 also seeks enhanced disclosure around derivative instruments in financial
statements, accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and how hedges affect an entitys financial position, financial performance and cash
flows. The adoption of SFAS No. 161 did not have a material impact on RAIs consolidated results of
operations, cash flows or financial position.
Recently Issued Accounting Pronouncements
On April 9, 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly. FSP No. FAS 157-4 amends SFAS No. 157 and provides additional guidance for estimating fair value in accordance with SFAS
No. 157 when the volume and level of activity for the asset and liability have significantly
decreased, as well as provides guidance on identifying circumstances that indicate a transaction is
not orderly. FSP No. FAS 157-4 is effective for interim and annual periods ending after June 15,
2009. The adoption of FSP No. FAS 157-4 is not expected to have a material impact on RAIs
consolidated results of operations, cash flows or financial position.
On April 9, 2009, FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation
of Other-Than-Temporary Impairments. FSP No. FAS 115-2 and FAS 124-2 amends SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, and FSP No. FAS 115-1 and FAS
124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.
FSP No. FAS 115-2 and FAS 124-2 provides additional guidance to make other-than-temporary
impairments more operational and to improve the financial statement presentation of such
impairments. FSP No. FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending
after June 15, 2009. The adoption of FSP No. FAS 115-2 and FAS 124-2 is not expected to have a
material impact on RAIs consolidated results of operations, cash flows or financial position.
On April 9, 2009, FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair
Value of Financial Instruments. FSP No. FAS 107-1 and APB 28-1 amends SFAS No. 107, Disclosures
about Fair Value of Financial Instruments, and APB Opinion No. 28, Interim Financial Reporting,
by requiring disclosures about fair value of financial instruments in interim financial statements
as well as in annual financial statements. FSP No. FAS 107-1 and APB 28-1 is effective for interim
periods ending after June 15, 2009. The adoption of FSP No. FAS 107-1 and APB 28-1 is not expected
to have a material impact on RAIs consolidated results of operations, cash flows or financial
position.
Note 2 Fair Value Measurement
SFAS No. 157 establishes a fair value hierarchy and defines fair value as the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date, essentially an exit price.
The levels of the fair value hierarchy established by SFAS No. 157 are:
Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: inputs are other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly. A Level 2 input must be observable for
substantially the full term of the asset or liability.
Level 3: inputs are unobservable and reflect the reporting entitys own assumptions about
the assumptions that market participants would use in pricing the asset or liability.
8
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Financial assets/(liabilities) carried at fair value on a recurring basis as of March 31,
2009, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
Money market funds |
|
$ |
3,100 |
|
|
$ |
|
|
|
$ |
10 |
|
|
$ |
3,110 |
|
Auction rate securities corporate credit risk |
|
|
|
|
|
|
|
|
|
|
35 |
|
|
|
35 |
|
Auction rate securities financial insurance companies |
|
|
|
|
|
|
|
|
|
|
14 |
|
|
|
14 |
|
Mortgage-backed security |
|
|
|
|
|
|
|
|
|
|
18 |
|
|
|
18 |
|
Assets held in grantor trusts |
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
15 |
|
Interest rate swaps fixed to floating rate |
|
|
|
|
|
|
258 |
|
|
|
|
|
|
|
258 |
|
Interest rate swaps floating to fixed rate |
|
|
|
|
|
|
(16 |
) |
|
|
|
|
|
|
(16 |
) |
The fair value of the interest rate swaps, classified as a Level 2, utilized a market approach
model using the notional amount of the interest rate swap multiplied by the observable inputs of
time to maturity, interest rates and credit spreads. See note 9 for additional information on
interest rate swaps.
The fair value of the money market funds, classified as a Level 3, utilized an income approach
model and was based upon expected future cash flows from accumulated cash in the fund and future
maturities of the remaining securities held in the fund. During the first quarter of 2009,
redemptions of $2 million were received from the Reserve Fund-Primary Fund and redemptions of $11
million were received from the Reserve Fund-International Liquidity Fund. No current valuations had
been issued by either fund and RAI was unable to identify a similar fund that carried identical
holdings. As a result, the observable transactions and pricing were not current. The funds did
issue a detailed listing of the securities that were held and not matured, as well as their face
value and maturity date. This observable data, along with unobservable factors such as discount
rate, and assumptions about fund liquidation of accumulated cash and the collectability of the
outstanding underlying securities were used to determine the fair value of the funds as of March
31, 2009.
The fair value of the auction rate securities, either related to certain financial insurance
companies or linked to the longer-term credit risk of a diverse range of corporations, including,
but not limited to, manufacturing, financial and insurance sectors, classified as a Level 3,
utilized an income approach model and were based upon calculating the weighted average present
value of future cash payments, given the probability of certain events occurring within the market.
RAI considers the market for auction rate securities to be inactive. The income approach models
utilized observable inputs, including LIBOR-based interest rate curves, corporate credit spreads
and corporate ratings/market valuations. Additionally, unobservable factors incorporated into the
models included default probability assumptions, recovery potential and how these factors changed
as collateral ratings migrated from one level to another.
The fair value for the mortgage-backed security, classified as a Level 3, utilized a market
approach and was based upon the calculation of an overall weighted average valuation, derived from
the actual, or modeled, market pricing of the specific collateral, depending on availability. The
market approach utilized actual pricing inputs when observable and modeled pricing when
unobservable. RAI has deemed the market for the mortgage-backed security to be inactive.
The changes in financial assets classified as Level 3 investments as of March 31, 2009, were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market Funds |
|
|
Mortgage-Backed Security |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Estimated |
|
|
|
|
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Fair Value |
|
|
Cost |
|
|
Loss |
|
|
Fair Value |
|
Balance as of January 1, 2009 |
|
$ |
23 |
|
|
$ |
23 |
|
|
$ |
37 |
|
|
$ |
(16 |
) |
|
$ |
21 |
|
Unrealized losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2 |
) |
|
|
(2 |
) |
Settlements |
|
|
(13 |
) |
|
|
(13 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2009 |
|
$ |
10 |
|
|
$ |
10 |
|
|
$ |
36 |
|
|
$ |
(18 |
) |
|
$ |
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction Rate Securities
|
|
|
Auction Rate Securities |
|
|
|
Corporate Credit Risk |
|
|
Financial Insurance Companies |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Unrealized |
|
|
Estimated |
|
|
|
|
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Loss |
|
|
Fair Value |
|
|
Cost |
|
|
Loss |
|
|
Fair Value |
|
Balance as of January 1, 2009 |
|
$ |
95 |
|
|
$ |
(51 |
) |
|
$ |
44 |
|
|
$ |
17 |
|
|
$ |
(2 |
) |
|
$ |
15 |
|
Unrealized losses |
|
|
|
|
|
|
(9 |
) |
|
|
(9 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2009 |
|
$ |
95 |
|
|
$ |
(60 |
) |
|
$ |
35 |
|
|
$ |
17 |
|
|
$ |
(3 |
) |
|
$ |
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On January 1, 2009, RAI adopted SFAS No. 157 for nonfinancial assets and liabilities after
electing, in 2008, to defer the effective date of SFAS No. 157 based on FSP No. 157-2, Effective
Date of FASB Statement No. 157.
Nonfinancial assets measured at fair value on a nonrecurring basis as of March 31, 2009, were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
|
Total Loss |
Trademarks |
|
$ |
|
|
|
$ |
|
|
|
$ |
875 |
|
|
$ |
875 |
|
|
$ |
(453 |
) |
The
fair value of the trademarks measured on a nonrecurring basis,
classified as Level 3, represent certain
trademarks for which impairment during the first quarter of 2009
reduced their book value. The fair value determination utilized an income approach model and was based on a discounted cash flow
valuation model under a relief from royalty methodology. This approach utilized unobservable
factors such as royalty rate, projected revenues and a discount rate applied to the estimated cash
flows. The determination of the discount rate was based on a cost of equity model, using a
risk-free rate, adjusted by a stock-beta adjusted risk premium and a size premium. See note 3 for
additional information with respect to the event that required impairment testing of trademarks and
the assumptions used therefor, as well as the consolidated amount of trademarks as of March 31,
2009.
Note 3 Intangible Assets
The carrying amounts of indefinite-lived intangible assets by segment not subject to
amortization were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RJR |
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco |
|
|
Conwood |
|
|
All Other |
|
|
Consolidated |
|
Trademarks |
|
$ |
1,653 |
|
|
$ |
1,222 |
|
|
$ |
155 |
|
|
$ |
3,030 |
|
Other intangibles |
|
|
55 |
|
|
|
|
|
|
|
48 |
|
|
|
103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2008 |
|
$ |
1,708 |
|
|
$ |
1,222 |
|
|
$ |
203 |
|
|
$ |
3,133 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trademarks |
|
$ |
1,277 |
|
|
$ |
1,152 |
|
|
$ |
155 |
|
|
$ |
2,584 |
|
Other intangibles |
|
|
99 |
|
|
|
|
|
|
|
4 |
|
|
|
103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2009 |
|
$ |
1,376 |
|
|
$ |
1,152 |
|
|
$ |
159 |
|
|
$ |
2,687 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Concurrent with the transfer of the management of tobacco products sold to certain U.S.
territories, U.S. duty-free shops and U.S. overseas military bases, from R. J. Reynolds Global
Products, Inc., referred to as GPI, to RJR Tobacco on January 1, 2009, a $44 million
indefinite-lived intangible asset was transferred from All Other to RJR Tobacco.
During the first quarter of 2009, President Obama signed an increase of $0.62 in the federal
excise tax per pack of cigarettes as well as significant tax increases on other tobacco products,
to fund expansion of the State Childrens Health Insurance Program, referred to as the SCHIP. The
tax increases were effective April 1, 2009.
The increase in federal excise tax is expected to adversely impact the net sales of RAIs
operating subsidiaries. This event was considered a triggering event and required the testing for
impairment of the carrying value of trademarks and goodwill during the first quarter of 2009. As a
result of this testing, RJR Tobacco recorded a trademark impairment charge of $377 million, and
Conwood recorded a trademark impairment charge of $76 million in the first quarter of 2009. These
charges were based on the excess of certain brands carrying values over their estimated fair
values. The analysis of the fair value of trademarks in accordance with SFAS No. 142,
10
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Goodwill and Other Intangible Assets, was based on estimates of fair value on an income
approach using a discounted cash flow valuation model under a relief from royalty methodology. The
relief from royalty model includes the estimates of the royalty rate that a market participant
might assume, projected revenues and judgment regarding the 10.50% discount rate applied to those
estimated cash flows. The determination of the discount rate was based on a cost of equity model,
using a risk-free rate, adjusted by a stock-beta-adjusted risk premium and a size premium.
The trademark impairment charge is reflected as a decrease in the carrying value of the
trademarks in the condensed consolidated balance sheet (unaudited) as of March 31, 2009, as a
trademark impairment charge in the condensed consolidated statements of income (unaudited) for the
three months ended March 31, 2009, and had no impact on cash flows.
Details of finite-lived intangible assets subject to amortization as of March 31, 2009, were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
Gross |
|
|
Amortization |
|
|
Net |
|
Contract manufacturing |
|
$ |
151 |
|
|
$ |
71 |
|
|
$ |
80 |
|
Trademarks |
|
|
95 |
|
|
|
53 |
|
|
|
42 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
246 |
|
|
$ |
124 |
|
|
$ |
122 |
|
|
|
|
|
|
|
|
|
|
|
Pre-tax amortization expense for intangible assets was $8 million and $5 million for the three
months ended March 31, 2009 and 2008, respectively. The estimated remaining amortization associated
with finite-lived intangible assets is expected to be expensed as follows:
|
|
|
|
|
Year |
|
Amount |
|
Remainder of 2009 |
|
$ |
21 |
|
2010 |
|
|
26 |
|
2011 |
|
|
23 |
|
2012 |
|
|
21 |
|
2013 |
|
|
16 |
|
Thereafter |
|
|
15 |
|
|
|
|
|
|
|
$ |
122 |
|
|
|
|
|
For the impairment testing of the goodwill of RAIs reporting units, each reporting units
estimated fair value was compared with its carrying value. A reporting unit is an operating segment
or one level below an operating segment. The determination of estimated fair value of each
reporting unit was calculated primarily utilizing an income approach model, based on the present
value of the estimated future cash flows of the reporting unit assuming a discount rate. The
determination of the discount rate was based on a weighted average cost of capital and cost of
equity, described above as utilized in the trademark valuation. Additionally, the aggregate
estimated fair value of the reporting units, determined with the use of the income approach model,
was compared with RAIs market capitalization. In considering RAIs market capitalization, an
estimated premium to reflect the fair value on a control basis was applied. The estimated fair
value of each reporting unit, determined utilizing the income approach and RAIs market
capitalization, was greater than its respective carrying value.
Note 4 Restructuring Charges
2008 Restructuring Charge
In 2008, RAI and RJR Tobacco announced changes in their organizational structures to
streamline non-core business processes and programs in order to allocate additional resources to
strategic growth initiatives. The reorganizations will result in the elimination of approximately
600 full-time jobs, expected to be substantially completed by December 31, 2009.
11
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Under existing benefit plans, $83 million of severance-related cash benefits and $7 million of
non-cash pension-related benefits comprised a restructuring charge of $90 million in 2008. Of this
charge, $81 million was recorded in the RJR Tobacco segment. Of the cash portion of the charge, $13
million was paid as of March 31, 2009. Accordingly, in the condensed consolidated balance sheet
(unaudited) as of March 31, 2009, $43 million was included in other current liabilities and $27
million was included in other noncurrent liabilities. The cash benefits are expected to be
substantially paid by December 31, 2010.
The component of the restructuring charge accrued and utilized was as follows:
|
|
|
|
|
|
|
Employee |
|
|
|
Severance |
|
|
|
and Benefits |
|
Original accrual |
|
$ |
91 |
|
Utilized in 2008 |
|
|
(12 |
) |
Adjusted in 2008 |
|
|
(1 |
) |
|
|
|
|
Balance as of December 31, 2008 |
|
|
78 |
|
|
|
|
|
Utilized in 2009 |
|
|
(8 |
) |
|
|
|
|
Balance as of March 31, 2009 |
|
$ |
70 |
|
|
|
|
|
Note 5 Income Per Share
On
January 1, 2009, RAI adopted FSP No. EITF 03-6-1, which addresses
whether instruments granted in share-based payment transactions are participating securities prior
to vesting and, therefore, need to be included in the earnings allocation in computing earnings per
share. Unvested restricted shares awarded under the 2007 and 2008 LTIP grants have been determined
to be participating securities as defined by FSP No. EITF 03-6-1 because they have non-forfeitable
dividend rights equivalent to common shares. Accordingly, these restricted shares are included in
the basic EPS calculation for the first quarter of 2009 and
retrospectively in the basic EPS calculation for the first quarter
of 2008.
The components of the calculation of income per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended March 31, |
|
|
|
2009 |
|
|
2008 |
|
Net income |
|
$ |
8 |
|
|
$ |
505 |
|
|
|
|
|
|
|
|
Basic weighted average shares, in thousands |
|
|
291,424 |
|
|
|
295,098 |
|
Effect of dilutive potential shares: |
|
|
|
|
|
|
|
|
Options |
|
|
144 |
|
|
|
232 |
|
Stock units |
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares, in thousands |
|
|
291,606 |
|
|
|
295,330 |
|
|
|
|
|
|
|
|
Note 6 Investments
Short-term investments classified as available-for-sale were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2008 |
|
|
|
March 31, 2009 |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated |
|
|
|
|
|
|
Realized |
|
|
|
|
|
|
Estimated |
|
|
|
Cost |
|
|
Redemptions |
|
|
Fair Value |
|
|
Cost |
|
|
Loss |
|
|
Redemptions |
|
|
Fair Value |
|
Reserve Fund Primary Fund |
|
$ |
7 |
|
|
$ |
(2 |
) |
|
$ |
5 |
|
|
$ |
37 |
|
|
$ |
(1 |
) |
|
$ |
(29 |
) |
|
$ |
7 |
|
Reserve Fund
International Liquidity
Fund |
|
|
16 |
|
|
|
(11 |
) |
|
|
5 |
|
|
|
17 |
|
|
|
(1 |
) |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
23 |
|
|
$ |
(13 |
) |
|
$ |
10 |
|
|
$ |
54 |
|
|
$ |
(2 |
) |
|
$ |
(29 |
) |
|
$ |
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
During the first quarter of 2009, redemptions of $13 million were received from the Reserve
Funds. On February 26, 2009, The Reserve Fund released a statement regarding the establishment of a
special reserve to cover the Primary Funds total potential liabilities. This special reserve may
be increased or decreased and could reduce the amount of distributions that will be made out of the
Primary Fund. RAI has the intent and the ability to hold the investments in the Reserve Funds
until maturity.
Long-term investments classified as available-for-sale were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
|
December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized |
|
|
Estimated |
|
|
|
|
|
|
Realized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Redemptions |
|
|
Loss |
|
|
Fair Value |
|
|
Cost |
|
|
Loss |
|
|
Loss |
|
|
Fair Value |
|
Auction rate securities
corporate credit
risk |
|
$ |
95 |
|
|
$ |
|
|
|
$ |
(60 |
) |
|
$ |
35 |
|
|
$ |
95 |
|
|
$ |
|
|
|
$ |
(51 |
) |
|
$ |
44 |
|
Auction rate securities
financial insurance
companies |
|
|
17 |
|
|
|
|
|
|
|
(3 |
) |
|
|
14 |
|
|
|
50 |
|
|
|
(33 |
) |
|
|
(2 |
) |
|
|
15 |
|
Mortgage-backed security |
|
|
37 |
|
|
|
(1 |
) |
|
|
(18 |
) |
|
|
18 |
|
|
|
37 |
|
|
|
|
|
|
|
(16 |
) |
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
149 |
|
|
$ |
(1 |
) |
|
$ |
(81 |
) |
|
$ |
67 |
|
|
$ |
182 |
|
|
$ |
(33 |
) |
|
$ |
(69 |
) |
|
$ |
80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAI has five investments in auction rate securities linked to corporate credit risk, four
investments in auction rate securities related to financial insurance companies and one investment
in a mortgage-backed security. These securities were included in other assets and deferred charges
in RAIs condensed consolidated balance sheet (unaudited) as of March 31, 2009. The funds
associated with the auction rate securities will not be accessible until a successful auction
occurs or a buyer is found. The mortgage-backed security matures in March 2010. RAI is in the
process of evaluating its alternatives surrounding extending this investment beyond 2010.
RAI reviews these investments on a quarterly basis to determine if it is probable that RAI
will realize some portion of the unrealized loss in accordance with SFAS No. 115, FSP No. FAS 115-1
and FAS 124-1, and FSP No. EITF 99-20-1, and to determine the classification of the impairment as
temporary or other-than-temporary.
In determining if the difference between cost and estimated fair value of the auction rate
securities or the mortgage-backed security was deemed either temporary or other-than-temporary
impairment, RAI evaluated each type of long-term investment using a set of criteria including
decline in value, duration of the decline, period until anticipated recovery, nature of investment,
probability of recovery, financial condition and near-term prospects of the issuer, RAIs intent
and ability to retain the investment, attributes of the decline in value, status with rating
agencies, status of principal and interest payments and any other issues related to the underlying
securities.
RAI determined the change in the fair value of the investments in the auction rate securities
linked to corporate credit risk was temporary as of March 31, 2009, primarily based on estimated
cash flows of the investments, present and expected defaults of the underlying collateral and RAIs
ability and intent to hold such investments. RAI believes the decline in the fair value of the
securities is related to present market conditions and that the investments will continue to be
carried at less than cost until economic conditions improve. RAI believes it is probable these
securities will eventually recover, and RAI has no intention of selling these securities in the
foreseeable future.
The additional change in the fair value of the investments in auction rate securities related
to financial insurance companies has been determined by RAI to be temporary as of March 31, 2009,
primarily based on estimated cash flows of these securities, near-term prospects and financial
condition of the issuer and RAIs ability and intent to hold such investments. RAI believes the
decline in the fair value of these securities is related to present market conditions and that
these investments will continue to be carried at less than cost until economic conditions improve.
RAI believes it is probable these securities will eventually recover, and RAI has no intention
of selling these securities in the foreseeable future.
RAI determined the change in the fair value of the investment of the mortgage-backed security,
classified above sub-prime at inception, was also temporary as of March 31, 2009, primarily based
on estimated cash flows of the security and the underlying collateral of the security. RAI believes
the decline in the fair value of the mortgage-
13
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
backed security is related to present market conditions and that this investment will continue
to be carried at less than cost until economic conditions surrounding the housing markets improve.
RAI believes it is probable this security will recover as the lowering of interest rates and the
assistance of government-related funds will result in refinancing opportunities. In addition,
during the first quarter of 2009, RAI received $1 million in principal payments on the
mortgage-backed security. RAI has no intention of selling this security in the foreseeable future
and has the ability to allow financial markets to recover and ultimately realize the value of this
investment.
The unrealized losses of $12 million for the three months ended March 31, 2009, on the
previously mentioned long-term investments were included in accumulated other comprehensive loss in
the condensed consolidated balance sheet (unaudited) as of March 31, 2009. Such unrealized losses
did not reduce net income for the three months ended March 31, 2009.
Note 7 Inventories
The major components of inventories were as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
|
December 31, 2008 |
|
Leaf tobacco |
|
$ |
956 |
|
|
$ |
993 |
|
Other raw materials |
|
|
70 |
|
|
|
60 |
|
Work in process |
|
|
61 |
|
|
|
58 |
|
Finished products |
|
|
217 |
|
|
|
145 |
|
Other |
|
|
31 |
|
|
|
26 |
|
|
|
|
|
|
|
|
Total |
|
|
1,335 |
|
|
|
1,282 |
|
Less LIFO allowance |
|
|
120 |
|
|
|
112 |
|
|
|
|
|
|
|
|
|
|
$ |
1,215 |
|
|
$ |
1,170 |
|
|
|
|
|
|
|
|
RJR Tobacco will perform its annual LIFO inventory valuation at December 31, 2009, as interim
periods represent an estimate of the expected annual valuation.
Note 8 Income Taxes
The provision for income taxes in the first quarter of 2009 was $9 million, or an effective
rate of 53.3%, compared with $291 million, or an effective rate of 36.6%, in the first quarter of
2008. The effective tax rate for the first three months of 2009 was unfavorably impacted by
increases in unrecognized income tax benefits and increases in tax attributable to accumulated and
undistributed foreign earnings. The effective rate for the first three months of 2008 was
favorably impacted by a lower tax rate related to the gain on the termination of the
Reynolds-Gallaher International Sarl joint venture.
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 domestic production activities
deduction of the American Jobs Creation Act, enacted on October 22, 2004.
The gross accruals for unrecognized income tax benefits, including interest and penalties,
reflected in other noncurrent liabilities were $163 million and $159 million at March 31, 2009, and
December 31, 2008, respectively. RAI accrues interest and penalties related to accruals for income
taxes and reflects these amounts in tax expense.
The gross amount of interest accrued at March 31, 2009, and December 31, 2008, was $52 million
and $50 million, respectively. The gross amount of penalties accrued was $12 million at March 31,
2009, and December 31, 2008.
Gross increases in unrecognized tax benefits related to tax positions were $2 million for the
three months ended March 31, 2009, attributable to current year tax positions.
Gross decreases in unrecognized tax benefits were $1 million for the three months ended March
31, 2009, attributable to prior-year tax positions.
14
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
As of March 31, 2009, $57 million of unrecognized tax benefits and $45 million of interest and
penalties, if recognized, would affect the effective tax rate.
Included in the provision for income taxes for the three months ended March 31, 2009, was $2
million of additional tax expense attributable to interest expense, net of federal benefit, and
penalties associated with unrecognized tax benefits. Comparable amounts for the three months ended
March 31, 2008, were $8 million of additional tax expense, including $1 million of interest
expense, net of federal benefit, and penalties.
RAI and its subsidiaries may be subject to income taxes in the United States, certain foreign
jurisdictions and multiple state jurisdictions. A number of years may elapse before a particular
matter, for which RAI has established an accrual, is audited and finally resolved. The number of
years with open tax audits varies depending on the tax jurisdiction. RAIs major taxing
jurisdictions and related open tax audits are discussed below.
RAI filed a federal consolidated income tax return for the years 2005 through 2007. RAI
expects to file a federal consolidated income tax return for 2008 on or before September 15, 2009.
The statute of limitations remains open for the years 2005 through 2007. There are no IRS
examinations scheduled at this time for these open years.
In 2007, the State of North Carolina completed its examination of RJR Tobacco for years 2000
through 2002 and issued a total assessment of $37 million: $21 million related to tax, $8 million
related to interest and $8 million related to penalties. RJR Tobacco filed a protest in January
2008. RJR Tobacco will continue to work with North Carolina to resolve issues identified and
assessed for years 2000 through 2002. A complete resolution is not anticipated within the next 12
months. However, in the event a complete resolution of this audit is reached during the next 12
months, RJR Tobacco could recognize additional expense up to $13 million, inclusive of tax,
interest, net of federal benefit, and penalties.
It is expected that the amount of unrecognized tax benefits will change in the next 12 months.
Excluding the impact of North Carolinas assessment for years 2000 through 2002, RAI does not
expect the change to have a significant impact on its consolidated results of operations, cash flow
or financial position.
Note 9 Financial Instruments
Interest Rate Management
RAI and RJR use interest rate swaps to manage interest rate risk on a portion of their
respective debt obligations.
Interest rate swaps existed on the following principal amounts of debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed to Floating Rate |
|
|
Floating to Fixed Rate |
|
|
Fixed to Floating Rate |
|
|
|
March 31, 2009 |
|
|
March 31, 2009 |
|
|
December 31, 2008 |
|
RJR 7.25% notes, due 2012 |
|
$ |
44 |
|
|
$ |
44 |
|
|
$ |
57 |
|
|
|
|
|
|
|
|
|
|
|
Total swapped RJR debt |
|
|
44 |
|
|
|
44 |
|
|
|
57 |
|
|
|
|
|
|
|
|
|
|
|
RAI 7.25% notes, due 2012 |
|
|
306 |
|
|
|
306 |
|
|
|
393 |
|
RAI 7.625% notes, due 2016 |
|
|
450 |
|
|
|
450 |
|
|
|
450 |
|
RAI 6.75% notes, due 2017 |
|
|
700 |
|
|
|
700 |
|
|
|
700 |
|
|
|
|
|
|
|
|
|
|
|
Total swapped RAI debt |
|
|
1,456 |
|
|
|
1,456 |
|
|
|
1,543 |
|
|
|
|
|
|
|
|
|
|
|
Total notional amount |
|
$ |
1,500 |
|
|
$ |
1,500 |
|
|
$ |
1,600 |
|
|
|
|
|
|
|
|
|
|
|
Historically, the interest rate swap agreements were derivative instruments that qualified for
hedge accounting under SFAS No. 133. RAI and RJR assess at the inception of the hedge whether the hedging derivatives are
highly effective in offsetting changes in fair value of the hedged item. Ineffectiveness results
when changes in the market value of the hedged debt are not completely offset by changes in the
market value of the interest rate swap. There was no ineffectiveness recognized related to
derivative instruments during 2009 or 2008. As detailed below, at March 31, 2009, RAI and RJR had
no derivative instruments designated as hedges.
15
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On
January 6, 2009, the fair value of RAIs and RJRs fixed to floating interest rate swaps,
designated as hedges, was $258 million. RAI and RJR locked in the value of these swaps by entering
into offsetting floating to fixed interest rate swap agreements in the notional amount of $1.5
billion with maturity dates ranging from June 1, 2012 to June 15, 2017. The floating to fixed
interest rate swaps were entered into with the same financial institution that holds a notional
amount of $1.5 billion of fixed to floating interest rate swaps and have a legal right of offset.
The future cash flows, established as a result of entering into the January 6, 2009 floating to
fixed interest rate swaps, total $321 million, and will be amortized and effectively reduce net
interest costs over the remaining life of the notes. Concurrent with entering the floating to fixed
interest rate swap agreements on January 6, 2009, which were not designated as hedging instruments,
RAI and RJR removed the designation of fair value hedge from the fixed to floating interest rate
swaps.
On January 7, 2009, RAI and RJR terminated an interest rate swap agreement in the notional
amount of $100 million with a maturity date of June 1, 2012. The resulting gain of approximately
$12 million will be amortized to effectively reduce interest expense over the remaining life of the
notes.
As a result of these actions, RAI and RJR have economically decreased the fixed rate on $1.6
billion of debt to a fixed rate of interest of approximately 4.0%.
As of March 31, 2009, a summary of interest rate swaps outstanding was as follows:
|
|
|
|
|
|
|
Fixed to Floating |
|
Floating to Fixed |
Pay
|
|
Floating based on
one and six month
LIBOR
|
|
4.0% fixed |
Receive
|
|
7.1% fixed
|
|
Floating based on
one and six month
LIBOR |
Weighted average maturity
|
|
6.73 years
|
|
6.73 years |
Interest rate swaps are presented in the condensed consolidated balance sheets at fair value
as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
December 31, 2008 |
|
|
(Unaudited) |
|
|
|
|
Designated as hedging instrument: |
|
|
|
|
|
|
|
|
Other assets and deferred charges |
|
$ |
|
|
|
$ |
287 |
|
Long-term debt (less current maturities) |
|
|
|
|
|
|
(287 |
) |
|
|
|
|
|
|
|
|
|
Not designated as hedging instrument: |
|
|
|
|
|
|
|
|
Other assets and deferred charges |
|
|
258 |
|
|
|
|
|
Long-term debt (less current maturities) |
|
|
(261 |
) |
|
|
|
|
Other noncurrent liabilities |
|
|
(16 |
) |
|
|
|
|
Interest
rate swaps impacted the condensed consolidated statements of income
(unaudited) as
follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
March 31, 2008 |
Interest and debt expense |
|
$ |
(12 |
) |
|
$ |
(9 |
) |
Other (income) expense, net |
|
|
16 |
|
|
|
|
|
Credit Risk
RAI and its subsidiaries minimize counterparty credit risk related to their financial
instruments by using major financial institutions.
16
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 10 Commitments and Contingencies
Tobacco Litigation General
Introduction
Various legal proceedings or claims, including litigation claiming that cancer and other
diseases, as well as addiction, have resulted from the use of, or exposure to, RAIs operating
subsidiaries products, are pending or may be instituted against RJR Tobacco, the Conwood companies
or their affiliates, including RAI and RJR, or indemnitees, including B&W. These pending 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 the Conwood companies. 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 the Conwood companies are discussed separately
under the heading Smokeless Tobacco Litigation below.
In connection with the B&W business combination, RJR Tobacco has agreed to indemnify B&W and
its affiliates, including its indirect parent, British American Tobacco p.l.c., referred to as BAT,
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 B&W business
combination. In addition, pursuant to this indemnity, RJR Tobacco expensed less than $1 million
during each of the first three months of 2009 and 2008 respectively, for funds to be reimbursed to
BAT for costs and expenses incurred arising out of certain tobacco-related litigation.
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 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.
17
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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, the Conwood companies 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 for claims arising after 1986, 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 the Conwood
companies, 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 the Conwood companies, 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 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
consolidated balance sheet (unaudited) as of March 31, 2009. However, as of March 31, 2009, RJR
Tobacco had an accrual for $2 million related to non-smoking and health litigation, and RJR, and
its subsidiary RJR Tobacco, had 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 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 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 Master Settlement Agreement 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 Master Settlement Agreement to benefit
tobacco growers; and |
18
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
the original Broin flight attendant case discussed below under Litigation Affecting
the Cigarette Industry Class-Action Suits. |
The circumstances surrounding the MSA 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 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
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 a table depicting the related payment schedule, is set forth below under Litigation
Affecting the Cigarette Industry Health-Care Cost Recovery Cases MSA.
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 Health-Care Cost Recovery Cases, also can be distinguished from the circumstances
surrounding the MSA. 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. A comprehensive discussion of this case is set forth below
under Litigation Affecting the Cigarette Industry Health-Care Cost Recovery Cases.
As with claims that were resolved by the MSA, 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.
Likewise, RJR Tobacco and B&W separately settled the antitrust case DeLoach v. Philip Morris
Cos., Inc., which was brought by a unique class of plaintiffs: a class of all tobacco growers and
tobacco allotment holders. 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 DeLoach case and the
antitrust cases currently pending against RJR Tobacco and B&W involve different types of plaintiffs
and different theories of recovery under the antitrust laws than other cases pending against RJR
Tobacco and its affiliates and indemnitees.
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.
The Conwood companies also believe that they have valid defenses to the smokeless tobacco
litigation against them. The Conwood companies have 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 the Conwood
companies and their counsel. No verdict or judgment has been returned or entered against the
Conwood companies on any claim for personal injuries allegedly resulting from the use of smokeless
tobacco. The Conwood companies intend to defend vigorously all smokeless
19
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
tobacco litigation claims asserted against them. No liability for pending smokeless tobacco
litigation was recorded in RAIs consolidated balance sheet (unaudited) as of March 31, 2009.
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 the Conwood
companies, 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, the Conwood companies 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 of adverse verdicts 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,
or difficulties in obtaining the bonding required to stay execution
of judgments on appeal, 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 position could be materially adversely affected by the
ultimate outcome of certain pending litigation matters against RJR Tobacco or its affiliates or
indemnitees.
Similarly, smokeless tobacco litigation is subject to many uncertainties. Notwithstanding the
quality of defenses available to the Conwood companies, it is possible that RAIs results of
operations, cash flows or financial position could be materially adversely affected by the ultimate
outcome of certain pending litigation matters against the Conwood companies.
Litigation Affecting the Cigarette Industry
Overview
Introduction. In connection with the B&W business combination, 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 B&W business combination.
During the first quarter of 2009, 16 tobacco-related cases were served against RJR Tobacco or
its affiliates or indemnitees. On March 31, 2009, there were 4,135 cases, including 687 individual
smoker cases pending in West Virginia state court as a consolidated action and 3,264 Engle Progeny
Cases, involving approximately 8,806 individual plaintiffs, pending in the United States against
RJR Tobacco or its affiliates or indemnitees, as compared with 2,802 total cases on March 31, 2008,
pending in the United States against RJR Tobacco or its affiliates or indemnitees.
20
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
As of April 9, 2009, 209 tobacco-related cases were pending against RJR Tobacco or its
affiliates or indemnitees: 204 in the United States; one in Puerto Rico; three in Canada; and one
in Israel. Of the 204 total U.S. cases, 26 cases are pending against B&W that are not also pending
against RJR Tobacco. The U.S. case number does not include the 2,620 Broin II or the 3,266 Engle
Progeny Cases, as discussed below, pending as of April 9, 2009.
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 April 9, 2009, exclusive of the Broin II
and Engle Progeny Cases:
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
Florida |
|
|
23 |
|
New York |
|
|
22 |
|
Maryland |
|
|
20 |
|
Missouri |
|
|
20 |
|
Louisiana |
|
|
17 |
|
California |
|
|
13 |
|
Mississippi |
|
|
9 |
|
Illinois |
|
|
7 |
|
West Virginia |
|
|
6 |
* |
Connecticut |
|
|
4 |
|
Georgia |
|
|
4 |
|
Ohio |
|
|
3 |
|
Pennsylvania |
|
|
3 |
|
Kentucky |
|
|
3 |
|
District of Columbia |
|
|
3 |
|
Delaware |
|
|
2 |
|
Washington |
|
|
2 |
|
Alabama |
|
|
2 |
|
Kansas |
|
|
2 |
|
Minnesota |
|
|
2 |
|
New Mexico |
|
|
2 |
|
North Carolina |
|
|
2 |
|
South Dakota |
|
|
2 |
|
Tennessee |
|
|
2 |
|
Vermont |
|
|
2 |
|
Wisconsin |
|
|
2 |
|
New Jersey |
|
|
1 |
|
Maine |
|
|
1 |
|
Arizona |
|
|
1 |
|
Michigan |
|
|
1 |
|
Oregon |
|
|
1 |
|
South Carolina |
|
|
1 |
|
Alaska |
|
|
1 |
|
Arkansas |
|
|
1 |
|
Colorado |
|
|
1 |
|
Hawaii |
|
|
1 |
|
Idaho |
|
|
1 |
|
Indiana |
|
|
1 |
|
Iowa |
|
|
1 |
|
Mariana Islands |
|
|
1 |
|
Massachusetts |
|
|
1 |
|
Montana |
|
|
1 |
|
Nebraska |
|
|
1 |
|
Nevada |
|
|
1 |
|
New Hampshire |
|
|
1 |
|
North Dakota |
|
|
1 |
|
Oklahoma |
|
|
1 |
|
Rhode Island |
|
|
1 |
|
Utah |
|
|
1 |
|
Virginia |
|
|
1 |
|
21
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
Number of |
State |
|
U.S. Cases |
Wyoming |
|
|
1 |
|
|
|
|
|
|
Total |
|
|
204 |
** |
|
|
|
|
|
|
|
|
* |
|
Includes as one case the 687 cases pending as a consolidated action In Re: Tobacco Litigation Individual
Personal Injury Cases, described below. |
|
** |
|
Of the 204 pending U.S. cases, 29 are pending in federal court, 174 in state court and 1 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 April 9, 2009, compared with the number of cases
pending against RJR Tobacco, its affiliates or indemnitees as of February 6, 2009, as reported in
RAIs Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the SEC on
February 23, 2009, and a cross-reference to the discussion of each case type.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in |
|
|
|
|
|
|
|
|
Number of |
|
|
|
|
RJR Tobaccos |
|
Cases Since |
|
|
|
|
Case Numbers as |
|
February 6, 2009 |
|
Page |
Case Type |
|
of April 9, 2009 |
|
Increase/(Decrease) |
|
Reference |
Individual Smoking and Health |
|
|
113 |
|
|
|
11 |
|
|
|
26 |
|
West Virginia IPIC (Number of Plaintiffs)* |
|
|
1(687 |
) |
|
|
No Change |
|
|
|
28 |
|
Engle Progeny (Number of Plaintiffs)** |
|
|
3,266 (8,800 |
) |
|
|
110 |
|
|
|
28 |
|
Broin II |
|
|
2,620 |
|
|
|
No Change |
|
|
|
29 |
|
Class-Action |
|
|
15 |
|
|
|
No Change |
|
|
|
29 |
|
Health-Care Cost Recovery |
|
|
4 |
|
|
|
No Change |
|
|
|
35 |
|
MSA-Enforcement and Validity |
|
|
58 |
|
|
|
(2 |
) |
|
|
39 |
|
Antitrust |
|
|
2 |
|
|
|
No Change |
|
|
|
41 |
|
Other Litigation and Developments |
|
|
11 |
|
|
|
1 |
|
|
|
42 |
|
|
|
|
* |
|
The West Virginia Individual Personal Injury Cases have been separated
from the Individual Smoking and Health cases for reporting purposes. |
|
** |
|
The Engle Progeny Cases have been separated from the Individual
Smoking and Health cases for reporting purposes. Plaintiffs counsel
are attempting to include multiple plaintiffs in most of the cases
filed. The increase in the number of cases includes new cases served
and new cases filed by severed plaintiffs. |
Four pending cases against RJR Tobacco and B&W have attracted significant attention: the
Florida state court class-action case, Engle v. R. J. Reynolds Tobacco Co., the Louisiana state
court class-action case, Scott v. American 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 were permitted to file
individual lawsuits. On October 1, 2007, the U.S. Supreme Court denied the defendants petition for
writ of certiorari. As of April 9, 2009, RJR Tobacco had been served in 3,266 Engle Progeny Cases
in both state and federal courts in Florida. These cases include approximately 8,800 plaintiffs.
The number of cases will likely change due to individual plaintiffs being severed from
multi-plaintiff cases. In addition, RJR Tobacco is aware of 31 additional cases that have been
filed but not served (with 312 plaintiffs).
In 2004, a jury in Scott returned a verdict in favor of the Louisiana class for $591 million
to establish a state-wide smoking cessation program. In 2007, the Louisiana Court of Appeals upheld
class certification, significantly reduced the scope of recovery, and remanded the case for further
proceedings. The Louisiana and U.S. Supreme Courts denied the defendants applications for writ of
certiorari. In July 2008, the trial court entered an amended judgment in favor of the class for
approximately $263 million plus interest from June 30, 2004. On December 15, 2008, the trial court
signed the order for appeal of the amended judgment. Briefing is underway.
22
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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, including RJR Tobacco and B&W, 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. Oral argument occurred on October
14, 2008. A decision is pending.
In September 2006, the U.S. District Court for the Eastern District of New York in Schwab
certified a nation-wide class of lights smokers. 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. On April 3, 2008, the Second Circuit decertified the
class. The case was returned to the trial court for further proceedings.
For a detailed description of these cases, see Class-Action Suits Engle Case,
Class-Action Suits Medical Monitoring and Smoking Cessation Cases, 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, including the four
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 in perpetuity on RJR Tobacco, B&W and other major
U.S. cigarette manufacturers; and |
|
|
|
|
placed significant restrictions on their ability to market and sell cigarettes and
smokeless tobacco products. |
MSA payments are subject to adjustments for, among other things, the volume of cigarettes
sold, market share and inflation. See Health-Care Cost Recovery Cases MSA below for a
detailed discussion of the MSA, including RAIs operating subsidiaries 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. It is likely, however, that RJR Tobacco and other cigarette manufacturers will face an
increased number of tobacco-related trials in 2009 compared to recent years. The following table
lists the non-Engle Progeny trials scheduled, as of April 9, 2009, for RJR Tobacco or its
affiliates and indemnitees through March 31, 2010. There are 50
Engle Progeny cases against
RJR Tobacco and/or B&W set for trial in 2009, but it is not
known how many of these cases will actually be tried
in 2009.
|
|
|
|
|
|
|
Trial Date |
|
Case Name/Type |
|
Defendant(s) |
|
Jurisdiction |
May 18, 2009
|
|
Star Scientific v. R.J. Reynolds Tobacco Co.
[Other]
|
|
RJR Tobacco
|
|
U.S. District Court
District of Maryland
(Baltimore, MD) |
July 27, 2009
|
|
Smith v. Brown and Williamson Tobacco Corp.
[Individual]
|
|
B&W
|
|
Circuit Court
Jackson County
(Independence, MO) |
August 3, 2009
|
|
Woods v. R.J. Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco, B&W
|
|
U.S. District Court
Southern District
(Jackson, MS) |
August 5, 2009
|
|
Coley v. 3M Company.
[Other]
|
|
RJR Tobacco
|
|
Superior Court
New Castle County
(Wilmington, DE) |
September 4, 2009
|
|
Nichols v. Asbestos Corporation Limited
[Individual]
|
|
RJR Tobacco
|
|
Superior Court
San Diego County
(San Diego, CA) |
October 19, 2009
|
|
Nuzum v. Brown & Williamson Tobacco Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Jackson County
(Kansas City, MO) |
23
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
Trial Date |
|
Case Name/Type |
|
Defendant(s) |
|
Jurisdiction |
November 6, 2009
|
|
Izzarelli v. R.J. Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco
|
|
U.S. District Court
District of
Connecticut
(Bridgeport, CT) |
November 17, 2009
|
|
Grisham v. Philip Morris Inc.
[Individual]
|
|
B&W
|
|
U.S. District Court
Central District
(Los Angeles, CA) |
November 30, 2009
|
|
Williams v. Brown and Williamson Tobacco
Corp.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
City of St. Louis
(St. Louis, MO) |
February 1, 2010
|
|
In Re: Tobacco Litigation IPIC v. R.J.
Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco, B&W
|
|
Circuit Court
Kanawha County
(Charleston, WV) |
March 1, 2010
|
|
Prater v. R.J. Reynolds Tobacco Co.
[Individual]
|
|
RJR Tobacco, B&W
|
|
U.S. District Court
Southern District
(Natchez, MS) |
Trial Results. From January 1, 1999 through April 9, 2009, 55 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 38 cases, including four mistrials, tried in Florida (12), 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 April 9, 2009, 25 smoking and health cases in which
RJR Tobacco, B&W, or their respective affiliates were not defendants were tried. Verdicts were
returned in favor of the defendants in 14 cases, including two mistrials, tried in Florida (6),
California (3), New Hampshire (1), New York (1), Pennsylvania (1), Rhode Island (1) and Tennessee
(1). Verdicts in favor of the plaintiffs were returned in 11 cases tried in California (4), Florida
(4), Oregon (2) and Illinois (1).
One smoking and health or health-care cost recovery case in which RJR Tobacco was a defendant
was tried in the first quarter of 2009. In Gelep v. R.J. Reynolds Tobacco Co., a jury returned a
verdict in favor of RJR Tobacco on March 24, 2009. On April 1, 2009, the plaintiff filed a motion
for new trial and to set aside the verdict and, or in the alternative, a motion for judgment
notwithstanding the verdict. For a detailed description of the case, see Engle Progeny Cases
below.
The following chart reflects the verdicts in the smoking and health cases that have been tried
and remain pending as of April 9, 2009, in which verdicts have been returned in favor of the
plaintiffs and against RJR Tobacco or B&W, or both.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross-Reference to |
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.
|
|
See
Class-Action Suits
Engle Case
below. |
24
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross-Reference to |
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
June 11, 2002
|
|
Lukacs v. R. J.
Reynolds Tobacco
Co. [Engle class
member]
|
|
Circuit Court,
Miami-Dade County
(Miami, FL)
|
|
$500,000 economic
damages, $24.5
million
non-economic
damages and $12.5
million loss of
consortium damages
against Philip
Morris, B&W and
Liggett, of which
B&W was assigned
22.5% of liability.
Final judgment was
entered in the
amount of $24.8
million plus
interest applicable
at the yearly
statutory rates
from July 11, 2002.
RJR Tobacco was
dismissed from the
case in May 2002,
prior to trial.
|
|
See Engle
Progeny Cases
below. |
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.
|
|
See Individual
Smoking and Health
Cases below. |
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.
|
|
See
Class-Action Suits
Medical
Monitoring and
Smoking Cessation
Cases below. |
February 2, 2005
|
|
Smith v. Brown &
Williamson Tobacco
Corp. [Individual]
|
|
Circuit Court,
Jackson County
(Independence, MO)
|
|
$2 million in
compensatory
damages which was
reduced to $500,000
because of jurys
findings that the
plaintiff was 75%
at fault; $20
million in punitive
damages.
|
|
See Individual
Smoking and Health
Cases below. |
25
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross-Reference to |
Date of Verdict |
|
Case Name/Type |
|
Jurisdiction |
|
Verdict |
|
Post-Trial Status |
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.
|
|
See Individual
Smoking and Health
Cases below. |
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.
|
|
See Health-Care
Cost Recovery Cases
Department of
Justice Case
below. |
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 jointly
against RJR Tobacco
and Philip Morris;
$250,000 punitive
damages against RJR
Tobacco only.
|
|
See Individual
Smoking and Health
Cases below. |
Individual Smoking and Health Cases
As of April 9, 2009, 113 individual cases 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, Engle Progeny or West Virginia IPIC Cases discussed below. A total of 110 of the
individual cases are brought by or on behalf of individual smokers or their survivors, while the
remaining three cases are brought by or on behalf of individuals or their survivors alleging
personal injury as a result of exposure to ETS.
26
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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, 2009, to March 31,
2009, or remained on appeal as of March 31, 2009.
In Whiteley v. R. J. Reynolds Tobacco Co., the retrial of Whiteley v. Raybestos-Manhattan, a
case filed in April 1999 in Superior Court, San Francisco County, California and originally tried
in 2000, the jury awarded the plaintiff $2.46 million in compensatory damages jointly against RJR
Tobacco and Philip Morris, in May 2007, and returned a punitive damages verdict award of $250,000
against RJR Tobacco. RJR Tobaccos motion for judgment notwithstanding the verdict or, in the
alternative, for a new trial was denied on September 5, 2007. RJR Tobacco has appealed. Briefing is
complete. Oral argument has not been scheduled. RJR Tobacco deposited with the court approximately
$2.6 million in U.S. Treasury bills in lieu of supersedeas bond to stay enforcement of the judgment
pending 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 and attorneys fees in this wrongful death action
against B&W. 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, and
on December 28, 2007, remanded the case to the Superior Court for further review. Briefing is
complete. 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, who was dismissed prior to trial, 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 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.
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 against the defendants 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. Oral argument occurred on January 26, 2009. A decision is pending.
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 and ordered a new trial on punitive damages. On December 16, 2008, the
Missouri Court of Appeals issued an opinion that affirmed in part, reversed in part, and remanded
the case for further proceedings on the issue of punitive damages. On December 30, 2008, the
defendants filed a motion for rehearing, which was denied on January 27, 2009. A new trial on the
issue of punitive damages is scheduled to begin July 27, 2009.
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Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 December 12, 2006. Pursuant to its agreement to indemnify B&W, RJR
Tobacco posted a supersedeas bond in the amount of $2.058 million on February 7, 2006. On April 10,
2008, the Appellate Division reversed the judgment in the plaintiffs favor and ordered that the
case be dismissed. On May 8, 2008, the plaintiffs filed a notice of appeal. On December 16, 2008,
the New York Court of Appeals affirmed the order. The plaintiffs motion for leave to reargue was
denied on March 26, 2009.
West Virginia IPIC
In West Virginia, there are 729 cases (of which 687 are actions against RJR Tobacco and/or
B&W) pending as a consolidated action, In re: Tobacco Litigation Individual Personal Injury Cases.
These cases are proposed to be tried in a single proceeding. The West Virginia Supreme Court of
Appeals ruled that the U.S. Constitution does not preclude a trial in multiple phases in this case,
and the U.S. Supreme Court declined to review the issue. The current trial plan provides for a
three phase proceeding, with certain elements of liability and entitlement to punitive damages
being tried in Phase I. Phase II would address the ratio between any compensatory and punitive
damages awarded. Phase III would address all remaining individual issues including medical and
legal causation and compensatory damages. Trial is scheduled to begin February 1, 2010.
Engle Progeny Cases
Pursuant to the Florida Supreme Courts July 6, 2006, ruling in Engle v. R. J. Reynolds
Tobacco Co., which decertified the class, former class members had 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, also are 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 the Engle Progeny Cases. As
of April 9, 2009, RJR Tobacco had been served in 3,266 Engle Progeny Cases in both state and
federal courts in Florida. These cases include approximately 8,800 plaintiffs. The number of cases
will likely change due to individual plaintiffs being severed from multi-plaintiff cases. Many of
these cases are in active discovery, and several are expected to be tried in 2009. For further
information on the Engle case, see Class-Action Suits Engle Case, below.
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., was filed in February 2001, and is pending in Circuit Court,
Miami-Dade County, Florida, against the major U.S. cigarette manufacturers seeking to recover an
unspecified amount in compensatory and punitive damages. The plaintiff, John Lukacs, 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 case was tried against Philip
Morris, Liggett and B&W, and resulted in a verdict for the plaintiffs on June 11, 2002. The
Florida state court jury awarded the plaintiffs a total of $37.5 million in compensatory damages.
The jury assigned 22.5% fault to B&W, 72.5% fault to the other defendants and 5% fault to plaintiff
John Lukacs. On April 1, 2003, the Miami-Dade County Circuit Court granted in part the defendants
motion for remittitur and reduced the jurys award to plaintiff Yolanda Lukacs on the loss of
consortium claim from $12.5 million to $0.125 million, decreasing the total award to $25.125
million. On August 2, 2006, the plaintiff filed a motion for entry of partial judgment and notice
of jury trial on punitive damages. On January 2, 2007, the defendants asked the court to set aside
the jurys 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, which the court deferred
until the U.S. Supreme Court completed its review of Engle and after further submissions by the
parties. On January 28, 2008, the defendants filed a submission asking the court to set aside the
verdict and to dismiss the case. The court granted the plaintiffs motion for entry of judgment on
August 14, 2008. Pursuant to the verdict rendered, the plaintiff, Robin Lukacs, as personal
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Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
representative of the estate of John and Yolanda Lukacs, will recover the sum of $24.8 million
plus interest applicable at the yearly statutory rates from June 11, 2002. On October 17, 2008, the
plaintiff withdrew her request for punitive damages. On October 30, 2008, the defendants motion
for reconsideration of or, in the alternative, to alter or amend the order on the plaintiffs
motion for entry of judgment was denied. On November 12, 2008, the court entered final judgment. On
December 1, 2008, the defendants filed a notice of appeal. Briefing is underway. Pursuant to its
agreement to indemnify B&W, RJR Tobacco posted a supersedeas bond in the amount of approximately
$15.2 million on March 19, 2009.
On March 24, 2009, in Gelep v. R.J. Reynolds Tobacco Co., a case filed in October 1998 in
Circuit Court, Pinellas County, Florida, a jury returned a verdict in favor of the defendants. The
plaintiff, Mary Gelep, alleged that use of the defendants products caused Mr. Gelep to develop
lung cancer, kidney cancer and other smoking related conditions and/or diseases which resulted in
his death. The plaintiff was seeking an unspecified amount of actual and punitive damages. On
April 1, 2009, the plaintiff filed a motion for new trial or, in the alternative, a motion for
judgment notwithstanding the verdict.
Broin II Cases
As of April 9, 2009, there were 2,620 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 airplane cabins, that is, specific causation.
Class-Action Suits
Overview. As of April 9, 2009, 15 class-action cases, exclusive of antitrust class actions,
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, Illinois, Louisiana,
Minnesota, Missouri, New York, West Virginia and Georgia. All pending class-action cases are
discussed below.
The pending class-actions against RJR Tobacco or its affiliates or indemnitees include eight
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 Illinois, Minnesota, Missouri and New York and are discussed below under Lights
Cases.
Finally, certain third-party payers have filed health-care cost recovery actions in the form
of class-actions. These cases are discussed below under Health-Care Cost Recovery Cases.
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 smoker class actions have been certified by a federal court In re
Simon (II) Litigation, 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 and ultimately decertified.
Medical Monitoring and Smoking Cessation Cases. 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
29
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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. 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 II 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, that
is, the portions for RJR Tobacco and B&W, towards the bond. On February 7, 2007, the Louisiana
Court of Appeals upheld the class certification and found the defendants responsible for funding
smoking cessation for eligible class members. The appellate court also ruled, however, that the
defendants were not liable for any post-1988 claims, rejected the award of prejudgment interest and
struck eight of the 12 components of the smoking cessation program. In particular, the appellate
court ruled that no class member, who began smoking after September 1, 1988, could receive any
relief, and that only those smokers, whose claims accrued on or before September 1, 1988, would be
eligible for the smoking cessation program. The plaintiffs have expressly represented to the trial
court that none of their claims accrued before 1988 and that the class claims did not accrue until
around 1996, when the case was filed. On March 2, 2007, the defendants application for rehearing
and clarification was denied. The defendants application for writ of certiorari with the Louisiana
Supreme Court was denied on January 7, 2008. The defendants petition for writ of certiorari with
the U.S. Supreme Court was denied on June 10, 2008. On July 21, 2008, the trial court entered an
amended judgment in the case. The court found that the defendants are jointly and severally liable
for funding the cost of a court-supervised smoking cessation program and ordered the defendants to
deposit approximately $263 million together with interest from June 30, 2004, into a trust for the
funding of the program. The court also stated that it would favorably consider a motion to return
to defendants a portion of unused funds at the close of each program year in the event the monies
allocated for the preceding program year were not fully expended because of a reduction in class
size or underutilization by the remaining plaintiffs.
On August 27, 2008, the court denied the defendants request for permission to pursue an
appeal. On September 9, 2008, the defendants filed an emergency application for writ of mandamus or
supervisory writ with request for stay and expedited consideration. The same day, the Louisiana
Court of Appeals stayed all proceedings pending further orders of the court. On November 17, 2008,
the Court of Appeals granted the defendants writ and ordered the trial court to sign the order for
appeal. On December 10, 2008, the plaintiffs application for supervisory writs of certiorari and
or review from the November 17, 2008 ruling was denied by the Louisiana Supreme Court. On December
15, 2008, the trial court judge signed an order granting the defendants an appeal from the amended
judgment. Briefing is underway.
Peoples v. Reynolds American, Inc., filed November 17, 2008 in the U.S. District Court for the
Northern District of Georgia, is a purported RICO class action on behalf of Georgia smokers
claiming that RAI, Altria and Lorillard, and/or their affiliates wrongfully influenced the federal
governments National Cancer Institute not to recommend CT scans as a routine lung cancer screening
test for smokers. Plaintiffs claim that the NCIs failure to endorse the test leads insurers to
deny reimbursement and persuades doctors not to order the tests as a result. The plaintiffs seek a
variety of damages, including alleged contemplated damages under RICO, punitive damages, attorneys
fees, interest and costs. The defendants have moved to dismiss the case based on the plaintiffs
failure to state a claim under RICO.
Engle Case. Trial began in July 1998 in Engle v. R. J. Reynolds Tobacco Co., a case filed in
May 1994, 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
30
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 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 became 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 the
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. As of April 9, 2009, 3,266 individual cases were
filed in Florida as a result of the Engle decision. These cases include approximately 8,800
plaintiffs. 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 October 1, 2007, the defendants petition for writ of certiorari with the U.S. Supreme Court was
denied. On November 26, 2007, the defendants petition for rehearing with the U.S. Supreme Court
was denied. As a result, the verdicts in favor of Mary Farnan and Angie Della Vecchia, mentioned
above, became final. On February 8, 2008, RJR Tobacco paid approximately $5.9 million relating to
the compensatory damages verdicts mentioned above, which amount was determined using the total
amount of the verdicts together with accrued interest beginning November 7, 2000. On May 14, 2008,
the court entered an order granting the motion for discharge and return of compensatory damages
supersedeas bond. During the second quarter of 2008, RJR Tobacco received the cash collateral of
$3.8 million that it posted for the compensatory damages bond. Also on May 14, 2008, plaintiffs
Mary Farnan and Ralph Della Vecchia, as representative of the estate of Angie Della Vecchia, filed
satisfactions of judgment and waived all claims for punitive damages and acknowledged full payment
in satisfaction of the November 7, 2000, amended final judgment.
31
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
The same day, the court granted the parties joint motion to sever moving plaintiffs claims.
Plaintiffs Raymond Lacey, Michael Matyi and Loren Lowery have filed new cases. Plaintiff Howard
Engle filed a stipulation for dismissal with prejudice, which the court ordered on July 2, 2008. On
January 7, 2009, plaintiff Marilyn Calhouns motion for relief from judgment, which sought to
extend the deadline for filing Engle Progeny Cases beyond January 11, 2008, was denied by the
Florida Supreme Court.
Since the Florida Supreme Courts July 6, 2006 opinion, one Engle Progeny Case has proceeded
to trial against RJR Tobacco or B&W. RJR Tobacco expects that other Engle Progeny Cases will
proceed to trial against RJR Tobacco and/or B&W in 2009. For further information on Engle Progeny
Cases, see Engle Progeny Cases above.
California Business and Professions Code Cases. 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
court 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.
On March 7, 2005, the court granted the defendants motion to decertify the class. On September 5,
2006, the California Court of Appeal affirmed the judges order decertifying the class. On November
1, 2006, the plaintiffs petition for review with the California Supreme Court was granted.
Briefing is complete. Oral argument occurred on March 3, 2009. A decision is pending.
Lights Cases. As noted above, lights class-action cases are pending against RJR Tobacco
or B&W in Illinois (3), Missouri (2), Minnesota (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.
Many of these lights cases were stayed pending review of the Good v. Altria Group, Inc. case
by the U.S. Supreme Court. On December 15, 2008, the U.S. Supreme Court decided that these claims
are not preempted by the Federal Cigarette Labeling and Advertising Act or by the Federal Trade
Commissions, referred to as FTC, historic regulation of the industry. In light of this decision,
it is likely that one or more of the stayed cases will become active in 2009.
The seminal lights class-action case involved RJR Tobaccos competitor, Philip Morris, Inc.
Trial began in Price v. Philip Morris, Inc. in January 2003. In March 2003, the trial judge entered
judgment against Philip Morris in the amount of $7.1 billion in compensatory damages and $3 billion
in punitive damages to the State of Illinois. Based on Illinois law, the bond required to stay
execution of the judgment was set initially at $12 billion. Philip Morris pursued various avenues
of relief from the $12 billion bond requirement. In December 2005, the Illinois Supreme Court
reversed the lower courts decision and sent the case back to the trial court with instructions to
dismiss the case. In December 2006, the defendants motion to dismiss and for entry of final
judgment was granted and the case was dismissed with prejudice the same day. The plaintiffs motion
to vacate and/or withhold judgment was dismissed by the court on August 30, 2007. On December 18,
2008, the plaintiffs filed a petition for relief from judgment stating that the U.S. Supreme
Courts decision in Good v. Altria Group, Inc. rejected the basis for the reversal. The trial court
granted the defendants motion to dismiss the plaintiffs petition for relief from judgment on
February 4, 2009. On March 3, 2009, the plaintiffs filed a notice of appeal to the Illinois
Appellate Court, Fifth Judicial District, requesting a reversal of the February 4, 2009 order and
remand to the circuit court.
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 pending Philip Morriss appeal of the Price v. Philip
Morris Inc. case mentioned above, which the judge denied on July 11, 2003. On October 17, 2003, the
Illinois Fifth District Court of Appeals denied RJR Tobaccos emergency
32
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
stay/supremacy order request. On November 5, 2003, the Illinois Supreme Court granted RJR
Tobaccos motion for a stay pending the courts final appeal decision in Price. On October 11,
2007, the Illinois Fifth District Court of Appeals dismissed RJR Tobaccos appeal and remanded the
case to the circuit court. There is currently no activity in the case.
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 mentioned above. 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. There
is currently no activity in the case.
Schwab [McLaughlin] v. Philip Morris USA, Inc., a nation-wide lights class-action, was filed
on May 11, 2004, in the U.S. District Court for the Eastern District of New York, against RJR
Tobacco and B&W, as well as other tobacco manufacturers. 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. 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. On April 3, 2008, the Second Circuit decertified the class. The
case was returned to the trial court for further proceedings.
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. On April 16, 2008, the court stayed the case pending U.S. Supreme Court review in
Good v. Altria Group, Inc., a lights class-action pending against Altria and Philip Morris USA.
As a result of the U.S. Supreme Courts decision in Good v. Altria Group, Inc., this case is likely
to become active in 2009.
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. On April 16, 2008, the court stayed the case pending
U.S. Supreme Court review in Good v. Altria Group, Inc. As a result of the U.S. Supreme Courts
decision in Good v. Altria Group, Inc., this case is likely to become active in 2009.
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, ruling the lights
claims are preempted by the Federal Cigarette Labeling and Advertising Act. On July 11, 2005, the
plaintiffs appealed to 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, which on December 4, 2007, reversed the judgment and remanded the case to the District
Court. On February 27, 2008, RJR Tobaccos motion to stay its January 3, 2008, petition for review
until the completion of the U.S. Supreme Court review in Good v. Altria Group, Inc. was granted. On
January 20, 2009, the Minnesota Supreme Court issued an order vacating the February 27, 2008 order
that granted RJR Tobaccos petition for review. As a result of the U.S. Supreme Courts decision in
Good v. Altria Group, Inc., the case is likely to become active in 2009.
In Thompson v. R. J. Reynolds Tobacco Co., a case filed in February 2005 in District Court,
Hennepin County, Minnesota, RJR Tobacco removed the case on September 23, 2005 to the U.S. 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. On October 29, 2007,
the U.S. District Court remanded the case to the District Court for Hennepin County. On February 1,
2008, the court stayed the case until the completion of the appeal in Dahl v. R. J. Reynolds
Tobacco Co. and Good v. Altria Group, Inc. As a result of the U.S. Supreme Courts decision in Good
v. Altria Group, Inc., this case is likely to become active in 2009.
33
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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 March 27, 2006, the court
dismissed count V, public nuisance, and count VI, unjust enrichment. On July 11, 2006, the
plaintiffs filed a motion for class certification. The plaintiffs filed an amended complaint on
March 3, 2009, to add a claim of unjust enrichment and to include in the class individuals who
smoked light cigarettes. On March 13, 2009, the defendants filed a notice of removal to the U.S.
District Court for the Northern District of Illinois. RJR Tobacco and B&W answered the amended
complaint on March 31, 2009. The plaintiffs filed a motion to remand back to the Circuit Court of
Cook County on April 13, 2009.
On April 17, 2009, plaintiffs in several pending lights cases filed a motion before the
Federal Panel on Multi-District Litigation to transfer and consolidate eleven lights cases for
pretrial proceedings. Among the cases sought to be consolidated were Schwab and Cleary, as well as
nine additional cases currently pending against Philip Morris. Plaintiffs also requested that the
actions all be transferred to Judge Jack Weinstein of the Eastern District of New York.
In the event RJR Tobacco and its affiliates or indemnitees lose one or more of the pending
lights class-action suits, RJR Tobacco could face 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 position.
Other Class Actions. Young v. American Tobacco Co., Inc., a case filed in November 1997 in
Circuit Court, Orleans Parish, Louisiana, the plaintiffs brought an ETS class action against U.S.
cigarette manufacturers, including RJR Tobacco and B&W, and parent companies of U.S. cigarette
manufacturers, including RJR, on behalf of all residents of Louisiana who, though not themselves
cigarette smokers, have been exposed to secondhand smoke from cigarettes which were manufactured by
the defendants, and who allegedly suffered 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 million in compensatory and punitive damages individually and an unspecified amount for
the class in both compensatory and punitive damages. The class is brought on behalf of persons who
allegedly have personal injury claims arising from their exposure to respirable asbestos fibers and
cigarette smoke. 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.
Finally, 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
34
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
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 have suffered 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 airplane cabins, referred to as specific causation, the individual plaintiff will have
the burden of proof. 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.
Health-Care Cost Recovery Cases
Health-care cost recovery cases have been brought by a variety of plaintiffs. Other than
certain governmental actions, these cases largely have been unsuccessful on remoteness grounds,
which means that one who pays an injured persons medical expenses is legally too remote to
maintain an action against the person allegedly responsible for the injury.
As of April 9, 2009, four health-care cost recovery cases were pending in the United States
against RJR Tobacco, B&W, as its indemnitee, or both, as discussed below after the MSA discussion.
MSA. 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 Master Settlement Agreement 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 Master Settlement Agreement 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. |
35
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Set forth below are tables depicting the unadjusted tobacco industry settlement payment
schedule and the settlement payment schedule for RAIs operating subsidiaries under the MSA,
including the settlement agreements with the states of Mississippi, Florida, Texas and Minnesota,
and related information for 2007 and beyond:
Unadjusted Original Participating Manufacturers Settlement Payment Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013 and |
|
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
|
2011 |
|
|
2012 |
|
|
thereafter |
|
First Four States Settlements: (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mississippi Annual Payment |
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
|
$ |
136 |
|
Florida Annual Payment |
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
|
|
440 |
|
Texas Annual Payment |
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
|
|
580 |
|
Minnesota Annual Payment |
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
|
|
204 |
|
Remaining States Settlement: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Payments (1) |
|
|
7,004 |
|
|
|
8,004 |
|
|
|
8,004 |
|
|
|
8,004 |
|
|
|
8,004 |
|
|
|
8,004 |
|
|
|
8,004 |
|
Base Foundation Funding |
|
|
25 |
|
|
|
25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Growers Trust (2) |
|
|
500 |
|
|
|
500 |
|
|
|
295 |
|
|
|
295 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Offset by federal tobacco buyout(2) |
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(295 |
) |
|
|
(295 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
8,389 |
|
|
$ |
9,389 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
$ |
9,364 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RAIs
Operating Subsidiaries Settlement Expenses and Payment
Schedule
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement expenses |
|
$ |
2,821 |
|
|
$ |
2,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Settlement cash payments |
|
$ |
2,616 |
|
|
$ |
2,830 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected settlement expenses |
|
|
|
|
|
|
|
|
|
$ |
>2,400 |
|
|
$ |
>2,300 |
|
|
$ |
>2,250 |
|
|
$ |
>2,200 |
|
|
$ |
>2,200 |
|
Projected settlement cash payments |
|
|
|
|
|
|
|
|
|
$ |
>2,200 |
|
|
$ |
>2,400 |
|
|
$ |
>2,300 |
|
|
$ |
>2,250 |
|
|
$ |
>2,200 |
|
|
|
|
(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 and Related Litigation below. |
The MSA also contains provisions restricting the marketing of tobacco products. 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. Furthermore, the MSA required the dissolution of three
industry-sponsored research and trade organizations.
The MSA has materially adversely affected RJR Tobaccos shipment volumes. RAI believes that
these settlement obligations may materially adversely affect the results of operations, cash flows
or financial position of RAI and RJR Tobacco in future periods. The degree of the adverse impact
will depend, among other things, on the rate of decline in U.S. cigarette sales in the premium and
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.
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 non-jury, bench trial began in September 2004, and closing arguments concluded on
June 10, 2005.
36
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On August 17, 2006, the court found certain defendants, including RJR Tobacco and B&W, 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 the defendants appeal. On
September 28, 2006, the district court denied the 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. Oral argument in the appeals
occurred on October 14, 2008. A decision is pending.
The stay of the district courts order suspends the enforcement of the order pending the
outcome of the 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,
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 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 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
in the United States against RJR Tobacco and its affiliates or indemnitees.
Three health-care reimbursement cases are pending against RJR Tobacco or B&W outside the
United States, two in Canada and one in 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 to 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
37
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
and competition acts. In September 2008, the trial date of September 6, 2010, was adjourned to
a target trial date of September 2011.
On March 13, 2008, a case was filed on behalf of Her Majesty the Queen in Right of the
Province of New Brunswick, Canada, against certain cigarette manufacturers, including RJR Tobacco,
in the Trial Division in the Court of Queens Bench of New Brunswick. The plaintiff seeks to
recover the present value of total expenditures by the Province for health care benefits resulting
or expecting to result from tobacco-related diseases or risk of tobacco-related diseases, costs or
special or increased costs. The plaintiff alleges that the defendants are liable under the
following theories: deceit and misrepresentation, failure to warn, promotion of cigarettes to
children and adolescents, negligent design and manufacture, breaches of other common law, equitable
and statutory duties and obligations and conspiracy and concerted action in Canada. On June 26,
2008, RJR Tobacco filed a notice of intent to defend.
On September 1, 1998, the General Health Services filed a statement of claim against certain
cigarette manufacturers, including RJR Tobacco and B&W, in the District Court of Jerusalem, Israel.
The plaintiff seeks to recover the past and future value of the total expenditures for health-care
services provided to residents of Israel resulting from tobacco-related disease, court ordered
interest for past expenditures from date of filing the statement of claim, increased and/or
punitive and/or exemplary damages and costs. The plaintiff alleges 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. A decision is pending.
Native American Tribe Cases. As of April 9, 2009, 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 April 9, 2009, 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.
Trial is scheduled for June 7, 2010. On July 11, 2008, certain defendants, including RJR Tobacco
and B&W, filed a motion for summary judgment based on the plaintiffs lack of proof linking the
defendants allegedly wrongful conduct with the claimed damages. Oral argument occurred on November
24, 2008. A decision is pending. On March 2, 2009, the defendants filed a motion for partial
summary judgment against plaintiff City of St. Louis. On March 27, 2009, certain defendants,
including RJR Tobacco and B&W, filed a motion for summary judgment against IRHC Corp.
Other Cases. On May 20, 2008, the National Committee to Preserve Social Security and Medicare
filed a case against the major U.S. cigarette manufacturers, including RJR Tobacco, in the U.S.
District Court for the Eastern District of New York. The case seeks to recover twice the amount
paid by Medicare for health services provided to Medicare beneficiaries to treat their diseases
attributable to smoking the defendants cigarettes from May 21, 2002, to the present, for which
treatment the defendants were required or responsible to make payment under the Medicare
Secondary Payer Act. On July 21, 2008, the defendants filed a motion to dismiss for failure to
state a claim for lack of standing. On the same day, the plaintiffs filed a motion for summary
judgment as to liability under
the Federal Rules of Civil Procedure 56(d)(2). On March 5, 2009, the court granted the
defendants motion to dismiss and denied the plaintiffs cross-motion for summary judgment. The
plaintiffs filed a motion for reconsideration on March 13, 2009.
38
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
MSA-Enforcement and Validity
As of April 9, 2009, there were 58 cases concerning the enforcement, validity or
interpretation of the MSA in which RJR Tobacco or B&W is a party. This number includes those cases,
discussed below, relating to disputed payments under the MSA.
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 advertising for the Eclipse
cigarette brand violated both the MSA and the Vermont Consumer Fraud Statute. The State of Vermont
is seeking declaratory, injunctive, and monetary relief. The bench trial in this action began on
October 6, 2008, and lasted a total of five weeks. Closing arguments occurred on March 11, 2009. A
decision is pending.
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 exceeded $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.
On October 28, 2008, Vibo Corporation, Inc. d/b/a General Tobacco, referred to as General,
filed a complaint in the U.S. District Court for the Western District of Kentucky against RJR
Tobacco and other participating manufacturers, referred to as PMs, under the MSA, and the Attorneys
General of the 52 states and territories that are parties to the MSA. General sought, among other
things, to enjoin enforcement of certain provisions of the MSA and an order relieving it of certain
of its payment obligations under the MSA and, in the event such relief was not granted, rescission
of Generals 2004 agreement to join the MSA. General also moved for a preliminary injunction that,
among other things, would have enjoined the states from enforcing certain of Generals payment
obligations under the MSA. On November 14, 2008, RJR Tobacco and the other defendants moved to
dismiss Generals complaint. On January 5, 2009, the court issued a memorandum opinion and order
granting the defendants motions and dismissing Generals lawsuit.
On December 11, 2008, General filed a second complaint, for declaratory relief under the MSA
in the California Superior Court for the County of San Diego against the State of California and
RJR Tobacco and other PMs under the MSA. Generals complaint seeks a declaration that a proposed
amendment to its agreement to join the MSA, under which it would no longer have to make certain MSA
payments, did not trigger the MSAs most favored nations provision or require that the settling
states agree to make similar terms available to other PMs. RJR Tobacco filed an answer to the
complaint on February 17, 2009. On March 9, 2009, RJR Tobacco and certain other PMs filed a motion
for summary judgment or, in the alternative, for summary adjudication. On March 17, 2009, a
group of subsequent participating manufacturers, referred to as SPMs, filed a similar motion.
Both motions are pending.
In December 2007, nine states (California, Connecticut, Illinois, Maine, Maryland, New York,
Ohio, Pennsylvania and Washington) sued RJR Tobacco claiming that an advertisement published in a
magazine the prior
39
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
month violated the MSAs ban on the use of cartoons. The states asserted that
the magazines content adjacent to a Camel gatefold advertisement included cartoon images
prohibited by the MSA and that certain images used in the Camel ad itself were prohibited cartoons.
In addition, three states (Connecticut, New York and Maryland) also claimed that a direct mail
piece distributed by RJR Tobacco violated the MSA prohibition against distributing utilitarian
items bearing a tobacco brand name. Each state sought injunctive relief and punitive monetary
sanctions. Eight of the nine courts have since ruled that the states are not entitled to the
punitive sanctions being sought. (The issue has not been resolved definitively by the other court
at this time). Four of these cases have been ruled upon following bench trials. In two states
(Washington and Maine), RJR Tobacco received complete defense rulings. In one state (Ohio), the
Court agreed that the Camel advertisement did not use any cartoons, but ruled that the company
should have prevented the use of cartoons in magazine-created content next to the RJR Tobacco
advertisement. In the most recent decision, the California MSA court ruled the opposite: it held
that the company was not liable for preventing the use of cartoons in magazine-created content next
to the RJR Tobacco advertisement, but that a few of the images in the RJR Tobacco advertisement
itself were technical and unintentional cartoons. No monetary sanctions were awarded by the Ohio
or California courts. In Ohio, however, the state has submitted a petition to recover
approximately $43,000 in attorneys fees and costs. RJR Tobacco has filed a notice of appeal and
believes it has strong bases for the appeal. RJR Tobacco is awaiting rulings by the MSA courts in
Pennsylvania and Illinois. Finally, in Stewart v. RJR Tobacco, a class-action suit was filed in
California state court in December 2007, against the magazines publisher, Wenner Media, and RJR
Tobacco claiming the mention of bands in the magazine-created content violated their right of
publicity. The plaintiffs seek compensatory and punitive damages. This case is still in a
preliminary phase.
NPM Adjustment. The MSA includes an adjustment, referred to as an NPM Adjustment, that
potentially reduces the annual payment obligations of RJR Tobacco and the other PMs. Certain
requirements must be satisfied before the NPM Adjustment for a given year is available: (1) an
independent auditor designated under the MSA must determine that the PMs have experienced a market
share loss beyond a triggering threshold to those manufacturers that do not participate in the MSA,
such non-participating manufacturers referred to as NPMs, and (2) in a binding arbitration
proceeding, a firm of independent economic consultants must find that the disadvantages of the MSA
were a significant factor contributing to the loss. When these two requirements are satisfied, the
MSA provides that the NPM Adjustment applies to reduce the annual payment obligation of the PMs.
However, an individual settling state may avoid its share of the NPM Adjustment if it had in place
and diligently enforced during the entirety of the relevant year a Qualifying Statute that
imposes escrow obligations on NPMs that are comparable to what the NPMs would have owed if they had
joined the MSA. In such event, the states share of the NPM Adjustment is reallocated to other
settling states, if any, that did not have in place and diligently enforce a Qualifying Statute.
NPM Adjustment Claim for 2003. For 2003, the MSA independent auditor determined that the PMs
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. As a
result, on April 19, 2007, RJR Tobacco instructed the independent auditor to release to the
settling states approximately $32 million from the disputed payments account.
Following RJR Tobaccos payment of a portion of its 2006 MSA payment into the disputed
payments 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 compelling RJR Tobacco and the other PMs that placed money in the disputed payments
account to pay the disputed amounts to the settling states. In response, RJR Tobacco and other PMs,
pursuant to the MSAs arbitration provisions, moved to compel arbitration of the parties dispute
concerning the 2003 NPM Adjustment, including the States diligent enforcement claims, before a
single, nationwide arbitration panel of three former federal judges. The settling states opposed
these motions, arguing, among other things, that the issue of diligent enforcement must be resolved
by MSA courts in each of the 52 settling states and territories.
As of April 9, 2009, all 48 courts that had addressed the question whether the dispute
concerning the 2003 NPM Adjustment is arbitrable had ruled that arbitration is required under the
MSA. In 46 states, the orders compelling arbitration are final and/or non-appealable.
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Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On December 8, 2008, RJR Tobacco and certain other PMs entered into an Agreement Regarding
Arbitration, referred to as the Agreement, with 25 of the settling states. The Agreement
establishes October 1, 2009, as the date by which arbitration begins. To encourage the
participation of the settling states, the Agreement provided certain financial incentives to the
signing settling states, in the form of a potential reduction in the amount of a given settling
states liability (if any) with respect to the 2003 NPM Adjustment, as well as the potential for
release of a portion of certain amounts deposited in the disputed payments account by RJR Tobacco
and certain other PMs in connection with the 2005 NPM Adjustment. Other settling states were given
until January 30, 2009, to sign the Agreement and also receive the benefit of the financial
incentives provided in that agreement. As of January 30, 2009, 45 of the settling states,
representing approximately 90% of the allocable share of the settling states, had signed the
Agreement. By virtue of the fact that settling states representing allocable share greater than 80%
have signed the Agreement, signing states will have their ultimate liability (if any) with respect
to the 2003 NPM Adjustment reduced by 20%, and RJR Tobacco and the other PMs that placed their
share of the disputed 2005 NPM Adjustment into the disputed payments account will, without
releasing or waiving any claims, authorize the release of those funds to the settling states.
NPM Adjustment Claim for 2004. During 2006, proceedings were initiated with respect to an NPM
Adjustment for 2004. The MSA independent auditor again determined that the PMs had suffered a
market share loss sufficient to trigger an NPM Adjustment for 2004. On April 17, 2006, RJR Tobacco
and other PMs initiated the significant factor proceeding before the independent economic
consultant 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.
NPM Adjustment Claim for 2005. During 2007, proceedings were initiated with respect to an NPM
Adjustment for 2005. The MSA independent auditor again determined that the PMs had suffered a
market share loss sufficient to trigger an NPM Adjustment for 2005. On April 18, 2007, RJR Tobacco
and other PMs initiated the significant factor proceeding called for under the MSA. On February
7, 2008, the independent economic consulting firm issued a final, non-appealable determination that
the disadvantages of the MSA were a significant factor contributing to the 2005 market share
loss. On April 15, 2008, RJR Tobacco placed approximately $431 million of its 2008 MSA payment into
the disputed payments account. That amount represented RJR Tobaccos share of the 2005 NPM
Adjustment as calculated by the independent auditor, net of certain slight adjustments to reflect
revised independent auditor calculations of RJR Tobaccos share of the 2003 and 2004 NPM
Adjustments.
NPM Adjustment Claim for 2006. During 2008, proceedings were initiated with respect to an NPM
Adjustment for 2006. The MSA independent auditor again determined that the PMs had suffered a
market share loss sufficient to trigger an NPM Adjustment for 2006. On April 29, 2008, RJR Tobacco
and other PMs initiated the significant factor proceeding called for under the MSA. On March 24,
2009, the independent economic consulting firm issued its final determination that the
disadvantages of the MSA were a significant factor contributing to the 2006 market share loss. On
April 15, 2009, RJR Tobacco retained approximately $406.5 million of its 2009 MSA payment to
reflect its share of the 2006 NPM Adjustment as calculated by the independent auditor.
In
addition to the NPM Adjustment claims described above, RJR Tobacco
has filed dispute notices with respect to its 2007 and 2008 annual
MSA payments relating to the NPM Adjustments potentially applicable
to those years. The total amount at issue for those two years is
approximately $900 million.
Due to the uncertainty over the final resolution of the NPM Adjustment claims asserted by RJR
Tobacco, no assurances can be made related to the amounts, if any, that will be realized.
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 April 9, 2009, all of the federal and state
court cases
on behalf of indirect purchasers have been dismissed, except for one state court case pending
in each of 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
41
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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.
The parties are currently engaged in discovery.
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 November 18, 2008, the New Mexico Court of Appeals reversed the grant of summary
judgment in favor of RJR Tobacco, B&W and Philip Morris. On January 7, 2009, RJR Tobacco filed a
petition for a writ of certiorari, and on February 27, 2009, the Supreme Court of the State of New
Mexico granted that petition.
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.
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In February 2003, the RCMP filed criminal charges in the Province of Ontario against,
and purported to serve summonses on, JTI-Macdonald Corp., referred to as JTI-MC, Northern
Brands, R. J. Reynolds Tobacco International, Inc., referred to as RJR-TI, R. J. Reynolds
Tobacco Co., Puerto Rico, referred to as RJR-PR, and eight individuals associated with
RJR-MI and/or RJR-TI during the period January 1, 1991, through December 31, 1996. The
charges allege fraud and conspiracy to defraud Canada and the Provinces of Ontario and
Quebec in connection with the purchase, sale, export, import and/or re-export of cigarettes
and/or fine cut tobacco. In October 2003, Northern Brands, RJR-TI and RJR-PR each
challenged both the propriety of the service of the summonses and the jurisdiction of the
court. On February 9, 2004, the Superior Court of Justice ruled in favor of these
companies. The government filed a notice of appeal from that ruling on February 18, 2004,
but did not perfect its appeal until May 8, 2007. At the oral argument on October 29, 2007,
the Court of Appeal announced a unanimous decision in favor of the companies position and
dismissed the governments appeal. A final written order dismissing the appeal was entered
by the Court of Appeal on December 3, 2007. |
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A preliminary hearing commenced on April 11, 2005, for the purpose of determining whether
the Canadian prosecutor had sufficient evidence supporting the criminal charges to justify a
trial of the defendants that had 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 separately filed papers seeking an order quashing the order
committing them to stand trial, and the government filed papers seeking an order quashing
the order discharging six of the accused. On December 19, 2007, JTI-MC abandoned its effort
to have the order committing it to trial quashed. On February 19, 2008, the Superior Court
of Justice in Ontario denied Mr. Langs request to quash the order committing him to trial.
The court granted the governments request to quash the order discharging six individuals
and remanded the matter to the
preliminary hearing judge for reconsideration. No appeals were taken from that decision. The
matter is currently being reconsidered by the preliminary hearing judge. |
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On July 31, 2007, each of the accused companies, including RJR-TI, RJR-PR and Northern
Brands, and each of the seven accused individuals were given notice that the Canadian
prosecutor had requested the |
42
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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Attorney General of Ontario to consent to the issuance of
preferred indictments against each of them. RJR-TI, RJR-PR and Northern Brands as well as
the other accused filed written submissions with the Attorney General opposing the issuance
of the indictments against them. On October 31, 2007, the Office of the Attorney General of
Ontario confirmed that the prosecutors request for preferred indictments against RJR-TI,
RJR-PR and Northern Brands had been denied at that point in time. |
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In July 2003, a Statement of Claim was filed against JTI-MC and others in the Superior
Court of Justice, Ontario, Canada by Leslie and Kathleen Thompson. Mr. Thompson is a former
employee of Northern Brands and JTI-MCs predecessor, RJR-MI. Mr. and Mrs. Thompson have
alleged breach of contract, breach of fiduciary duty and negligent misrepresentation, among
other claims. They are seeking lost wages and other damages, including punitive damages, in
an aggregate amount exceeding $12 million. |
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On September 18, 2003, RJR, RJR Tobacco, RJR-TI, RJR-PR, and Northern Brands were
served with a Statement of Claim filed in August 2003 by the Attorney General of Canada in
the Superior Court of Justice, Ontario, Canada. Also named as defendants are JTI and a
number of its affiliates. The Statement of Claim seeks to recover taxes and duties
allegedly not paid as a result of cigarette smuggling and related activities. As filed, the
Attorney Generals Statement of Claim seeks to recover $1.5 billion Canadian in
compensatory damages and $50 million Canadian in punitive damages, as well as equitable and
other forms of relief. However, in the Companies Creditor Arrangement Act proceeding
described below, the Attorney General amended and increased Canadas claim to $4.3 billion
Canadian. The parties have agreed to a stay of all proceedings pending in the Superior
Court of Justice, subject to notice by one of the parties that it wishes to terminate the
stay. On January 19, 2007, the court ordered that the case be scheduled for trial no later
than December 31, 2008, subject to further order of the court. On January 15, 2009, the
Court ordered that the deadline for setting the action for trial is January 31, 2011. |
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In August 2004, the Quebec Ministry of Revenue (1) issued a tax assessment, covering
the period January 1, 1990, through December 31, 1998, against JTI-MC for alleged unpaid
duties, penalties and interest in an amount of about $1.36 billion Canadian; (2) issued an
order for the immediate payment of that amount; and (3) obtained an ex parte judgment to
enforce the payment of that amount. On August 24, 2004, JTI-MC applied for protection under
the Companies Creditor Arrangement Act in the Ontario Superior Court of Justice, Toronto,
Canada, referred to as CCAA Proceedings, and the court entered an order staying the Quebec
Ministry of Revenues proceedings as well as other claims and proceedings against JTI-MC.
The stay has been extended to July 21, 2009. 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. Discussions regarding possible agreed-upon procedures for
adjudicating and appellate review of the claims and defenses asserted in the CCAA
Proceedings are taking place. Without waiving any of their rights and defenses, RJR and
certain of its subsidiaries, including RJR Tobacco, may participate in those proceedings,
if procedures are agreed upon, approved by the court and implemented. |
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On November 17, 2004, a Statement of Claim was filed against JTI-MC in the Supreme
Court of British Columbia by Stanley Smith, a former executive of RJR-MI, for alleged
breach of contract and other legal
theories. Mr. Smith is claiming $840,000 Canadian for salary allegedly owed under his
severance agreement with RJR-MI, as well as other unspecified compensatory and punitive
damages. |
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In 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 |
43
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
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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 (as discussed in greater detail
below) October 30, 2002, and against JTI on January 11, 2002. |
On December 14, 2007, the European Community and 26 member states entered into a series of
agreements with JTI and/or its subsidiaries regarding, principally, contraband and counterfeit
cigarettes bearing JTI trademarks in the European Community. Collectively, those agreements
resolved, in pertinent part, all claims that the European Community and member states either had or
might have had prior to December 14, 2007 against JTI and/or its subsidiaries with respect to any
such contraband and counterfeit cigarettes and claims for which JTI could become the subject of a
claim for indemnity by RJR under the terms of the 1999 Purchase Agreement. In addition, the
European Community and signatory member states agreed to release RJR and its affiliates from those
same claims.
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. RJR Tobacco expensed $3 million
during each of the first three months of 2009 and 2008, respectively,
for funds to be reimbursed to JTI for costs and expenses arising out
of the Canadian litigation. In addition, as of December 31, 2008, RJR,
including its subsidiary RJR Tobacco, had 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 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 has been stayed.
The European Community and the member states have recently suggested that they may file similar
claims regarding the U.S. tobacco business of B&W, which was acquired in 2004 in the B&W business
combination.
RJR Tobacco was named a defendant in a number of lawsuits originally filed in various federal
courts in 2002 by plaintiffs alleging descent from persons held in slavery in the United States and
seeking damages from numerous corporate defendants for having allegedly profited from historic
slavery. In October 2002, those actions were consolidated by the Judicial Panel on Multidistrict
Litigation for pre-trial proceedings in the U.S. District Court for the Northern District of
Illinois. On July 6, 2005, the court dismissed the entire action on a variety of grounds. On
December 13, 2006, the U.S. Court of Appeals for the Seventh Circuit affirmed dismissal in all
respects but one. It remanded some cases for further proceedings limited to the claims by some
plaintiffs that present-day representations about historic ties to slavery by some defendants
violated state consumer fraud laws. On October 1, 2007, the U.S. Supreme Court denied plaintiffs
petition for a writ of certiorari. The plaintiffs in all but one of the cases either voluntarily
dismissed their claims or otherwise abandoned the litigation. On August 11, 2008, the district
court granted the defendants motion to dismiss the
remaining plaintiffs and terminated the case.
However, the motion to dismiss excluded plaintiffs Timothy and Chester Hurdle, who filed a third
amended complaint on July
31, 2007. At the time, no ruling was made on the motion to dismiss the Hurdle plaintiffs and
the plaintiffs named in the third amended complaint. On April 15, 2009, the court granted the
defendants motion to dismiss the third amended complaint without prejudice.
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Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
On May 23, 2001, and July 30, 2002, Star Scientific, Inc., referred to as Star, filed two
patent infringement actions, which have been consolidated, against RJR Tobacco in the U.S. District
Court for the District of Maryland. Both patents at issue are entitled Method of Treating Tobacco
to Reduce Nitrosamine Content, and Products Produced Thereby, and bear U.S. Patent Nos. 6,202,649
and 6,425,401. The plaintiffs 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, including a reasonable royalty, to compensate for the infringement;
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 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, referred to as the PTO. 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 with the U.S. Court
of Appeals for the Federal Circuit. Oral argument occurred on March 7, 2008.
On August 25, 2008, the Federal Circuit issued a decision reversing the district courts
holdings and remanded the case to the district court for further proceedings on the issues of
validity and infringement. In September 2008, the Federal Circuit denied Stars motion for
reassignment of the case on remand to a new trial judge. The Federal Circuit denied RJR Tobaccos
combined petition for panel hearing and rehearing en banc on October 22, 2008.
On December 31, 2008 and January 2, 2009, RJR Tobacco petitioned the PTO to reexamine Stars
patents-in-suit. On January 16, 2009, RJR Tobacco filed a petition for writ of certiorari to the
U.S. Supreme Court, which was denied on March 9, 2009. On January 30, 2009, RJR Tobacco filed
summary judgment motions of invalidity based on indefiniteness, of invalidity based on 35 U.S.C. §
101, of invalidity based on anticipation and obviousness, and for noninfringement. On February 12,
2009, the PTO issued an order granting the request for ex parte reexamination as to the petition
filed on December 31, 2008. On March 3, 2009, the court revised the trial schedule and set an
aspirational date of May 18, 2009 to start trial, with trial to run between May 18, 2009 to June
12, 2009. On March 5, 2009, the PTO issued an order granting the request for ex parte
reexamination as to the petition filed on January 2, 2009. As a result, both of Stars patents are
now undergoing reexamination in the PTO, based on substantial new questions of patentability that
exist for both patents. On March 6, 2009, Star updated its damages calculation based on a
reasonable royalty to a range of $294.9 to $362.1 million. Star seeks treble damages based on
willful infringement allegations. On March 9, 2009, RJR Tobacco filed a motion to continue the
trial date based on Stars patents being placed into reexamination.
On March 20, 2009, the district court had a status conference/hearing. At that status
conference/hearing, the district court denied the motion to continue the trial date, and the case
remains scheduled to commence trial on May 18, 2009. The district court scheduled a hearing for
argument on all pending motions, followed by a case planning conference, on April 17, 2009. The
district court has also issued a procedural order setting forth dates for additional trial-related
disclosures.
Finally, in the first quarter of 2005, Commonwealth Brands, Inc., referred to as Commonwealth,
was served with an individual smoking and health case, Croft v. Akron Gasket in Cuyahoga County,
Ohio. 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 B&W business
combination, RJR Tobacco agreed to indemnify Commonwealth for this claim 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.
45
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Smokeless Tobacco Litigation
As of April 9, 2009, Conwood Company, LLC was a defendant in six 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 the Conwood companies smokeless tobacco products.
These actions are pending before the same West Virginia court as the 687 consolidated individual
smoker cases against RJR Tobacco, B&W, as RJR Tobaccos indemnitee, or both. Pursuant to the
courts December 3, 2001, order, the smokeless tobacco claims and defendants remain severed.
Pursuant to a second amended complaint filed in September 2006, Conwood Company, LLC is a
defendant in Vassallo v. United States Tobacco Company, pending in the Eleventh Circuit Court in
Miami-Dade County, Florida. The individual plaintiff 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 the Conwood companies. The plaintiff seeks unspecified
compensatory and consequential damages in an amount greater than $15,000. There is not a punitive
damages demand in this case, though the plaintiff retains the right to seek leave of court to add
such a demand later. Discovery is underway.
Tobacco Buyout Legislation and Related Litigation
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 $210 million to $240 million.
RAIs operating subsidiaries will record the FETRA assessment on a quarterly basis as cost of
goods sold. RAIs operating subsidiaries estimate that their overall share of the buyout will
approximate $2.3 billion to $2.8 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 position and results of operations.
As noted above, the MSA Phase II obligations will be offset against the tobacco quota buyout
obligations. Because growers in two states, Maryland and Pennsylvania, did not participate in the
quota system, they are not eligible for payments under FETRA. Given that the assessments paid by
tobacco product manufacturers and importers under FETRA would fully offset their MSA Phase II
payment obligations, the growers in Maryland and Pennsylvania would no longer receive payments
under the MSA Phase II program. Thus, the growers in these two states would not receive payment
under either FETRA or the MSA Phase II program.
On December 17, 2004, Maryland and Pennsylvania filed in the North Carolina Business Court a
Motion for Clarification or Modification of the Trust, that is, the Growers Trust that created the
MSA Phase II obligations. They later supplemented this filing with a Statement of Claim, filed on
June 24, 2005. Maryland and Pennsylvania contend that they are entitled to relief from the
operation of the tax offset adjustment provision of the Growers Trust and that payments under the
Growers Trust to the growers in their states should continue. Following discovery, the parties
filed cross-motions for summary judgment on May 5, 2006. On August 17, 2007, the Business Court
granted summary judgment in favor of Maryland and Pennsylvania and denied summary judgment to the
tobacco manufacturers, including RJR Tobacco, that were the settlors of the Growers Trust. The
Business Court ruled that the Growers Trust, as written and without judicial modification, requires
continuing payments to the Growers Trust for the benefit of tobacco growers in Maryland and
Pennsylvania. RJR Tobacco and the other tobacco manufacturer/settlors filed their Notice of Appeal
on September 14, 2007. On January 14, 2008, RJR Tobacco and the other tobacco manufacturer/settlors
filed a petition seeking direct discretionary review by the North Carolina Supreme Court. On
February 25, 2008, the North Carolina Supreme Court denied that petition. On August 20, 2008, oral
arguments were held before the North Carolina Court of Appeals. On December 16, 2008, the North
Carolina
46
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Court of Appeals, in a 2-1 decision, reversed the Business Court and remanded the case for
entry of judgment in favor of RJR Tobacco and the other tobacco manufacturers/settlors. On January
20, 2009, Maryland and Pennsylvania filed an appeal of right based on the dissenting opinion and
also filed a petition for discretionary review on certain additional issues. On January 30, 2009,
RJR Tobacco and the other tobacco manufacturers/settlors filed a response to the states petition
for discretionary review. On March 19, 2009, the North Carolina Supreme Court granted the states
petition for discretionary review. A briefing schedule has been set.
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 March 7, 2007, the court
granted the plaintiff leave to file an amended complaint and denied all pending motions as moot. 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 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. On March 13, 2008, the
court denied this motion. On November 19, 2007, the plaintiff filed a motion for class
certification, which the court granted on September 29, 2008. The district court ordered mediation,
which occurred on July 10, 2008, but no resolution of the case was reached at that time. On
September 18, 2008, each of the plaintiffs and the defendants filed motions for summary judgment. A
decision is pending. Finally, on January 9, 2009, the defendants filed a motion to decertify the
class; that motion remains pending as well. On February 20, 2009, the defendants motion for
judgment on the pleadings was denied. The case is scheduled for trial during the civil trial term
beginning on July 6, 2009.
Employment Litigation
On March 19, 2007, in Marshall v. R.J. Reynolds Tobacco Co., the plaintiff filed a collective
action complaint against RJR Tobacco in the U.S. District Court for the Western District of
Missouri alleging violations of the Fair Labor Standards Act, referred to as FLSA. 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 total number of
current or former retail representatives participating as of April 9, 2009, is 469, including those
who have opted in the Marshall case and subsequent lawsuits filed in New York and California as
described below.
Two other cases alleging violations of the FLSA and other state law wage and hour claims were
filed in February 2008: Radcliffe v. R.J. Reynolds Tobacco Co., filed on February 14, 2008, in
federal court in California, was served on May 9, 2008; and Dinino v. R.J. Reynolds Tobacco Co.,
filed on February 29, 2008, in federal court in New York, was served on April 18, 2008. The Dinino
and Radcliffe matters have been transferred to the Missouri court
47
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
and consolidated with the already pending Marshall case due to the similarity of issues to be
resolved. The plaintiffs in the Dinino and Radcliffe matters failed to move for class certification
on the state law claims.
On December 22, 2008, RJR Tobaccos motion for partial summary judgment was granted. The court
ruled that the plaintiffs commutes from their homes to their first assignment of the day, and
their commutes from their last assignments of the day to their homes, are non-compensable. On
February 5, 2009, the court denied the plaintiffs motion for reconsideration on this issue or, in
the alternative, plaintiffs request for certification for interlocutory appeal.
The
consolidated case is still in the discovery phase. Two mediation
sessions were held in the first quarter
of 2009, but the parties were unable to reach a resolution.
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 position 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 position of RAI or its subsidiaries.
Other Contingencies
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,
48
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
and the parties have agreed to resolve their differences at a later date. RJR, including its
subsidiary RJR Tobacco, have liabilities totaling $94 million that were recorded in 1999 in
connection with these indemnification claims.
RJR Tobacco, Santa Fe, the Conwood companies 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, the Conwood companies 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.
Except as otherwise noted above, RAI is not able to estimate the maximum potential amount of
future payments, if any, related to these indemnification obligations.
Note 11 Shareholders Equity
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Total |
|
|
|
|
|
|
Common |
|
|
Paid-In |
|
|
Accumulated |
|
|
Comprehensive |
|
|
Shareholders |
|
|
Comprehensive |
|
|
|
Stock |
|
|
Capital |
|
|
Deficit |
|
|
Loss |
|
|
Equity |
|
|
Loss |
|
Balance as of December 31,
2008 |
|
$ |
|
|
|
$ |
8,463 |
|
|
$ |
(531 |
) |
|
$ |
(1,695 |
) |
|
$ |
6,237 |
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
8 |
|
|
$ |
8 |
|
Retirement benefits SFAS
No. 158, net of $9
million tax expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15 |
|
|
|
15 |
|
|
|
15 |
|
Unrealized loss on
long-term investments, net
of $5 million tax benefit |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7 |
) |
|
|
(7 |
) |
|
|
(7 |
) |
Cumulative translation
adjustment, net of $4 million tax benefit |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
|
(14 |
) |
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends $0.85 per share |
|
|
|
|
|
|
|
|
|
|
(249 |
) |
|
|
|
|
|
|
(249 |
) |
|
|
|
|
Common stock repurchased |
|
|
|
|
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
(5 |
) |
|
|
|
|
Equity incentive award
plan and stock-based
compensation |
|
|
|
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
16 |
|
|
|
|
|
Excess tax benefit on
stock-based compensation
plans |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31,
2009 |
|
$ |
|
|
|
$ |
8,475 |
|
|
$ |
(772 |
) |
|
$ |
(1,701 |
) |
|
$ |
6,002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due to RAIs incorporation in North Carolina, which does not recognize treasury shares, the
shares repurchased are cancelled at the time of repurchase. During the first quarter of 2009, at a
cost of $5 million, RAI purchased 144,924 shares that were forfeited with respect to tax
liabilities associated with restricted stock vesting under its LTIP.
On February 3, 2009, RAIs board of directors declared a quarterly cash dividend of $0.85 per
common share, or $3.40 on an annualized basis, to shareholders of record as of March 10, 2009.
Note 12 Stock Plans
In February 2009, the board of directors of RAI approved a grant, to key employees of RAI and
its subsidiaries, of nonvested share units, referred to as performance shares, under the LTIP,
effective March 2, 2009, which will be settled exclusively in shares of RAI common stock. The
1,382,243 units were granted based on the average per share closing price of RAI common stock for
the 60 trading days prior to the grant date, or $39.23. These units generally will vest on March
2, 2012. Upon settlement, each grantee will receive a number of shares of RAIs common stock equal
to the product of the number of vested units and 0%-150% based on the average three-year RAI annual
incentive award plan score.
49
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
As an equity-based grant, compensation expense relating to the February 2009 LTIP grant will
take into account the vesting period lapsed and will be calculated on the per share closing price
of RAI common stock on the date of grant, or $33.10. Dividends paid on shares of RAI common stock
will accumulate on the performance shares and be paid to the grantee on the vesting date. If RAI
fails to pay its shareholders cumulative dividends of at least $10.20 per share for the three-year
performance period, then each award will be reduced by an amount equal to three times the
percentage of the dividend underpayment, up to a maximum reduction of 50%.
In February 2009, the board of directors of RAI also approved and adopted, subject to
shareholder approval at the 2009 annual meeting of shareholders, the Reynolds American Inc. 2009
Omnibus Incentive Compensation Plan, referred to as the Omnibus Plan. The maximum number of shares
of RAI common stock that may be issued upon the exercise of stock options or stock appreciation
rights, in payment or settlement of restricted stock, in payment or settlement of restricted stock
units, in payment or settlement of performance shares or performance units that have been earned,
in payment or settlement of other awards, or in payment of dividend equivalents paid with respect
to awards made under the Omnibus Plan, will not exceed 19,000,000 shares in the aggregate.
Note 13 Segment Information
RAIs reportable operating segments are RJR Tobacco and Conwood. The RJR Tobacco segment
consists of the primary operations of R. J. Reynolds Tobacco Company. The Conwood segment consists
of Conwood Holdings, Inc., the primary operations of the Conwood companies and Lane. RAIs wholly
owned subsidiary, Santa Fe, among others, is included in All Other. The segments were identified
based on how RAIs chief operating decision maker allocates resources and assesses performance.
Some of RAIs wholly owned operating subsidiaries have entered into intercompany agreements for
products or services with other RAI operating subsidiaries. As a result, certain activities of an
operating subsidiary may be included in a different segment of RAI.
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 and WINSTON, were five of the ten best-selling brands of cigarettes in the United
States as of March 31, 2009. Those brands, and its other brands, including SALEM, MISTY and CAPRI,
are manufactured in a variety of styles and marketed in the United States. RJR Tobacco also manages
contract manufacturing of cigarette and tobacco products through arrangements with BAT affiliates.
On January 1, 2009, the management of tobacco products sold to certain U.S. territories, U.S.
duty-free shops and U.S. overseas military bases was transferred to RJR Tobacco from GPI.
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, the best-selling moist snuff brand in the United States as of March
31, 2009, and KODIAK. Conwoods other products include loose leaf chewing tobacco, dry snuff, plug
and twist tobacco products, as well as WINCHESTER and CAPTAIN BLACK little cigars, and BUGLER
roll-your-own tobacco.
Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL
AMERICAN SPIRIT brand, as well as manages the super premium cigarette brands licensed from BAT,
DUNHILL and STATE EXPRESS 555. The financial position and results of operations of this operating
segment does not meet the materiality criteria to be reportable.
The amounts with respect to the income statements presented for prior periods have been
reclassified to reflect the current segment composition.
Intersegment revenues and items below the operating income line of the condensed consolidated
statements of income are not presented by segment, since they are excluded from the measure of
segment profitability reviewed by RAIs chief operating decision maker.
Segment Data:
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|
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|
|
For the Three Months |
|
|
|
Ended March 31, |
|
|
|
2009 |
|
|
2008 |
|
Net sales: |
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
1,671 |
|
|
$ |
1,807 |
|
50
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
|
Ended March 31, |
|
|
|
2009 |
|
|
2008 |
|
Conwood |
|
|
166 |
|
|
|
167 |
|
All Other |
|
|
84 |
|
|
|
83 |
|
|
|
|
|
|
|
|
Consolidated net sales |
|
$ |
1,921 |
|
|
$ |
2,057 |
|
|
|
|
|
|
|
|
Operating income: |
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
82 |
|
|
$ |
426 |
|
Conwood |
|
|
8 |
|
|
|
81 |
|
All Other |
|
|
24 |
|
|
|
25 |
|
Corporate expense |
|
|
(17 |
) |
|
|
(26 |
) |
|
|
|
|
|
|
|
Consolidated operating income |
|
$ |
97 |
|
|
$ |
506 |
|
|
|
|
|
|
|
|
Reconciliation to income before income taxes: |
|
|
|
|
|
|
|
|
Operating income |
|
$ |
97 |
|
|
$ |
506 |
|
Interest and debt expense |
|
|
66 |
|
|
|
72 |
|
Interest income |
|
|
(5 |
) |
|
|
(22 |
) |
Gain on termination of joint venture |
|
|
|
|
|
|
(328 |
) |
Other (income) expense, net |
|
|
19 |
|
|
|
(12 |
) |
|
|
|
|
|
|
|
Income before income taxes |
|
$ |
17 |
|
|
$ |
796 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Assets: |
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
15,811 |
|
|
$ |
15,338 |
|
Conwood |
|
|
4,294 |
|
|
|
4,386 |
|
All Other |
|
|
1,367 |
|
|
|
1,384 |
|
Corporate |
|
|
15,724 |
|
|
|
15,647 |
|
Elimination adjustments |
|
|
(18,907 |
) |
|
|
(18,601 |
) |
|
|
|
|
|
|
|
Consolidated assets |
|
$ |
18,289 |
|
|
$ |
18,154 |
|
|
|
|
|
|
|
|
Note 14 Related Party Transactions
RAIs operating subsidiaries engage in transactions with related parties in the normal course
of business. The following is a summary of balances and transactions with affiliates.
Balances:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
|
2009 |
|
2008 |
Accounts receivable, BAT |
|
$ |
64 |
|
|
$ |
91 |
|
Due to BAT |
|
|
1 |
|
|
|
3 |
|
Deferred revenue, BAT |
|
|
34 |
|
|
|
50 |
|
Transactions for the three months ended March 31:
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
Net sales, related party, BAT |
|
$ |
89 |
|
|
$ |
113 |
|
Research and development services billed to BAT |
|
|
1 |
|
|
|
|
|
Purchases from BAT |
|
|
2 |
|
|
|
1 |
|
Equipment lease payments to BAT |
|
|
1 |
|
|
|
|
|
51
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
RAIs operating subsidiaries have entered into various transactions with affiliates of BAT,
the indirect parent of B&W. RAIs operating subsidiaries sell contract-manufactured cigarettes,
processed strip leaf, pipe tobacco and little cigars to BAT affiliates. Pricing for
contract-manufactured cigarettes is 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 subsequent years, reported by the U.S. Bureau of Labor Statistics. Net
sales to BAT affiliates, primarily cigarettes, represented approximately 5.0% of RAIs total net
sales during the three months ended March 31, 2009.
RJR
Tobacco records deferred sales revenue relating to leaf sold to BAT
affiliates that has
not been delivered as of the end of the respective quarter, given that RJR Tobacco has a legal
right to bill the BAT affiliates. Leaf sales revenue to BAT affiliates is recognized when the
product is shipped to the customer.
RJR Tobacco performs certain research and development for BAT affiliates pursuant to a joint
technology sharing agreement entered into as a part of the B&W business combination. These services
were accrued and billed to BAT affiliates and were recorded in RJR Tobaccos selling, general and
administrative expenses, net of associated costs.
RAIs operating subsidiaries also purchase unprocessed leaf at market prices, and imports
cigarettes at prices not to exceed manufacturing costs plus 10%, from BAT affiliates. The payable
due to related party in the condensed consolidated balance sheet (unaudited) primarily relates to
cigarette purchases.
RJR Tobacco leases certain cigarette manufacturing equipment from a BAT affiliate.
52
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 15 RAI 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 Guarantors of RAIs $4.5 billion guaranteed, unsecured
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, the Conwood companies, Conwood Holdings, Inc., Santa Fe, Lane, GPI
and certain of RJR Tobaccos other subsidiaries, the Guarantors; other indirect subsidiaries of RAI
that are not Guarantors; and elimination adjustments.
Condensed Consolidating Statements of Income
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
For the Three Months Ended March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
1,830 |
|
|
$ |
40 |
|
|
$ |
(38 |
) |
|
$ |
1,832 |
|
Net sales, related party |
|
|
|
|
|
|
89 |
|
|
|
|
|
|
|
|
|
|
|
89 |
|
Cost of products sold |
|
|
|
|
|
|
1,018 |
|
|
|
18 |
|
|
|
(38 |
) |
|
|
998 |
|
Selling, general and administrative expenses |
|
|
3 |
|
|
|
348 |
|
|
|
14 |
|
|
|
|
|
|
|
365 |
|
Amortization expense |
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
8 |
|
Trademark impairment charge |
|
|
|
|
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(3 |
) |
|
|
92 |
|
|
|
8 |
|
|
|
|
|
|
|
97 |
|
Interest and debt expense |
|
|
64 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
66 |
|
Interest income |
|
|
|
|
|
|
(2 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
(5 |
) |
Intercompany interest (income) expense |
|
|
(27 |
) |
|
|
27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
11 |
|
|
|
|
|
Other (income) expense, net |
|
|
17 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(57 |
) |
|
|
74 |
|
|
|
11 |
|
|
|
(11 |
) |
|
|
17 |
|
Provision for (benefit from) income taxes |
|
|
(20 |
) |
|
|
28 |
|
|
|
1 |
|
|
|
|
|
|
|
9 |
|
Equity income from subsidiaries |
|
|
45 |
|
|
|
10 |
|
|
|
|
|
|
|
(55 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
8 |
|
|
$ |
56 |
|
|
$ |
10 |
|
|
$ |
(66 |
) |
|
$ |
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended March 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
1,935 |
|
|
$ |
38 |
|
|
$ |
(29 |
) |
|
$ |
1,944 |
|
Net sales, related party |
|
|
|
|
|
|
113 |
|
|
|
|
|
|
|
|
|
|
|
113 |
|
Cost of products sold |
|
|
|
|
|
|
1,175 |
|
|
|
17 |
|
|
|
(28 |
) |
|
|
1,164 |
|
Selling, general and administrative expenses |
|
|
6 |
|
|
|
362 |
|
|
|
14 |
|
|
|
|
|
|
|
382 |
|
Amortization expense |
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(6 |
) |
|
|
506 |
|
|
|
7 |
|
|
|
(1 |
) |
|
|
506 |
|
Interest and debt expense |
|
|
70 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
72 |
|
Interest income |
|
|
|
|
|
|
(20 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
(22 |
) |
Intercompany interest (income) expense |
|
|
(18 |
) |
|
|
17 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
11 |
|
|
|
|
|
Gain on termination of joint venture |
|
|
|
|
|
|
|
|
|
|
(328 |
) |
|
|
|
|
|
|
(328 |
) |
Other (income) expense, net |
|
|
1 |
|
|
|
(12 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(59 |
) |
|
|
530 |
|
|
|
337 |
|
|
|
(12 |
) |
|
|
796 |
|
Provision for (benefit from) income taxes |
|
|
(21 |
) |
|
|
311 |
|
|
|
1 |
|
|
|
|
|
|
|
291 |
|
Equity income from subsidiaries |
|
|
543 |
|
|
|
336 |
|
|
|
|
|
|
|
(879 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
505 |
|
|
$ |
555 |
|
|
$ |
336 |
|
|
$ |
(891 |
) |
|
$ |
505 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53
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 Three Months Ended March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
15 |
|
|
$ |
856 |
|
|
$ |
3 |
|
|
$ |
(11 |
) |
|
$ |
863 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from settlement of short-term investments |
|
|
|
|
|
|
13 |
|
|
|
|
|
|
|
|
|
|
|
13 |
|
Capital expenditures |
|
|
|
|
|
|
(26 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(27 |
) |
Other, net |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Intercompany notes receivable |
|
|
20 |
|
|
|
8 |
|
|
|
|
|
|
|
(28 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing activities |
|
|
20 |
|
|
|
(3 |
) |
|
|
(1 |
) |
|
|
(28 |
) |
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(248 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(248 |
) |
Dividends paid on preferred stock |
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Other, net |
|
|
(4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4 |
) |
Intercompany notes payable |
|
|
(8 |
) |
|
|
(20 |
) |
|
|
|
|
|
|
28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) financing activities |
|
|
(271 |
) |
|
|
(20 |
) |
|
|
|
|
|
|
39 |
|
|
|
(252 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and cash
equivalents |
|
|
|
|
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(236 |
) |
|
|
833 |
|
|
|
(6 |
) |
|
|
|
|
|
|
591 |
|
Cash and
cash equivalents at beginning of period |
|
|
272 |
|
|
|
2,091 |
|
|
|
215 |
|
|
|
|
|
|
|
2,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and
cash equivalents at end of period |
|
$ |
36 |
|
|
$ |
2,924 |
|
|
$ |
209 |
|
|
$ |
|
|
|
$ |
3,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended March 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
217 |
|
|
$ |
722 |
|
|
$ |
20 |
|
|
$ |
(81 |
) |
|
$ |
878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from settlement of short-term investments |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Capital expenditures |
|
|
|
|
|
|
(38 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
(39 |
) |
Other, net |
|
|
|
|
|
|
4 |
|
|
|
(3 |
) |
|
|
|
|
|
|
1 |
|
Intercompany notes receivable |
|
|
20 |
|
|
|
(107 |
) |
|
|
|
|
|
|
87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing activities |
|
|
20 |
|
|
|
(139 |
) |
|
|
(4 |
) |
|
|
87 |
|
|
|
(36 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(251 |
) |
|
|
(70 |
) |
|
|
|
|
|
|
70 |
|
|
|
(251 |
) |
Dividends paid on preferred stock |
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Intercompany notes payable |
|
|
107 |
|
|
|
(20 |
) |
|
|
|
|
|
|
(87 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing activities |
|
|
(155 |
) |
|
|
(90 |
) |
|
|
|
|
|
|
(6 |
) |
|
|
(251 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
82 |
|
|
|
493 |
|
|
|
16 |
|
|
|
|
|
|
|
591 |
|
Cash and
cash equivalents at beginning of period |
|
|
243 |
|
|
|
1,885 |
|
|
|
87 |
|
|
|
|
|
|
|
2,215 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and
cash equivalents at end of period |
|
$ |
325 |
|
|
$ |
2,378 |
|
|
$ |
103 |
|
|
$ |
|
|
|
$ |
2,806 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
54
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
36 |
|
|
$ |
2,924 |
|
|
$ |
209 |
|
|
$ |
|
|
|
$ |
3,169 |
|
Short-term investments |
|
|
1 |
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
10 |
|
Accounts receivable, net |
|
|
|
|
|
|
72 |
|
|
|
12 |
|
|
|
|
|
|
|
84 |
|
Accounts receivable, related party |
|
|
|
|
|
|
64 |
|
|
|
|
|
|
|
|
|
|
|
64 |
|
Notes receivable |
|
|
|
|
|
|
1 |
|
|
|
34 |
|
|
|
|
|
|
|
35 |
|
Other receivables |
|
|
7 |
|
|
|
20 |
|
|
|
1 |
|
|
|
|
|
|
|
28 |
|
Inventories |
|
|
|
|
|
|
1,182 |
|
|
|
35 |
|
|
|
(2 |
) |
|
|
1,215 |
|
Deferred income taxes, net |
|
|
11 |
|
|
|
839 |
|
|
|
1 |
|
|
|
|
|
|
|
851 |
|
Prepaid expenses and other |
|
|
3 |
|
|
|
193 |
|
|
|
8 |
|
|
|
|
|
|
|
204 |
|
Short-term intercompany notes and interest receivable |
|
|
81 |
|
|
|
56 |
|
|
|
|
|
|
|
(137 |
) |
|
|
|
|
Other intercompany receivables |
|
|
464 |
|
|
|
|
|
|
|
4 |
|
|
|
(468 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
603 |
|
|
|
5,360 |
|
|
|
304 |
|
|
|
(607 |
) |
|
|
5,660 |
|
Property, plant and equipment, net |
|
|
7 |
|
|
|
992 |
|
|
|
26 |
|
|
|
|
|
|
|
1,025 |
|
Trademarks and other intangible assets, net |
|
|
|
|
|
|
2,805 |
|
|
|
4 |
|
|
|
|
|
|
|
2,809 |
|
Goodwill |
|
|
|
|
|
|
8,166 |
|
|
|
8 |
|
|
|
|
|
|
|
8,174 |
|
Long-term intercompany notes |
|
|
2,060 |
|
|
|
1,398 |
|
|
|
|
|
|
|
(3,458 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
9,561 |
|
|
|
422 |
|
|
|
|
|
|
|
(9,983 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
317 |
|
|
|
178 |
|
|
|
153 |
|
|
|
(27 |
) |
|
|
621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
12,548 |
|
|
$ |
19,321 |
|
|
$ |
495 |
|
|
$ |
(14,075 |
) |
|
$ |
18,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement accruals |
|
$ |
|
|
|
$ |
2,897 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
2,897 |
|
Accounts payable and other accrued liabilities |
|
|
496 |
|
|
|
835 |
|
|
|
32 |
|
|
|
|
|
|
|
1,363 |
|
Due to related party |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Deferred revenue, related party |
|
|
|
|
|
|
34 |
|
|
|
|
|
|
|
|
|
|
|
34 |
|
Current maturities of long-term debt |
|
|
189 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
200 |
|
Short-term intercompany notes and interest payable |
|
|
32 |
|
|
|
82 |
|
|
|
23 |
|
|
|
(137 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
468 |
|
|
|
|
|
|
|
(468 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
717 |
|
|
|
4,328 |
|
|
|
55 |
|
|
|
(605 |
) |
|
|
4,495 |
|
Intercompany notes and interest payable |
|
|
1,398 |
|
|
|
2,060 |
|
|
|
|
|
|
|
(3,458 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,337 |
|
|
|
123 |
|
|
|
|
|
|
|
|
|
|
|
4,460 |
|
Deferred income taxes, net |
|
|
|
|
|
|
124 |
|
|
|
|
|
|
|
(27 |
) |
|
|
97 |
|
Long-term retirement benefits (less current portion) |
|
|
65 |
|
|
|
2,761 |
|
|
|
18 |
|
|
|
|
|
|
|
2,844 |
|
Other noncurrent liabilities |
|
|
29 |
|
|
|
361 |
|
|
|
1 |
|
|
|
|
|
|
|
391 |
|
Shareholders equity |
|
|
6,002 |
|
|
|
9,564 |
|
|
|
421 |
|
|
|
(9,985 |
) |
|
|
6,002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
12,548 |
|
|
$ |
19,321 |
|
|
$ |
495 |
|
|
$ |
(14,075 |
) |
|
$ |
18,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
55
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Non- |
|
|
|
|
|
|
|
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
272 |
|
|
$ |
2,091 |
|
|
$ |
215 |
|
|
$ |
|
|
|
$ |
2,578 |
|
Short-term investments |
|
|
1 |
|
|
|
22 |
|
|
|
|
|
|
|
|
|
|
|
23 |
|
Accounts receivable, net |
|
|
|
|
|
|
68 |
|
|
|
16 |
|
|
|
|
|
|
|
84 |
|
Accounts receivable, related party |
|
|
|
|
|
|
91 |
|
|
|
|
|
|
|
|
|
|
|
91 |
|
Notes receivable |
|
|
|
|
|
|
1 |
|
|
|
34 |
|
|
|
|
|
|
|
35 |
|
Other receivables |
|
|
9 |
|
|
|
27 |
|
|
|
1 |
|
|
|
|
|
|
|
37 |
|
Inventories |
|
|
|
|
|
|
1,145 |
|
|
|
27 |
|
|
|
(2 |
) |
|
|
1,170 |
|
Deferred income taxes, net |
|
|
12 |
|
|
|
825 |
|
|
|
1 |
|
|
|
|
|
|
|
838 |
|
Prepaid expenses and other |
|
|
35 |
|
|
|
128 |
|
|
|
4 |
|
|
|
(4 |
) |
|
|
163 |
|
Short-term intercompany notes and interest receivable |
|
|
81 |
|
|
|
65 |
|
|
|
|
|
|
|
(146 |
) |
|
|
|
|
Other intercompany receivables |
|
|
68 |
|
|
|
|
|
|
|
6 |
|
|
|
(74 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
478 |
|
|
|
4,463 |
|
|
|
304 |
|
|
|
(226 |
) |
|
|
5,019 |
|
Property, plant and equipment, net |
|
|
7 |
|
|
|
999 |
|
|
|
25 |
|
|
|
|
|
|
|
1,031 |
|
Trademarks and other intangible assets, net |
|
|
|
|
|
|
3,266 |
|
|
|
4 |
|
|
|
|
|
|
|
3,270 |
|
Goodwill |
|
|
|
|
|
|
8,166 |
|
|
|
8 |
|
|
|
|
|
|
|
8,174 |
|
Long-term intercompany notes |
|
|
2,080 |
|
|
|
1,409 |
|
|
|
|
|
|
|
(3,489 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
9,751 |
|
|
|
430 |
|
|
|
|
|
|
|
(10,181 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
349 |
|
|
|
180 |
|
|
|
160 |
|
|
|
(29 |
) |
|
|
660 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
12,665 |
|
|
$ |
18,913 |
|
|
$ |
501 |
|
|
$ |
(13,925 |
) |
|
$ |
18,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement accruals |
|
$ |
|
|
|
$ |
2,321 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
2,321 |
|
Accounts payable and other accrued liabilities |
|
|
350 |
|
|
|
974 |
|
|
|
29 |
|
|
|
(4 |
) |
|
|
1,349 |
|
Due to related party |
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
3 |
|
Deferred revenue, related party |
|
|
|
|
|
|
50 |
|
|
|
|
|
|
|
|
|
|
|
50 |
|
Current maturities of long-term debt |
|
|
189 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
200 |
|
Short-term intercompany notes and interest payable |
|
|
40 |
|
|
|
81 |
|
|
|
25 |
|
|
|
(146 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
74 |
|
|
|
|
|
|
|
(74 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
579 |
|
|
|
3,514 |
|
|
|
54 |
|
|
|
(224 |
) |
|
|
3,923 |
|
Intercompany notes and interest payable |
|
|
1,409 |
|
|
|
2,080 |
|
|
|
|
|
|
|
(3,489 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,362 |
|
|
|
124 |
|
|
|
|
|
|
|
|
|
|
|
4,486 |
|
Deferred income taxes, net |
|
|
|
|
|
|
311 |
|
|
|
|
|
|
|
(29 |
) |
|
|
282 |
|
Long-term retirement benefits (less current portion) |
|
|
64 |
|
|
|
2,755 |
|
|
|
17 |
|
|
|
|
|
|
|
2,836 |
|
Other noncurrent liabilities |
|
|
14 |
|
|
|
375 |
|
|
|
1 |
|
|
|
|
|
|
|
390 |
|
Shareholders equity |
|
|
6,237 |
|
|
|
9,754 |
|
|
|
429 |
|
|
|
(10,183 |
) |
|
|
6,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
12,665 |
|
|
$ |
18,913 |
|
|
$ |
501 |
|
|
$ |
(13,925 |
) |
|
$ |
18,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Note 16 RJR Guaranteed, Unsecured Notes Condensed Consolidating Financial Statements
The following condensed consolidating financial statements have been prepared pursuant to Rule
3-10 of Regulation S-X, relating to the guarantees of RJRs $74 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, GPI and certain of RJRs other subsidiaries, the other
Guarantors; other subsidiaries of RAI and RJR, including Santa Fe, Lane and the Conwood companies,
that are not Guarantors; and elimination adjustments.
57
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 March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,625 |
|
|
$ |
267 |
|
|
$ |
(60 |
) |
|
$ |
1,832 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
87 |
|
|
|
2 |
|
|
|
|
|
|
|
89 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
961 |
|
|
|
97 |
|
|
|
(60 |
) |
|
|
998 |
|
Selling, general and administrative expenses |
|
|
3 |
|
|
|
|
|
|
|
296 |
|
|
|
66 |
|
|
|
|
|
|
|
365 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
1 |
|
|
|
|
|
|
|
8 |
|
Trademark impairment charge |
|
|
|
|
|
|
|
|
|
|
377 |
|
|
|
76 |
|
|
|
|
|
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(3 |
) |
|
|
|
|
|
|
71 |
|
|
|
29 |
|
|
|
|
|
|
|
97 |
|
Interest and debt expense |
|
|
64 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
66 |
|
Interest income |
|
|
|
|
|
|
|
|
|
|
(2 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
(5 |
) |
Intercompany interest (income) expense |
|
|
(27 |
) |
|
|
(2 |
) |
|
|
(14 |
) |
|
|
43 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Other (income) expense, net |
|
|
17 |
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(57 |
) |
|
|
10 |
|
|
|
86 |
|
|
|
(11 |
) |
|
|
(11 |
) |
|
|
17 |
|
Provision for (benefit from) income taxes |
|
|
(20 |
) |
|
|
|
|
|
|
39 |
|
|
|
(10 |
) |
|
|
|
|
|
|
9 |
|
Equity income from subsidiaries |
|
|
45 |
|
|
|
57 |
|
|
|
9 |
|
|
|
|
|
|
|
(111 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
8 |
|
|
$ |
67 |
|
|
$ |
56 |
|
|
$ |
(1 |
) |
|
$ |
(122 |
) |
|
$ |
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended March 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
|
|
|
$ |
|
|
|
$ |
1,733 |
|
|
$ |
261 |
|
|
$ |
(50 |
) |
|
$ |
1,944 |
|
Net sales, related party |
|
|
|
|
|
|
|
|
|
|
110 |
|
|
|
3 |
|
|
|
|
|
|
|
113 |
|
Cost of products sold |
|
|
|
|
|
|
|
|
|
|
1,121 |
|
|
|
93 |
|
|
|
(50 |
) |
|
|
1,164 |
|
Selling, general and administrative expenses |
|
|
6 |
|
|
|
|
|
|
|
306 |
|
|
|
70 |
|
|
|
|
|
|
|
382 |
|
Amortization expense |
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(6 |
) |
|
|
|
|
|
|
411 |
|
|
|
101 |
|
|
|
|
|
|
|
506 |
|
Interest and debt expense |
|
|
70 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
72 |
|
Interest income |
|
|
|
|
|
|
(1 |
) |
|
|
(18 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
(22 |
) |
Intercompany interest (income) expense |
|
|
(18 |
) |
|
|
(2 |
) |
|
|
(27 |
) |
|
|
47 |
|
|
|
|
|
|
|
|
|
Intercompany dividend income |
|
|
|
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Gain on termination of joint venture |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(328 |
) |
|
|
|
|
|
|
(328 |
) |
Other (income) expense, net |
|
|
1 |
|
|
|
(12 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(59 |
) |
|
|
24 |
|
|
|
456 |
|
|
|
386 |
|
|
|
(11 |
) |
|
|
796 |
|
Provision for (benefit from) income taxes |
|
|
(21 |
) |
|
|
5 |
|
|
|
288 |
|
|
|
19 |
|
|
|
|
|
|
|
291 |
|
Equity income from subsidiaries |
|
|
543 |
|
|
|
504 |
|
|
|
335 |
|
|
|
|
|
|
|
(1,382 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
505 |
|
|
$ |
523 |
|
|
$ |
503 |
|
|
$ |
367 |
|
|
$ |
(1,393 |
) |
|
$ |
505 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
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 Three Months Ended March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
15 |
|
|
$ |
34 |
|
|
$ |
817 |
|
|
$ |
8 |
|
|
$ |
(11 |
) |
|
$ |
863 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing
activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from settlement of short-term
investments |
|
|
|
|
|
|
4 |
|
|
|
8 |
|
|
|
1 |
|
|
|
|
|
|
|
13 |
|
Intercompany notes receivable |
|
|
20 |
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
(28 |
) |
|
|
|
|
Capital expenditures |
|
|
|
|
|
|
|
|
|
|
(8 |
) |
|
|
(19 |
) |
|
|
|
|
|
|
(27 |
) |
Other, net |
|
|
|
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
20 |
|
|
|
5 |
|
|
|
9 |
|
|
|
(18 |
) |
|
|
(28 |
) |
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing
activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(248 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(248 |
) |
Dividends paid on preferred stock |
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Other, net |
|
|
(4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4 |
) |
Intercompany notes payable |
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
(20 |
) |
|
|
28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing activities |
|
|
(271 |
) |
|
|
|
|
|
|
|
|
|
|
(20 |
) |
|
|
39 |
|
|
|
(252 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and
cash equivalents |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(236 |
) |
|
|
39 |
|
|
|
826 |
|
|
|
(38 |
) |
|
|
|
|
|
|
591 |
|
Cash and cash equivalents at beginning of
period |
|
|
272 |
|
|
|
6 |
|
|
|
1,977 |
|
|
|
323 |
|
|
|
|
|
|
|
2,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and
cash equivalents at end of period |
|
$ |
36 |
|
|
$ |
45 |
|
|
$ |
2,803 |
|
|
$ |
285 |
|
|
$ |
|
|
|
$ |
3,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended March 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities |
|
$ |
217 |
|
|
$ |
17 |
|
|
$ |
727 |
|
|
$ |
10 |
|
|
$ |
(93 |
) |
|
$ |
878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) investing
activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from settlement of short-term
investments |
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
2 |
|
Intercompany notes receivable |
|
|
20 |
|
|
|
|
|
|
|
(108 |
) |
|
|
|
|
|
|
88 |
|
|
|
|
|
Capital expenditures |
|
|
|
|
|
|
|
|
|
|
(24 |
) |
|
|
(15 |
) |
|
|
|
|
|
|
(39 |
) |
Other, net |
|
|
|
|
|
|
1 |
|
|
|
3 |
|
|
|
(3 |
) |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from (used in) investing
activities |
|
|
20 |
|
|
|
1 |
|
|
|
(127 |
) |
|
|
(18 |
) |
|
|
88 |
|
|
|
(36 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from (used in) financing
activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends paid on common stock |
|
|
(251 |
) |
|
|
|
|
|
|
(12 |
) |
|
|
(70 |
) |
|
|
82 |
|
|
|
(251 |
) |
Dividends paid on preferred stock |
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
Intercompany notes payable |
|
|
107 |
|
|
|
1 |
|
|
|
|
|
|
|
(20 |
) |
|
|
(88 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flows used in financing activities |
|
|
(155 |
) |
|
|
1 |
|
|
|
(12 |
) |
|
|
(90 |
) |
|
|
5 |
|
|
|
(251 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
82 |
|
|
|
19 |
|
|
|
588 |
|
|
|
(98 |
) |
|
|
|
|
|
|
591 |
|
Cash and cash equivalents at beginning of
period |
|
|
243 |
|
|
|
25 |
|
|
|
1,623 |
|
|
|
324 |
|
|
|
|
|
|
|
2,215 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and
cash equivalents at end of period |
|
$ |
325 |
|
|
$ |
44 |
|
|
$ |
2,211 |
|
|
$ |
226 |
|
|
$ |
|
|
|
$ |
2,806 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
Condensed Consolidating Balance Sheets
(Dollars in Millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
March 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
36 |
|
|
$ |
45 |
|
|
$ |
2,803 |
|
|
$ |
285 |
|
|
$ |
|
|
|
$ |
3,169 |
|
Short-term investments |
|
|
1 |
|
|
|
3 |
|
|
|
5 |
|
|
|
1 |
|
|
|
|
|
|
|
10 |
|
Accounts receivable, net |
|
|
|
|
|
|
|
|
|
|
56 |
|
|
|
28 |
|
|
|
|
|
|
|
84 |
|
Accounts receivable, related party |
|
|
|
|
|
|
|
|
|
|
61 |
|
|
|
3 |
|
|
|
|
|
|
|
64 |
|
Notes receivable |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
34 |
|
|
|
|
|
|
|
35 |
|
Other receivables |
|
|
7 |
|
|
|
|
|
|
|
17 |
|
|
|
4 |
|
|
|
|
|
|
|
28 |
|
Inventories |
|
|
|
|
|
|
|
|
|
|
810 |
|
|
|
407 |
|
|
|
(2 |
) |
|
|
1,215 |
|
Deferred income taxes, net |
|
|
11 |
|
|
|
1 |
|
|
|
818 |
|
|
|
21 |
|
|
|
|
|
|
|
851 |
|
Prepaid expenses and other |
|
|
3 |
|
|
|
|
|
|
|
186 |
|
|
|
15 |
|
|
|
|
|
|
|
204 |
|
Short-term intercompany notes and interest
receivable |
|
|
81 |
|
|
|
31 |
|
|
|
174 |
|
|
|
|
|
|
|
(286 |
) |
|
|
|
|
Other intercompany receivables |
|
|
464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(464 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
603 |
|
|
|
81 |
|
|
|
4,930 |
|
|
|
798 |
|
|
|
(752 |
) |
|
|
5,660 |
|
Property, plant and equipment, net |
|
|
7 |
|
|
|
|
|
|
|
836 |
|
|
|
182 |
|
|
|
|
|
|
|
1,025 |
|
Trademarks and other intangible assets, net |
|
|
|
|
|
|
|
|
|
|
1,485 |
|
|
|
1,324 |
|
|
|
|
|
|
|
2,809 |
|
Goodwill |
|
|
|
|
|
|
|
|
|
|
5,303 |
|
|
|
2,871 |
|
|
|
|
|
|
|
8,174 |
|
Long-term intercompany notes |
|
|
2,060 |
|
|
|
198 |
|
|
|
1,398 |
|
|
|
|
|
|
|
(3,656 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
9,561 |
|
|
|
7,821 |
|
|
|
405 |
|
|
|
|
|
|
|
(17,787 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
317 |
|
|
|
61 |
|
|
|
467 |
|
|
|
153 |
|
|
|
(377 |
) |
|
|
621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
12,548 |
|
|
$ |
8,161 |
|
|
$ |
14,824 |
|
|
$ |
5,328 |
|
|
$ |
(22,572 |
) |
|
$ |
18,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement accruals |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,853 |
|
|
$ |
44 |
|
|
$ |
|
|
|
$ |
2,897 |
|
Accounts payable and other accrued liabilities |
|
|
496 |
|
|
|
6 |
|
|
|
768 |
|
|
|
93 |
|
|
|
|
|
|
|
1,363 |
|
Due to related party |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Deferred revenue, related party |
|
|
|
|
|
|
|
|
|
|
34 |
|
|
|
|
|
|
|
|
|
|
|
34 |
|
Current maturities of long-term debt |
|
|
189 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
200 |
|
Short-term intercompany notes and interest
payable |
|
|
32 |
|
|
|
131 |
|
|
|
|
|
|
|
123 |
|
|
|
(286 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
3 |
|
|
|
444 |
|
|
|
17 |
|
|
|
(464 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
717 |
|
|
|
151 |
|
|
|
4,100 |
|
|
|
277 |
|
|
|
(750 |
) |
|
|
4,495 |
|
Intercompany notes and interest payable |
|
|
1,398 |
|
|
|
|
|
|
|
|
|
|
|
2,258 |
|
|
|
(3,656 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,337 |
|
|
|
123 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,460 |
|
Deferred income taxes, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
474 |
|
|
|
(377 |
) |
|
|
97 |
|
Long-term retirement benefits (less current
portion) |
|
|
65 |
|
|
|
32 |
|
|
|
2,652 |
|
|
|
95 |
|
|
|
|
|
|
|
2,844 |
|
Other noncurrent liabilities |
|
|
29 |
|
|
|
106 |
|
|
|
251 |
|
|
|
5 |
|
|
|
|
|
|
|
391 |
|
Shareholders equity |
|
|
6,002 |
|
|
|
7,749 |
|
|
|
7,821 |
|
|
|
2,219 |
|
|
|
(17,789 |
) |
|
|
6,002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
12,548 |
|
|
$ |
8,161 |
|
|
$ |
14,824 |
|
|
$ |
5,328 |
|
|
$ |
(22,572 |
) |
|
$ |
18,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
60
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Parent |
|
|
|
|
|
|
Other |
|
|
Non- |
|
|
|
|
|
|
|
|
|
Guarantor |
|
|
Issuer |
|
|
Guarantors |
|
|
Guarantors |
|
|
Eliminations |
|
|
Consolidated |
|
December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
272 |
|
|
$ |
6 |
|
|
$ |
1,977 |
|
|
$ |
323 |
|
|
$ |
|
|
|
$ |
2,578 |
|
Short-term investments |
|
|
1 |
|
|
|
6 |
|
|
|
14 |
|
|
|
2 |
|
|
|
|
|
|
|
23 |
|
Accounts receivable, net |
|
|
|
|
|
|
|
|
|
|
38 |
|
|
|
46 |
|
|
|
|
|
|
|
84 |
|
Accounts receivable, related party |
|
|
|
|
|
|
|
|
|
|
88 |
|
|
|
3 |
|
|
|
|
|
|
|
91 |
|
Notes receivable |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
34 |
|
|
|
|
|
|
|
35 |
|
Other receivables |
|
|
9 |
|
|
|
1 |
|
|
|
23 |
|
|
|
4 |
|
|
|
|
|
|
|
37 |
|
Inventories |
|
|
|
|
|
|
|
|
|
|
784 |
|
|
|
388 |
|
|
|
(2 |
) |
|
|
1,170 |
|
Deferred income taxes, net |
|
|
12 |
|
|
|
|
|
|
|
806 |
|
|
|
20 |
|
|
|
|
|
|
|
838 |
|
Prepaid expenses and other |
|
|
35 |
|
|
|
|
|
|
|
125 |
|
|
|
10 |
|
|
|
(7 |
) |
|
|
163 |
|
Short-term intercompany notes and interest
receivable |
|
|
81 |
|
|
|
35 |
|
|
|
183 |
|
|
|
|
|
|
|
(299 |
) |
|
|
|
|
Other intercompany receivables |
|
|
68 |
|
|
|
19 |
|
|
|
|
|
|
|
2 |
|
|
|
(89 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
478 |
|
|
|
68 |
|
|
|
4,038 |
|
|
|
832 |
|
|
|
(397 |
) |
|
|
5,019 |
|
Property, plant and equipment, net |
|
|
7 |
|
|
|
|
|
|
|
856 |
|
|
|
168 |
|
|
|
|
|
|
|
1,031 |
|
Trademarks and other intangible assets, net |
|
|
|
|
|
|
|
|
|
|
1,869 |
|
|
|
1,401 |
|
|
|
|
|
|
|
3,270 |
|
Goodwill |
|
|
|
|
|
|
|
|
|
|
5,303 |
|
|
|
2,871 |
|
|
|
|
|
|
|
8,174 |
|
Long-term intercompany notes |
|
|
2,080 |
|
|
|
207 |
|
|
|
1,408 |
|
|
|
|
|
|
|
(3,695 |
) |
|
|
|
|
Investment in subsidiaries |
|
|
9,751 |
|
|
|
8,000 |
|
|
|
413 |
|
|
|
|
|
|
|
(18,164 |
) |
|
|
|
|
Other assets and deferred charges |
|
|
349 |
|
|
|
63 |
|
|
|
310 |
|
|
|
161 |
|
|
|
(223 |
) |
|
|
660 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
12,665 |
|
|
$ |
8,338 |
|
|
$ |
14,197 |
|
|
$ |
5,433 |
|
|
$ |
(22,479 |
) |
|
$ |
18,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tobacco settlement accruals |
|
$ |
|
|
|
$ |
|
|
|
$ |
2,288 |
|
|
$ |
33 |
|
|
$ |
|
|
|
$ |
2,321 |
|
Accounts payable and other accrued liabilities |
|
|
350 |
|
|
|
7 |
|
|
|
857 |
|
|
|
142 |
|
|
|
(7 |
) |
|
|
1,349 |
|
Due to related party |
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
1 |
|
|
|
|
|
|
|
3 |
|
Deferred revenue, related party |
|
|
|
|
|
|
|
|
|
|
50 |
|
|
|
|
|
|
|
|
|
|
|
50 |
|
Current maturities of long-term debt |
|
|
189 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
200 |
|
Short-term intercompany notes and interest
payable |
|
|
40 |
|
|
|
130 |
|
|
|
2 |
|
|
|
127 |
|
|
|
(299 |
) |
|
|
|
|
Other intercompany payables |
|
|
|
|
|
|
|
|
|
|
89 |
|
|
|
|
|
|
|
(89 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
579 |
|
|
|
148 |
|
|
|
3,288 |
|
|
|
303 |
|
|
|
(395 |
) |
|
|
3,923 |
|
Intercompany notes and interest payable |
|
|
1,409 |
|
|
|
|
|
|
|
|
|
|
|
2,286 |
|
|
|
(3,695 |
) |
|
|
|
|
Long-term debt (less current maturities) |
|
|
4,362 |
|
|
|
124 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,486 |
|
Deferred income taxes, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
505 |
|
|
|
(223 |
) |
|
|
282 |
|
Long-term retirement benefits (less current
portion) |
|
|
64 |
|
|
|
32 |
|
|
|
2,646 |
|
|
|
94 |
|
|
|
|
|
|
|
2,836 |
|
Other noncurrent liabilities |
|
|
14 |
|
|
|
106 |
|
|
|
263 |
|
|
|
7 |
|
|
|
|
|
|
|
390 |
|
Shareholders equity |
|
|
6,237 |
|
|
|
7,928 |
|
|
|
8,000 |
|
|
|
2,238 |
|
|
|
(18,166 |
) |
|
|
6,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
12,665 |
|
|
$ |
8,338 |
|
|
$ |
14,197 |
|
|
$ |
5,433 |
|
|
$ |
(22,479 |
) |
|
$ |
18,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
61
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 position. 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 position for the
periods presented in this report. The discussion and analysis of RAIs results of operations
compares the first quarter of 2009 with the first quarter of 2008. Disclosures related to liquidity
and financial position complete managements discussion and analysis. You should read this
discussion and analysis of RAIs consolidated financial position and results of operations in
conjunction with the financial information included in the condensed consolidated financial
statements (unaudited).
Overview and Business Initiatives
RAIs reportable operating segments are RJR Tobacco and Conwood. The RJR Tobacco segment
consists of the primary operations of R. J. Reynolds Tobacco Company. The Conwood segment consists
of Conwood Holdings, Inc., the primary operations of the Conwood companies and Lane. RAIs wholly
owned subsidiary, Santa Fe, among others, is included in All Other. Some of RAIs wholly owned
operating subsidiaries have entered into intercompany agreements for products or services with
other RAI operating subsidiaries. As a result, certain activities of an operating subsidiary may be
included in a different segment of RAI.
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 and WINSTON, were five of the ten best-selling brands of cigarettes in the United
States as of March 31, 2009. Those brands, and its other brands, including SALEM, 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.
On January 1, 2009, the management of tobacco products sold to certain U.S. territories, U.S.
duty-free shops and U.S. overseas military bases was transferred to RJR Tobacco from GPI.
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, the best-selling moist snuff brand in the United States as of March
31, 2009, and KODIAK. Conwoods other products include loose leaf chewing tobacco, dry snuff, plug
and twist tobacco products, as well as WINCHESTER and CAPTAIN BLACK little cigars, and BUGLER
roll-your-own tobacco.
Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL
AMERICAN SPIRIT brand and manages super premium brands, DUNHILL and STATE EXPRESS 555, licensed
from BAT.
On February 4, 2009, President Obama signed an increase of $0.62 in the excise tax per pack of
cigarettes, and significant tax increases on other tobacco products, to fund expansion of the
SCHIP. As a result, the federal tax rate for chewing tobacco increased $0.3083 per pound to $0.5033
per pound and increased $0.925 per pound to $1.51 per pound for snuff. The federal tax on small
cigars, defined as those weighing three pounds or less per thousand, increased $48.502 per thousand
to $50.33 per thousand. In addition, the federal tax rate for roll-your-own tobacco increased from
$1.097 per pound to $24.78 per pound. The tax increases were effective April 1, 2009. RAIs
operating subsidiaries expect that these federal excise tax increases on cigarettes and other
tobacco products will significantly and adversely impact sales volume. This event required the
testing for impairment of the carrying value of trademarks and goodwill during the first quarter of
2009. If the federal excise tax increase has a greater adverse impact on sales volumes than
projected as of March 31, 2009, RAIs operating subsidiaries may be required to test for further
intangible asset impairment during 2009. See note 3 to condensed consolidated financial statements
(unaudited) for information regarding trademark and goodwill impairment testing and the resulting
trademark impairment charge.
RJR Tobacco
RJR Tobacco primarily conducts business in the highly competitive U.S. cigarette market, which
has a few large manufacturers and many smaller participants. The U.S. cigarette market is a mature
market in which overall
62
consumer demand has declined since 1981 and is expected to continue to decline. Trade
inventory adjustments may result in short-term changes in demand for RJR Tobaccos products 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.
RJR Tobaccos brand portfolio strategy is based upon three brand categories: growth, support
and non-support. The growth brands consist of a premium brand, CAMEL, and a value brand, PALL MALL.
Although both of these brands are managed for long-term market share and profit growth, CAMEL will
continue to receive the most significant investment support. The support brands include four
premium brands, KOOL, WINSTON, SALEM and CAPRI, and two value brands, DORAL and MISTY, all of which
receive limited marketing support. The non-support brands, consisting of all other brands, are
managed to maximize near-term profitability. The key objectives of the portfolio strategy are to
ensure the long-term market share growth of the growth brands while managing the support brands for
long-term sustainability and profitability.
Competition is based primarily on brand positioning, including price, product attributes and
packaging, consumer loyalty, promotions, advertising and retail presence. Cigarette brands produced
by the major manufacturers generally require competitive pricing, substantial marketing support,
retail programs and other incentives to maintain or improve market position or to introduce a new
brand style. Having expanded beyond the cigarette market as an innovative tobacco company, RJR
Tobacco offers a smokeless, spitless tobacco, known as snus and new smoke-free tobacco products
called CAMEL Dissolvables. CAMEL Snus, launched nationally in 2009, is pasteurized tobacco that is
sold in a small pouch that provides convenient tobacco consumption. CAMEL Dissolvables include
CAMEL Orbs, Sticks and Strips, all of which are made of finely milled tobacco and dissolve
completely in the mouth. CAMEL Orbs were launched in lead markets during the first quarter of 2009,
and CAMEL Sticks and Strips will be launched in lead markets in the third quarter of 2009.
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 to RJR Tobacco brands. In addition to
building strong brand equity, RJR Tobaccos marketing approach utilizes a retail pricing strategy,
including discounting at retail, to defend certain brands shares of market against competitive
pricing pressure. RJR Tobaccos competitive pricing methods may include list price changes,
discounting programs, such as retail buydowns, periodic price reductions, dollar-off promotions,
free product promotions and consumer coupons. Retail buydowns refer to payments made to the
retailer to reduce the price that consumers pay at retail. Consumer coupons generally are
distributed by a variety of methods, including in, or on, the cigarette pack and by direct mail.
Free product promotions include offers such as Buy 2, Get 1 free. The cost of free product
promotions, including federal excise tax, is recorded in cost of goods sold.
Conwood
Conwood offers a range of differentiated smokeless and other tobacco products to adult
consumers. The moist snuff category is divided into premium and price-value brands. The moist snuff
category has developed many of the characteristics of the larger, cigarette market, including
multiple pricing tiers with intense competition, focused marketing programs and significant product
innovation.
In contrast to the declining U.S. cigarette market, U.S. moist snuff volumes grew over 7% in
2008 and have grown at an average rate of approximately 6% per year over the last four years,
driven by the accelerated growth of price-value brands. Profit margins on moist snuff products are
generally higher than on cigarette products. 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 the
growth of GRIZZLY, in recent years. Leveraging RAIs total tobacco business model, Conwood will
launch CAMEL Dip, a premium moist snuff, during the second quarter of 2009.
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. The parent
company of RJR Tobaccos largest competitor in the
63
cigarette market, Philip Morris USA, Inc., completed its acquisition of Conwoods largest
competitor, UST, in January 2009.
Critical Accounting Policies and Estimates
GAAP
requires estimates and assumptions to be made that affect the reported amounts in RAIs condensed
consolidated financial statements (unaudited) 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 position and results of operations of
RAI and its subsidiaries.
Litigation
RAI discloses information concerning 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 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 10 to condensed consolidated financial statements (unaudited), RJR
Tobacco, the Conwood companies 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. As of April
9, 2009, RJR Tobacco had paid approximately $6 million since January 1, 2007, related to
unfavorable judgments.
RAI and its subsidiaries believe that they have valid bases for appeal of adverse verdicts
against them 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 the
Conwood companies, when viewed on an individual basis, is not probable or estimable. As of March
31, 2009, RJR Tobacco had $2 million accrued for non-smoking and health litigation, and RJR,
including its subsidiary RJR Tobacco, had liabilities totaling $94 million that were recorded 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, the Conwood companies or their affiliates, including RAI, and indemnitees. Any unfavorable
outcome of such actions could have a material adverse effect on the consolidated results of
operations, cash flows or financial position of RAI or its subsidiaries. For further discussion of
the litigation and legal proceedings pending against RAI or its affiliates or indemnitees, see note
10 to condensed consolidated financial statements (unaudited).
Settlement Agreements
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 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 to RJR Tobacco under these
agreements is recorded in cost of products sold as the products are shipped. Adjustments to these
estimates are recorded in the period that the change becomes probable and the amount can be
reasonably estimated. The Conwood companies are not participants in the MSA. For more information
related to historical and expected
64
settlement expenses and payments under the MSA, see Litigation Affecting the Cigarette
Industry Health-Care Cost Recovery Cases MSA and MSA Enforcement and Validity in note
10 to condensed consolidated financial statements (unaudited).
Intangible Assets
Intangible
assets include goodwill, trademarks and other intangible assets and are accounted for
under SFAS No. 142, Goodwill and Other Intangible Assets. The determination of fair value
involves considerable estimates and judgment. In particular, the fair value of a reporting unit
involves, among other things, developing forecasts of future cash flows, determining an appropriate
discount rate, and when goodwill impairment is implied, determining the fair value of individual
assets and liabilities, including unrecorded intangibles. Although RAI believes it has based its
impairment testing and impairment charges on reasonable estimates and assumptions, the use of
different estimates and assumptions could result in materially different results. Generally, if the
current competitive or regulatory environment worsens or RAIs operating companies strategic
initiatives adversely affect their financial performance, the fair value of goodwill, trademarks
and other intangible assets could be impaired in future periods. See note 3 to condensed consolidated
financial statements (unaudited) for a discussion of the impairment charge in connection with RAIs
ongoing application of SFAS No. 142.
Fair Value Measurement
RAI determines fair
value of assets and liabilities under SFAS No. 157, which provides a definition of fair value, establishes a fair value hierarchy
that distinguishes between market participant assumptions developed based on market data obtained
from sources independent of the reporting entity, and the reporting entitys own assumptions about
market participant assumptions developed based on the best information available in the
circumstances and expands disclosure about fair value measurements.
FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active, clarifies the application of SFAS No. 157 in a
market that is not active and provides an example to illustrate key considerations in determining
the fair value of a financial asset when the market for that financial asset is not active.
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the measurement
date, essentially an exit price.
The levels of the fair value hierarchy established by SFAS No. 157 are:
Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: inputs are other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly. A Level 2 input must be observable for
substantially the full term of the asset or liability.
Level 3: inputs are unobservable and reflect the reporting entitys own assumptions about
the assumptions that market participants would use in pricing the asset or liability.
Investments
As of March 31, 2009, RAI held investments primarily in money market funds, auction rate
securities and a mortgage-backed security. Certain money market funds are classified as short-term
investments due to the liquidity restrictions by the fund managers preventing immediate withdrawal.
Adverse changes in financial markets caused certain auction rate securities and the mortgage-backed
security to revalue lower than carrying value and become less liquid. Auction rate securities and
the mortgage-backed security will not become liquid until a successful auction occurs or a buyer is
found. These investments will be evaluated on a quarterly basis to determine if it is probable that
RAI will realize some portion of the unrealized loss.
65
RAI reviews impairments associated with the above in accordance with SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities, FSP No. FAS 115-1 and FAS 124-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and FSP No.
EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20, to determine the
classification of the impairment as temporary or other-than-temporary. For additional information
relating to these investments, see note 6 to condensed consolidated financial statements
(unaudited).
Income Taxes
Tax law requires certain items to be excluded or 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. FASB Interpretation, referred to as 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 on a quarterly basis.
To the extent that any book and tax differences are temporary in nature, that is, the book
realization will occur in a different period than the tax realization, a deferred tax asset or
liability is established as required under SFAS No. 109. To the extent that a deferred tax asset is
created, management evaluates RAIs ability to realize this asset. Management currently believes it
is more likely than not that the deferred tax assets recorded in RAIs consolidated balance sheets
will be realized. To the extent a deferred tax liability is established under SFAS No. 109, it is
recorded, tracked and, once it becomes currently due and payable, paid to the taxing authorities.
The financial statements reflect managements best estimate of RAIs current and deferred tax
liabilities and assets. Future events, including but not limited to, additional resolutions with
taxing authorities could have an impact on RAIs current estimate of tax liabilities, realization
of tax assets and upon RAIs effective income tax rate.
Recently Adopted Accounting Pronouncements
Effective January 1, 2009, RAI adopted SFAS No. 157 for
nonfinancial assets and nonfinancial liabilities. 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 disclosure about fair value measurements. SFAS No. 157 also establishes a fair
value hierarchy that distinguishes between independent and observable inputs and unobservable
inputs based on the best information available. The adoption of SFAS No. 157 on nonfinancial assets
and nonfinancial liabilities did not have a material impact on RAIs consolidated results of
operations, cash flows or financial position.
Effective
January 1, 2009, RAI adopted FSP No. EITF 03-6-1, which
addresses whether instruments granted in share-based payment transactions are participating
securities prior to vesting and, therefore, need to be included in the earnings allocation in
computing earnings per share. As a result, unvested restricted shares outstanding under the LTIP
are included in basic EPS calculations. All prior-period earnings per share have been adjusted
retrospectively to conform to the provisions of this FSP, which reduced basic net income per share
for the first quarter of 2008 by $0.01 from $1.72 per share to $1.71 per share.
Effective
January 1, 2009, RAI adopted SFAS No. 161, which seeks
qualitative disclosures about the objectives and strategies for using derivatives; quantitative data about the
fair value of, and gains and losses on, derivative contracts; and details of credit-risk-related
contingent features in hedged positions. SFAS No. 161 also seeks enhanced disclosure around
derivative instruments in financial statements, accounted for under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, and how hedges affect an entitys financial
position, financial performance and cash flows. The adoption of SFAS No. 161 did not have a
material impact on RAIs consolidated results of operations, cash flows or financial position.
66
Recently Issued Accounting Pronouncements
On
April 9, 2009, the FASB issued FSP No. FAS 157-4, which amends SFAS No. 157 and provides additional guidance for estimating fair value in accordance with SFAS
No. 157 when the volume and level of activity for the asset and liability have significantly
decreased, as well as provides guidance on identifying circumstances that indicate a transaction is
not orderly. FSP No. FAS 157-4 is effective for interim and annual periods ending after June 15,
2009. The adoption of FSP No. FAS 157-4 is not expected to have a material impact on RAIs
consolidated results of operations, cash flows or financial position.
On
April 9, 2009, FASB issued FSP No. FAS 115-2 and FAS 124-2,
which amends SFAS No. 115 and FSP No. FAS 115-1 and FAS
124-1. FSP No. FAS 115-2 and FAS 124-2 provides additional guidance to make other-than-temporary
impairments more operational and to improve the financial statement presentation of such
impairments. FSP No. FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending
after June 15, 2009. The adoption of FSP No. FAS 115-2 and FAS 124-2 is not expected to have a
material impact on RAIs consolidated results of operations, cash flows or financial position.
On
April 9, 2009, FASB issued FSP No. FAS 107-1 and APB 28-1,
which amends SFAS No. 107 and APB Opinion No. 28 by requiring disclosures about fair value of financial instruments in interim financial statements
as well as in annual financial statements. FSP No. FAS 107-1 and APB 28-1 is effective for interim
periods ending after June 15, 2009. The adoption of FSP No. FAS 107-1 and APB 28-1 is not expected
to have a material impact on RAIs consolidated results of operations, cash flows or financial
position.
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
|
% Change |
|
Net sales:(1) |
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
$ |
1,671 |
|
|
$ |
1,807 |
|
|
|
(7.5 |
)% |
Conwood |
|
|
166 |
|
|
|
167 |
|
|
|
(0.7 |
)% |
All other |
|
|
84 |
|
|
|
83 |
|
|
|
1.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
1,921 |
|
|
|
2,057 |
|
|
|
(6.6 |
)% |
Cost of products sold(1)(2) |
|
|
998 |
|
|
|
1,164 |
|
|
|
(14.3 |
)% |
Selling, general and administrative expenses |
|
|
365 |
|
|
|
382 |
|
|
|
(4.5 |
)% |
Amortization expense |
|
|
8 |
|
|
|
5 |
|
|
|
60.0 |
% |
Trademark impairment charges |
|
|
453 |
|
|
|
|
|
|
|
NM |
(3) |
Operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
RJR Tobacco |
|
|
82 |
|
|
|
426 |
|
|
|
(80.8 |
)% |
Conwood |
|
|
8 |
|
|
|
81 |
|
|
|
(90.5 |
)% |
All other |
|
|
24 |
|
|
|
25 |
|
|
|
(4.0 |
)% |
Corporate expense |
|
|
(17 |
) |
|
|
(26 |
) |
|
|
(34.6 |
)% |
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
$ |
97 |
|
|
$ |
506 |
|
|
|
(80.8 |
)% |
|
|
|
|
|
|
|
|
|
|
|
67
|
|
|
(1) |
|
Excludes excise taxes of: |
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
2008 |
|
RJR Tobacco |
|
$ |
362 |
|
|
$ |
391 |
|
Conwood |
|
|
5 |
|
|
|
5 |
|
All other |
|
|
43 |
|
|
|
41 |
|
|
|
|
|
|
|
|
|
|
$ |
410 |
|
|
$ |
437 |
|
|
|
|
|
|
|
|
|
|
|
(2) |
|
See below for further information related to MSA settlement and
federal tobacco buyout expense included in cost of products sold. |
|
(3) |
|
Percentage change not meaningful. |
RJR Tobacco
Net Sales
Domestic shipment volume, in billions of units for RJR Tobacco and the industry, were as
follows(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
|
2009 |
|
2008 |
|
% Change |
Growth brands: |
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter |
|
|
5.0 |
|
|
|
5.3 |
|
|
|
(5.0 |
)% |
PALL MALL |
|
|
1.9 |
|
|
|
1.6 |
|
|
|
17.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.9 |
|
|
|
6.9 |
|
|
|
0.3 |
% |
Support brands |
|
|
9.7 |
|
|
|
11.3 |
|
|
|
(14.0 |
)% |
Non-support brands |
|
|
2.1 |
|
|
|
2.7 |
|
|
|
(23.1 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
18.7 |
|
|
|
20.8 |
|
|
|
(10.5 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premium |
|
|
11.7 |
|
|
|
13.2 |
|
|
|
(11.2 |
)% |
Total value |
|
|
7.0 |
|
|
|
7.7 |
|
|
|
(9.1 |
)% |
Premium/total mix |
|
|
62.7 |
% |
|
|
63.2 |
% |
|
|
|
|
Industry(2): |
|
|
|
|
|
|
|
|
|
|
|
|
Premium |
|
|
51.5 |
|
|
|
58.8 |
|
|
|
(12.5 |
)% |
Value |
|
|
20.5 |
|
|
|
21.6 |
|
|
|
(4.9 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
72.0 |
|
|
|
80.4 |
|
|
|
(10.4 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium/total mix |
|
|
71.5 |
% |
|
|
73.1 |
% |
|
|
|
|
|
|
|
(1) |
|
Amounts presented in this table are rounded on an individual basis and, accordingly, may not sum on
an aggregate basis. Percentages are calculated on unrounded numbers. |
|
(2) |
|
Based on information from MSAi. Prior year amounts have been restated to reflect current methodology. |
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. RJR Tobacco expects the federal excise tax increase, effective April 1,
2009, to significantly and adversely impact sales volume as RJR Tobacco believes its consumers are
more price-sensitive than consumers of competing brands and, therefore, are more negatively
affected by an increase in the federal excise tax and by the current adverse economic environment.
RJR Tobaccos net sales for the three months ended March 31, 2009, decreased $136 million, or
7.5%, from the prior-year quarter, driven by $128 million attributable to lower volume. RJR
Tobaccos decreases in net sales and
68
shipment volume primarily reflect wholesale and retail inventory reductions believed to be in
anticipation of the increase in federal excise tax. RJR Tobaccos total domestic shipment volume
decreased 10.5% in the first three months of 2009 compared with the same period in 2008. Industry
shipment volume for the first three months of 2009 was down 10.4% compared with the first three
months of 2008. Shipments are rebounding in the second quarter as wholesale and retail rebuild
inventory, but this inventory build is expected to be more than offset by a decrease in consumption
for the full year. Although it is difficult to predict the full
impact of the significant price increases in connection with the increase in federal
excise tax on consumption, RJR Tobaccos and industry shipment
volume declines for the full-year 2009 are expected to
be higher than prior years.
The shares of RJR Tobaccos brands as a percentage of total share of U.S. retail cigarette
sales according to Information Resources Inc., referred to as
IRI,/Capstone, data(1), were as follows(2)(3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
December 31, |
|
Share Point |
|
March 31, |
|
Share Point |
|
|
2009 |
|
2008 |
|
Change |
|
2008 |
|
Change |
|
|
|
|
|
Growth brands: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAMEL excluding non-filter |
|
|
7.6 |
% |
|
|
7.8 |
% |
|
|
(0.2 |
) |
|
|
7.5 |
% |
|
|
0.1 |
|
PALL MALL |
|
|
2.9 |
% |
|
|
3.2 |
% |
|
|
(0.3 |
) |
|
|
2.2 |
% |
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total growth brands |
|
|
10.5 |
% |
|
|
11.0 |
% |
|
|
(0.5 |
) |
|
|
9.7 |
% |
|
|
0.8 |
|
Support brands |
|
|
14.1 |
% |
|
|
14.1 |
% |
|
|
|
|
|
|
15.0 |
% |
|
|
(0.9 |
) |
Non-support brands |
|
|
3.1 |
% |
|
|
3.3 |
% |
|
|
(0.2 |
) |
|
|
3.7 |
% |
|
|
(0.6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total domestic |
|
|
27.7 |
% |
|
|
28.4 |
% |
|
|
(0.7 |
) |
|
|
28.4 |
% |
|
|
(0.7 |
) |
|
|
|
(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 IRI/Capstone data as being a precise
measurement of actual market share because it was a sample and
projection methodology that 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. |
|
(3) |
|
In 2009, at the request of RJR Tobacco, the IRI/Capstone model was
revised to better reflect actual retail sales. Prior year data has
been adjusted to reflect the new methodology. |
The retail share of market of CAMELs filtered styles increased 0.1 share points in the first
quarter of 2009 compared with the first quarter of 2008. CAMEL Crush has captured 0.6 share points
as of March 31, 2009, as the success of this style continues to be a key driver in the growing
menthol category.
CAMEL Snus was expanded nationally in the first quarter of 2009 and CAMEL Orbs were launched
in three lead markets in the first quarter of 2009. Two new styles of CAMEL Snus will be launched
in limited markets in the third quarter of 2009. CAMEL Sticks and Strips are planned to be
launched in lead markets during the third quarter of 2009.
PALL MALLs market share increased 0.6 share points in the first quarter of 2009 compared with
the first quarter of 2008. PALL MALLs growth is believed to be the result of the brands position
as a product that offers a longer-lasting cigarette at a value price.
The combined share of market of RJR Tobaccos growth brands during the first quarter of 2009
showed improvement over the same period in 2008. However, the decline in share of support and
non-support brands more than offset the gains on the growth brands.
69
Operating Income
RJR Tobaccos operating income for the quarter ended March 31, 2009, decreased $344 million to
$82 million from $426 million for the quarter ended March 31, 2008. An impairment charge of $377
million was recorded in the first quarter of 2009 as the result of impairment testing to reflect
the forecasted sales impact due to the increase in the federal excise tax. The impairment charge
was based on the excess of certain brands carrying value over their fair value using the present
value of estimated future cash flows assuming a discount rate of 10.5%.
RJR Tobaccos operating income was also negatively impacted by decreases in shipment volume
due to a decrease in consumption, wholesale and retail inventory reductions and higher pension
expense. These negative impacts were partially offset by higher pricing, lower promotional
spending and lower absolute MSA expense.
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 Ended |
|
|
|
March 31, |
|
|
|
2009 |
|
|
2008 |
|
Settlements |
|
$ |
567 |
|
|
$ |
644 |
|
|
|
|
|
|
|
|
Federal tobacco quota buyout |
|
$ |
50 |
|
|
$ |
60 |
|
|
|
|
|
|
|
|
MSA settlement expenses are expected to be approximately $2.4 billion in 2009, subject to
adjustment for changes in volume and other factors, and expense for the federal tobacco quota
buyout is expected to be approximately $210 million to $230 million in 2009. For additional
information, see Litigation Affecting the Cigarette Industry Health-Care Cost Recovery Cases
MSA and Tobacco Buyout Legislation and Related Litigation in note 10 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 three months ended March 31,
2009 and 2008, RJR Tobaccos product liability defense costs
were $27 million and $28 million,
respectively.
Product liability cases generally include the following types of smoking and health related
cases:
|
|
|
Individual Smoking and Health; |
|
|
|
|
West Virginia IPIC; |
|
|
|
|
Engle Progeny; |
|
|
|
|
Broin II; |
|
|
|
|
Class Actions; and |
|
|
|
|
Health-Care Cost Recovery 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 |
70
|
|
|
payments to fund legal defense costs for the now dissolved Council for Tobacco Research
U.S.A. |
Numerous factors affect 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 Industry
Overview in note 10 to condensed consolidated financial statements (unaudited) for detailed
information regarding the number and type of cases pending, and Litigation Affecting the
Cigarette Industry Scheduled Trials in note 10 to condensed consolidated financial statements
(unaudited) for detailed information regarding the number and nature of cases in trial and
scheduled for trial through March 31, 2010.
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 RJR Tobaccos experience in defending
its product liability cases and the reasonably anticipated level of activity in RJR Tobaccos
pending cases and possible new cases, RJR Tobacco anticipates that its product liability defense
costs will increase in 2009, compared with the most recent years. 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 consolidated results of
operations, cash flows or financial position 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
The moist snuff shipment volume, in millions of cans, for Conwood was as
follows(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
|
2009 |
|
2008 |
|
% Change |
|
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
KODIAK |
|
|
10.7 |
|
|
|
13.1 |
|
|
|
(18.5 |
)% |
Other |
|
|
0.5 |
|
|
|
0.6 |
|
|
|
(17.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11.2 |
|
|
|
13.7 |
|
|
|
(18.4 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Price-value: |
|
|
|
|
|
|
|
|
|
|
|
|
GRIZZLY |
|
|
65.0 |
|
|
|
61.7 |
|
|
|
5.2 |
% |
Other |
|
|
0.3 |
|
|
|
0.5 |
|
|
|
(34.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65.3 |
|
|
|
62.2 |
|
|
|
4.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total moist snuff |
|
|
76.4 |
|
|
|
75.9 |
|
|
|
0.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts presented in this table are rounded on an individual basis
and, accordingly, may not sum on an aggregate basis. Percentages are
calculated on unrounded numbers. |
Moist snuff has been the key driver to Conwoods overall growth and profitability within the
U.S. smokeless tobacco market. Moist snuff accounted for approximately 64% of Conwoods revenue in
the first quarter of 2009 and approximately 66% in the first quarter of 2008. Conwoods key brands
include KODIAK in the premium brand category and GRIZZLY in the price-value brand category.
Conwoods U.S. moist snuff market share was 28.8% in the first quarter of 2009 and 26.8% in the
first quarter of 2008 based on distributor-reported data processed by MSAi, for distributor
shipments to retail. Moist snuff industry shipment volume grew over 4.5% in the first quarter of
2009 compared with the same period in 2008. This growth is much lower than the historical growth
due to wholesale and retail inventory reductions believed to be in anticipation of the federal
excise tax increase that was effective April 1, 2009.
71
The Conwood shares of the moist snuff category as a percentage of total share of U.S.
shipments of moist snuff, according to distributor reported data(1) processed by MSAi,
were as follows(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
December 31, |
|
Share |
|
March 31, |
|
Share |
|
|
2009 |
|
2008 |
|
Point Change |
|
2008 |
|
Point Change |
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
KODIAK |
|
|
3.8 |
% |
|
|
3.7 |
% |
|
|
0.1 |
|
|
|
4.4 |
% |
|
|
(0.6 |
) |
Other |
|
|
0.2 |
% |
|
|
0.3 |
% |
|
|
(0.1 |
) |
|
|
0.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.0 |
% |
|
|
4.0 |
% |
|
|
|
|
|
|
4.6 |
% |
|
|
(0.6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Price-value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GRIZZLY |
|
|
24.7 |
% |
|
|
24.1 |
% |
|
|
0.6 |
|
|
|
22.1 |
% |
|
|
2.6 |
|
Other |
|
|
0.1 |
% |
|
|
0.1 |
% |
|
|
|
|
|
|
0.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24.8 |
% |
|
|
24.2 |
% |
|
|
0.6 |
|
|
|
22.2 |
% |
|
|
2.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total moist snuff |
|
|
28.8 |
% |
|
|
28.2 |
% |
|
|
0.6 |
|
|
|
26.8 |
% |
|
|
2.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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. |
Conwoods net sales for the three months ended March 31, 2009, were $166 million and
relatively flat compared with $167 million for the three months ended March 31, 2008. GRIZZLY,
Conwoods leading price-value moist snuff brand, continues to grow moist snuff sales and was the
leading brand in the U.S. as of March 31, 2009. During the first quarter of 2009, pricing was
significantly reduced by a competitor on its premium and certain price-value brands in an attempt
to gain market share. KODIAK, Conwoods leading premium moist snuff brand, reduced pricing at the
end of the first quarter of 2009 to remain competitive. Sales at the end of the first quarter of
2009 were negatively impacted by the inventory reduction at wholesale and retail believed to be in
anticipation of the federal excise tax increase.
GRIZZLY had a 24.7% share of moist snuff shipments in the first quarter of 2009, an increase
of 2.6 share points from the first quarter of 2008, due in part to the success of new GRIZZLY
styles. GRIZZLY launched mint and straight pouch styles in the first quarter of 2009.
Conwood will launch CAMEL Dip, a premium moist snuff in two styles, Wintergreen Wide Cut and
Dark Milled, in lead markets during the second quarter of 2009.
The shipment share of KODIAK declined 0.6 share points in the first quarter of 2009 compared
with the first quarter of 2008 due to competitive promotional activity and the brands core markets
being burdened by high tobacco taxes and the current economic recession. KODIAKs price reduction
during March is expected to improve the brands performance.
Operating Income
Conwoods operating income for the three months ended March 31, 2009, decreased to $8 million
from $81 million for the three months ended March 31, 2008, impacted by a trademark impairment
charge of $76 million. The impairment charge was a result of impairment testing triggered by
certain price reductions and the anticipated sales impact due to the increase in the federal excise
tax effective April 1, 2009. The 2009 impairment occurred on
72
several of Conwoods brands, including KODIAK, driven by the decrease in its list price to
meet competition, as well as the federal excise tax impact on multiple loose leaf and little cigar
brands. The impairment charge was based on the excess of certain brands carrying value over their
fair value using the present value of estimated future cash flows assuming a discount rate of
10.5%.
RAI Consolidated
Interest and debt expense was $66 million for the quarter ended March 31, 2009, a decrease of
$6 million over the comparable period in the prior year. This decrease was primarily due to lower
effective interest rates in 2009 as compared with 2008.
Interest income was $5 million for the quarter ended March 31, 2009, a decrease of $17 million
compared with the quarter ended March 31, 2008. This decrease was the result of investing available
cash at lower interest rates in 2009.
Other
expense (income), net was expense of $19 million for the
quarter ended March 31, 2009, and
included $16 million related to the mark-to-market of RAIs and RJRs interest rate swap agreements.
For the quarter ended March 31, 2008, other income was $12 million and included $8 million of
foreign exchange gain and $5 million gain on sale of an asset.
Provision for income taxes was $9 million, or an effective rate of 53.3%, for the three months
ended March 31, 2009, compared with $291 million, or an effective rate of 36.6%, for the three
months ended March 31, 2008. The effective tax rate for the first three months of 2009 was
unfavorably impacted by increases in unrecognized income tax benefits and increases in tax
attributable to accumulated and undistributed foreign earnings. The 2008 provision was favorably
impacted by a lower tax rate related to the gain on the termination of the Reynolds-Gallaher
International Sarl joint venture, but was offset by unfavorability related to tax reserves and U.S.
taxes recorded on foreign earnings. RAI expects its effective rate for the full-year of 2009 to be
approximately 38.0%. 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 domestic
production activities deduction of the American Jobs Creation Act, enacted on October 22, 2004.
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 intercompany loans and
advances, mainly from RAI and RJR. The principal capital resources and sources of liquidity for RAI
and RJR, in turn, are proceeds from issuances of debt securities by RAI and RJR and the RAI credit
facility described below under Borrowing Arrangements. 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.
Generally, 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, accelerated declines in consumption, particularly
from increases in regulation or excise taxes, or adverse impacts from financial markets, cannot be
predicted. However, the significant federal excise tax increase approved on February 4, 2009, and
effective April 1, 2009, will impact RAIs operating companies federal excise tax payment in the
third quarter of 2009 by approximately $235 million as a result of additional federal excise tax on
inventory held as of March 31, 2009.
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.
RAI has evaluated the liquidity of key suppliers and significant customers as of March 31,
2009. Where there were liquidity concerns identified with key suppliers, contingency plans are
being developed. To date, no business
73
interruptions have occurred caused by key supplier liquidity. No liquidity issues were
identified regarding significant customers.
As of March 31, 2009, RAI held investments primarily in money market funds, auction rate
securities and a mortgage-backed security. Certain money market funds are classified as short-term
investments due to liquidity restrictions by the fund managers preventing immediate withdrawal.
Given such restrictions, these funds will not be available until the underlying investments mature
or are sold. Adverse changes in financial markets caused the auction rate securities and the
mortgage-backed security to revalue lower than carrying value and become less liquid. The auction
rate securities and mortgage-backed security will not become liquid until a successful auction
occurs or a buyer is found. RAI intends, and has the ability, to hold these money market funds,
auction rate securities and mortgage-backed security for a period of time sufficient to allow for
sale, redemption or anticipated recovery in fair value. At March 31, 2009, RAI considered the
mortgage-backed security, the auction rate securities linked to corporate credit risk and the
auction rate securities related to financial insurance companies to be temporarily impaired.
Cash Flows
Net
cash flows from operating activities were $863 million in the first three months of 2009,
compared with $878 million in the first three months of 2008. This change was driven primarily by
higher inventories, a litigation bond posted in the first quarter of
2009, as well as lower interest
received in 2009, partially offset by lower tax payments.
Net
cash flows used in investing activities were $12 million in the first three months of 2009,
compared with $36 million for the first three months of 2008. This change was driven by lower
capital expenditures in 2009 and proceeds from the Reserve Fund money market funds.
Net
cash flows used in financing activities were $252 million in the first three months of
2009, compared with $251 million in the prior-year period.
Borrowing Arrangements
RAI and RJR use interest rate swaps to manage interest rate risk on a portion of their debt
obligations. On December 31, 2008, interest rate swaps existed on $1.6 billion of fixed- rate
notes. When entered into, these swaps were designated as hedges of underlying exposures. On January
6, 2009, RAI and RJR entered into offsetting interest rate swap agreements in the notional amount
of $1.5 billion with maturity dates ranging from June 1, 2012 to June 15, 2017. These swaps were
entered into with the same financial institution that holds a notional amount of $1.5 billion of
current swaps and have a legal right of offset. The future cash flows, established as a result of
entering into the January 6, 2009, swaps, totals $321 million, and will be amortized and
effectively reduce net interest costs over the remaining life of the notes. Concurrent with
entering the swap agreements on January 6, 2009, RAI de-designated the current swaps as fair value
hedges.
On January 7, 2009, RAI and RJR terminated an interest rate swap agreement in the notional
amount of $100 million with a maturity date of June 1, 2012. The resulting gain of approximately
$12 million will be amortized to effectively reduce interest expense over the remaining life of the
notes.
As a result of these actions, RAI and RJR have effectively converted $1.6 billion of
fixed-rate notes swapped to a variable rate of interest, to a fixed rate of interest of
approximately 4.0%.
At their 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.
RAIs floating rate notes are redeemable at par on any interest payment date after December 15,
2008.
RAIs credit facility provides for a five-year, $550 million revolving credit facility, which
may be increased to $900 million at the discretion of the lenders upon the request of RAI. The
credit facilitys maturity date of June 28, 2012, may be extended by one year, at the discretion of
the lenders upon RAIs request.
74
At March 31, 2009, RAI had $12 million in letters of credit outstanding under the credit
facility. At such date, no borrowings were outstanding, and the remaining $538 million of the
credit facility was available for borrowing.
In 2008, Lehman Commercial Paper Inc., referred to as LCPI, filed for protection under Chapter
11 of the federal Bankruptcy Code. RAI has never borrowed under the credit facility, but given
LCPIs bankruptcy filing, there can be no assurance that LCPI would loan LCPIs pro rata share of
any borrowing requests made by RAI. LCPIs commitment under the credit facility is $52 million.
Subject to the terms and conditions in the credit facility, RAI has the right to replace a lender
in certain circumstances, including upon a lender defaulting in its obligation to make loans. If
any lender were to default in its obligation to make loans, there can be no assurance as to when or
whether RAI could find an acceptable replacement lender.
Concerns about, or lowering of, RAIs 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.
RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed
by their indebtedness at March 31, 2009.
Dividends
On February 3, 2009, RAIs board of directors declared a quarterly cash dividend of $0.85 per
common share. The dividend was paid on April 1, 2009, to shareholders of record as of March 10,
2009. On an annualized basis, the dividend rate is $3.40 per common share. The current dividend
reflects RAIs policy of paying dividends to the holders of RAIs common stock in an aggregate
amount that is approximately 75% of RAIs annual consolidated net income.
Stock Repurchases
Due to RAIs incorporation in North Carolina, which does not recognize treasury shares, the
shares repurchased are cancelled at the time of repurchase. During the first three months of 2009,
at a cost of $5 million, RAI purchased 144,924 shares that were forfeited with respect to tax
liabilities associated with restricted stock vesting under its LTIP.
The $350 million share repurchase program approved by RAIs board of directors on April 29,
2008, authorizing RAI to repurchase outstanding shares of RAI common stock in open-market or
privately negotiated transactions, from time to time, expired on April 30, 2009. In connection
with this share repurchase program, RAI and B&W entered into an agreement, pursuant to which B&W
participated in the repurchase program on a basis approximately proportionate with B&Ws 42%
ownership of RAIs equity. RAI repurchased $207 million of its common stock pursuant to the
foregoing share repurchase program.
Capital Expenditures
RAIs operating subsidiaries recorded cash capital expenditures of $27 million and $39 million
for the first three months of 2009 and 2008, respectively. The decrease was primarily the result
of lower information technology spending at RJR Tobacco. RAIs operating subsidiaries plan to spend
an additional $160 million to $185 million for capital expenditures during the remainder of 2009.
Approximately $80 million of the remaining capital expenditures for 2009 is associated with
capacity expansion at Conwood. Capital expenditures are funded primarily by cash flows from
operations. RAIs operating subsidiaries capital expenditure programs are expected to continue at
a level sufficient to support their strategic and operating needs. There were no material long-term
commitments for capital expenditures as of March 31, 2009.
75
Retirement Benefits
RAI expects to contribute a minimum of $60 million to its pension plans in 2009, of which $3
million had been contributed as of March 31, 2009. During April 2009, RAI contributed another $50
million to its pension plans.
Litigation and Settlements
As discussed in note 10 to condensed consolidated financial statements (unaudited), RJR
Tobacco, the Conwood companies and their affiliates, including RAI, and indemnitees, including B&W,
have been named in a number of tobacco-related legal actions, proceedings or claims seeking damages
in amounts ranging into the hundreds of millions or even billions of dollars. Unfavorable judgments
have been returned in a number of tobacco-related cases and state enforcement actions. As of April
9, 2009, RJR Tobacco has paid approximately $6 million since January 1, 2007, related to
unfavorable judgments. As of March 31, 2009, RJR Tobacco had $2 million accrued for non-smoking and
health litigation, and RJR, including its subsidiary RJR Tobacco, had liabilities totaling $94
million that were recorded 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.
RAIs management continues to conclude that the loss of any particular smoking and health
tobacco litigation claim against RJR Tobacco or its affiliates or indemnitees, or the loss of any
particular claim concerning the use of smokeless tobacco against the Conwood companies, when viewed
on an individual basis, is not probable. RAI and its subsidiaries believe that they have valid
basis for appeal of adverse verdicts against them and have valid defenses to all actions and intend
to defend all actions vigorously. Nonetheless, the possibility of material losses related to
tobacco litigation is more than remote. Litigation is subject to many uncertainties, and generally
it is not possible to predict the outcome of the litigation pending against RJR Tobacco, the
Conwood companies or their affiliates or indemnitees, or to reasonably estimate the amount or range
of any possible loss. Moreover, notwithstanding the quality of defenses available to it and its
affiliates in tobacco-related litigation matters, it is possible that RAIs consolidated results of
operations, cash flows or financial position could be materially adversely affected by the ultimate
outcome of certain pending or future litigation matters or
difficulties in obtaining the bonds required to stay execution of
judgments on appeal.
In November 1998, RJR Tobacco, B&W and the other major U.S. cigarette manufacturers entered
into the MSA with attorneys general representing most U.S. states, territories and possessions. As
described in note 10 to condensed consolidated financial statements (unaudited), the MSA imposes a
perpetual stream of future payment obligations on RJR Tobacco and the other major U.S. cigarette
manufacturers and places significant restrictions on their ability to market and sell cigarettes in
the future. For more information related to historical and expected settlement expenses and
payments under the MSA, see Litigation Affecting the Cigarette Industry Health-Care Cost
Recovery Cases MSA in note 10 to condensed consolidated financial statements (unaudited). The
MSA has materially adversely affected RJR Tobaccos shipment volumes. RAI believes that these
settlement obligations may materially adversely affect the results of operations, cash flows or
financial position of RAI and RJR Tobacco in future periods. The degree of the adverse impact will
depend, among other things, on the rate of decline in U.S. cigarette sales in the premium and 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.
RJR Tobacco and certain of the other participating manufacturers under the MSA are currently
involved in litigation with the settling states with respect to the availability for certain market
years of a downward adjustment to the annual MSA settlement payment obligation, known as the
Non-Participating Manufacturer Adjustment. RJR Tobacco has disputed a
total of $2.9 billion for the years 2003 through 2008. For more information related to this litigation, see Litigation Affecting the Cigarette
Industry MSA Enforcement and Validity in note 10 to condensed consolidated financial
statements (unaudited).
76
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 fire standards compliance for cigarettes; |
|
|
|
|
raise the minimum age to possess or purchase tobacco products; |
|
|
|
|
restrict or ban the use of certain flavorings, including menthol, in tobacco products,
or the use of certain flavor descriptors in the marketing of tobacco products; |
|
|
|
|
require the disclosure of ingredients used in the manufacture of tobacco products; |
|
|
|
|
require the disclosure of nicotine yield information for cigarettes; |
|
|
|
|
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, as described in greater detail below, during 2009, the U.S. Congress adopted
legislation increasing the federal excise tax on cigarettes and other tobacco products, and is
considering legislation regarding the regulation of the manufacture and sale of tobacco products by
the U.S. Food and Drug Administration, referred to as the FDA. The U.S. Congress also may consider
legislation regarding:
|
|
|
regulation of environmental tobacco smoke; |
|
|
|
|
implementation of a national fire standards compliance for 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. |
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 and other tobacco products are subject to substantial taxes in the United States.
On February 4, 2009, President Obama signed an increase of $0.62 in the excise tax per pack of
cigarettes, and significant tax increases on other tobacco products, to fund expansion of the
SCHIP. The tax increases were effective April 1, 2009.
77
Under these federal tax increases:
|
|
|
the federal excise tax per pack of 20 cigarettes increased to $1.01; |
|
|
|
|
the federal tax rate for chewing tobacco increased $0.3083 per pound to $0.5033 per
pound, and for snuff increased $0.925 per pound to $1.51 per pound; |
|
|
|
|
the federal tax on small cigars, defined as those weighing three pounds or less per
thousand,
increased $48.502 per thousand to $50.33 per thousand; and |
|
|
|
|
the federal tax rate for roll-your-own tobacco increased from $1.097 per pound to $24.78
per pound. |
RAIs operating subsidiaries expect that these federal excise tax increases on cigarettes and
other tobacco products will significantly and adversely impact sales volume. This event required
the testing for impairment of the carrying value of trademarks and goodwill during the first
quarter of 2009. See note 3 to condensed consolidated financial statements (unaudited) for
information regarding trademark and goodwill impairment testing and the resulting trademark
impairment charge.
All states and the District of Columbia currently impose cigarette excise taxes at levels
ranging from $0.07 per pack in South Carolina to $2.75 per pack in New York. As of March 31, 2009,
the weighted average state cigarette excise tax per pack, calculated on a 12-month rolling average
basis, was approximately $1.018, an increase compared to the 12-month rolling average of $1.00 as
of December 31, 2008. As of March 31, 2009, two states, Arkansas and Kentucky, have passed
cigarette excise tax increases since January 1, 2009, and a number of other states are considering
an increase in their cigarette excise taxes for 2009. 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 by states on an ad valorem basis, ranging from 5% in South Carolina
to 75% in Alaska and Washington. Other states have unit-based tax schemes for cigars or tax little
cigars the same as cigarettes.
Forty-nine states also subject smokeless tobacco to excise taxes, and the Commonwealth of
Pennsylvania, which currently levies no tax on other tobacco products, considered one during its
2008 legislative session. As of March 31, 2009, 35 states taxed moist snuff, and 46 states taxed
chewing tobacco, on an ad valorem basis at rates that range from 5% in South Carolina to 90% in
Massachusetts. Other states have a unit tax or a weight-based tax. As of March 31, 2009, two
states, Nebraska and Wyoming, have passed legislation since January 1, 2009, that changed their tax
on moist snuff from an ad valorem tax to a weight-based tax, and legislation to convert from an ad
valorem to a weight-based tax is expected to be introduced in several other states in 2009.
Additionally, as of March 31, 2009, two states, Arkansas and Kentucky, passed tax increases on
other tobacco products, and a number of other states are considering an increase in their taxes on
other tobacco products for 2009.
On October 25, 2006, the Alcohol and Tobacco Tax and Trade Bureau of the U.S. Department of
Treasury, referred to as the TTB, issued a Notice of Proposed Rulemaking, proposing changes to the
regulations that govern the classification and labeling of cigars and cigarettes for federal excise
tax purposes. The TTB still is considering written comments that were received prior to the March
26, 2007, deadline. 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. It is not possible to fully assess and quantify the negative impact of
the proposed regulations, if adopted, on the little cigar products of Lane; however, if little
cigars are classified as cigarettes for federal excise tax purposes, it is possible that the states
would take the position that MSA obligations also apply to these products.
A bill that would grant the FDA authority to regulate tobacco products was introduced in
Congress in March 2009. On April 2, 2009, the U.S. House of Representatives passed the bill by a
vote of 298-112. The U.S. Senate has not yet scheduled any action on the issue.
78
It is anticipated that any proposed FDA regulation bill most likely would:
|
|
|
Require larger and more severe health warnings on packs and cartons; |
|
|
|
|
Ban the use of descriptors on tobacco products, such as low-tar and light; |
|
|
|
|
Require the disclosure of ingredients and additives to consumers; |
|
|
|
|
Require pre-market approval by the FDA for claims made with respect to reduced risk or
reduced exposure products; |
|
|
|
|
Allow the FDA to require the reduction of nicotine and the reduction or elimination of
any other compound in tobacco products; |
|
|
|
|
Prohibit the use of foreign grown tobacco that has been grown or processed with
pesticides not approved under federal law for use in domestic tobacco farming and
processing; |
|
|
|
|
Allow the FDA to place more severe restrictions on the advertising, marketing and sale
of cigarettes; |
|
|
|
|
Permit inconsistent state regulation of labeling and advertising and eliminate the
existing federal preemption of such regulation; and |
|
|
|
|
Grant the FDA the regulatory authority to impose broad additional restrictions. |
It is possible that such additional regulation could result in a decrease in cigarette and
smokeless tobacco sales in the United States, including sales of RJR Tobaccos and Conwoods
brands, and an increase in costs to RJR Tobacco and Conwood which may have a material adverse
effect on RAIs financial condition, results of operations, and cash flows. RAI believes that such
regulation may adversely affect the ability of its operating subsidiaries to compete against their
larger competitor, Philip Morris USA, Inc., who may be able to more quickly and cost-effectively
comply with these new rules and regulations.
In 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 March 31, 2009, 40 states in addition to New York, as well as Washington,
D.C., had enacted fire standards compliance 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 and Washington, D.C. Consistent with these state legislative trends and
its effort to increase productivity and reduce complexity, on October 25, 2007, RJR Tobacco
announced its plans to voluntarily convert all its brands to fire standards compliant paper by the
end of 2009. Varying standards from state to state could have an adverse effect on the business or
results of operations of RJR Tobacco.
It is not possible to determine what additional federal, state or local legislation or
regulations relating to smoking or cigarettes will be enacted or to predict the effect of new
legislation or regulations on RJR Tobacco or the cigarette industry in general, but any new
legislation or regulations could have an adverse effect on RJR Tobacco or the cigarette industry in
general. Similarly, it is not possible to determine what additional federal, state or local
legislation or regulations relating to smokeless tobacco products will be enacted or to predict the
effect of new regulation on Conwood or smokeless tobacco products in general, but any new
legislation or regulations could have an adverse effect on Conwood or smokeless tobacco products in
general.
Tobacco Buyout Legislation
For information relating to tobacco buyout legislation, see Tobacco Buyout Legislation and
Related Litigation in note 10 to condensed consolidated financial statements (unaudited).
79
Other Contingencies
For information relating to other contingencies of RAI, RJR, RJR Tobacco and Conwood, see
Other Contingencies in note 10 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 future events or the future performance or results of RAI
and its subsidiaries inherently are subject to a variety of risks and uncertainties that could
cause actual results to differ materially from those described in the forward-looking statements.
These risks and uncertainties include:
|
|
|
the substantial and increasing taxation and regulation of tobacco products, including
the recent federal excise tax increases, and the possible regulation of tobacco products by
the FDA; |
|
|
|
|
the possibility of further restrictions or bans on the use of certain flavorings,
including menthol, in tobacco products, or the use of certain flavor descriptors in the
marketing 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 potential difficulty of obtaining bonds as a result of litigation outcomes; |
|
|
|
|
the substantial payment obligations with respect to cigarette
sales, and the substantial limitations on the advertising and marketing of
cigarettes (and of RJR Tobaccos smokeless tobacco
products) under the MSA; |
|
|
|
|
the continuing decline in volume in the domestic cigarette industry and RAIs
dependence on the U.S. cigarette industry; |
|
|
|
|
concentration of a material amount of sales with a single customer or distributor; |
|
|
|
|
competition from other manufacturers, including any new entrants in the marketplace,
and further industry consolidations; |
|
|
|
|
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 the businesses of RAIs operating companies,
including outsourcing functions, without negatively affecting sales; |
|
|
|
|
the reliance on a limited number of suppliers for certain raw materials; |
|
|
|
|
the cost of tobacco leaf and other raw materials and other commodities used in
products; |
80
|
|
|
the effect of market conditions on foreign currency exchange rate risk, interest rate
risk and the return on corporate cash; |
|
|
|
|
declining liquidity in the financial markets, including bankruptcy of lenders
participating in the credit facility; |
|
|
|
|
the impairment of goodwill and other intangible assets, including trademarks; |
|
|
|
|
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 substantial amount of RAI debt; |
|
|
|
|
the credit rating of RAI and its 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; |
|
|
|
|
the significant ownership interest of B&W, RAIs largest shareholder, in RAI and the
rights of B&W under the governance agreement between the companies; |
|
|
|
|
the expiration of the standstill provisions of the governance agreement; and |
|
|
|
|
the potential existence of significant deficiencies or material weaknesses in internal
control over financial reporting that may be identified during the performance of testing
required under Section 404 of the Sarbanes-Oxley Act of 2002. |
Due to these uncertainties and risks, you are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this report. Except as provided by
federal securities laws, RAI is not required to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact the consolidated results of
operations, cash flows and financial position 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 immaterial exposure to
foreign currency exchange rate risk related primarily to purchases and foreign operations
denominated in euros, British pounds, Swiss francs, Chinese renminbi and Japanese yen. RAI and its
subsidiaries have established policies and procedures to manage their exposure to market risks and
use major 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.
81
The table below provides information about RAIs financial instruments, as of March 31, 2009,
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 |
|
|
2009 |
|
2010 |
|
2011 |
|
2012 |
|
2013 |
|
Thereafter |
|
Total |
|
Value(1) |
Investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable Rate |
|
$ |
3,126 |
|
|
$ |
24 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
39 |
|
|
$ |
3,189 |
|
|
$ |
3,189 |
|
Average Interest Rate |
|
|
0.2 |
% |
|
|
1.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.5 |
% |
|
|
0.2 |
% |
|
|
|
|
Fixed-Rate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
4 |
|
|
$ |
4 |
|
|
$ |
4 |
|
Average Interest Rate(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.7 |
% |
|
|
4.7 |
% |
|
|
|
|
Debt: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-Rate |
|
$ |
200 |
|
|
$ |
300 |
|
|
|
|
|
|
$ |
450 |
|
|
$ |
685 |
|
|
$ |
2,375 |
|
|
$ |
4,010 |
|
|
$ |
3,621 |
|
Average Interest Rate(2) |
|
|
7.9 |
% |
|
|
6.5 |
% |
|
|
|
|
|
|
7.3 |
% |
|
|
7.4 |
% |
|
|
7.3 |
% |
|
|
7.3 |
% |
|
|
|
|
Variable Rate |
|
|
|
|
|
|
|
|
|
$ |
400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
400 |
|
|
$ |
350 |
|
Average Interest Rate(2) |
|
|
|
|
|
|
|
|
|
|
2.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.0 |
% |
|
|
|
|
Swaps Fixed to Floating: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
350 |
|
|
|
|
|
|
$ |
1,150 |
|
|
$ |
1,500 |
|
|
$ |
258 |
|
Average Variable Interest
Pay Rate(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.3 |
% |
|
|
|
|
|
|
2.1 |
% |
|
|
2.4 |
% |
|
|
|
|
Average Fixed Interest
Receive Rate(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7.3 |
% |
|
|
|
|
|
|
7.1 |
% |
|
|
7.1 |
% |
|
|
|
|
Swaps Floating to Fixed: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount(4) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
350 |
|
|
|
|
|
|
$ |
1,150 |
|
|
$ |
1,500 |
|
|
$ |
(16 |
) |
Average Variable Interest
Receive Rate(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.3 |
% |
|
|
|
|
|
|
2.1 |
% |
|
|
2.4 |
% |
|
|
|
|
Average Fixed Interest
Pay Rate(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.8 |
% |
|
|
|
|
|
|
4.1 |
% |
|
|
4.0 |
% |
|
|
|
|
|
|
|
(1) |
|
Fair values are based on current market rates available or on rates
available for instruments with similar terms and maturities and quoted
fair values. |
|
(2) |
|
Based upon contractual interest rates for fixed-rate indebtedness or
current market rates for LIBOR plus negotiated spreads until maturity
for variable rate indebtedness. |
|
(3) |
|
As of March 31, 2009, RAI had swapped $1.5 billion of debt using both
fixed-rate to floating-rate interest rate swaps and floating-rate to
fixed-rate interest rate swaps. |
|
(4) |
|
As of March 31, 2009, RAI had swapped $1.5 billion of variable rate
debt to fixed-rate debt. See note 9 to condensed consolidated
financial statements (unaudited) for additional information. |
RAIs exposure to foreign currency transactions was not material to results of operations for
the three months ended March 31, 2009, but may become material in future periods in relation to
activity associated with RAIs international operations. RAI currently has no hedges for its
exposure to foreign currency.
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. |
82
(b) |
|
In the first quarter of 2009, the companies collectively referred to as the Conwood companies
and Lane, implemented an SAP enterprise business system. The implementation involved changes
in systems and accordingly, have required changes to internal controls. RAIs management has
reviewed the controls affected by the implementation and made appropriate changes to internal
controls as a part of the implementation. RAIs management believes that the controls, as
modified, are appropriate and functioning effectively as of the end of the period covered by
this report. |
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 10 to condensed
consolidated financial statements (unaudited) and Managements Discussion and Analysis of
Financial Condition and Results of Operations Critical Accounting Policies Litigation
included in Part I, Item 2.
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 the credit facility, interest rate swaps and notes
will not impair its payment of quarterly dividends.
The following table summarizes RAIs purchases of its common stock during the first quarter of
2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
|
Approximate Dollar |
|
|
|
|
|
|
|
|
|
|
|
Shares purchased |
|
|
Value that May |
|
|
|
Total Number |
|
|
|
|
|
|
as Part of Publicly |
|
|
Yet Be Purchased |
|
|
|
of Shares |
|
|
Average Price |
|
|
Announced Plans |
|
|
Under the Plans |
|
|
|
Purchased (1) |
|
|
Paid Per Share |
|
|
or Programs |
|
|
or Programs (2) |
|
January 1, 2009 to January 31, 2009 |
|
|
3,116 |
|
|
$ |
38.18 |
|
|
|
|
|
|
$ |
143 |
|
February 1, 2009 to February 28, 2009 |
|
|
6,463 |
|
|
|
33.58 |
|
|
|
|
|
|
$ |
143 |
|
March 1, 2009 to March 31, 2009 |
|
|
135,345 |
|
|
|
32.97 |
|
|
|
|
|
|
$ |
143 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter Total |
|
|
144,924 |
|
|
$ |
33.11 |
|
|
|
|
|
|
$ |
143 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
RAI repurchases and cancels shares of its common stock
forfeited with respect to the tax liability associated with
certain option exercises and vesting of restricted stock
grants under the LTIP. |
|
(2) |
|
On April 29, 2008, the board of directors of RAI authorized
the repurchase, on or before April 30, 2009, of up to $350
million of outstanding shares of RAI common stock. RAI
repurchased $207 million of its common stock pursuant to the
foregoing share repurchase program. |
83
Item 6. Exhibits
(a) Exhibits
|
|
|
Exhibit |
|
|
Number |
|
Description |
10.1
|
|
Joinder Agreement to Sixth Amended and Restated Subsidiary
Guaranty, dated as of January 1, 2009, among JPMorgan Chase Bank,
N.A., as Administrative Agent, and RAI Services Company
(incorporated by reference to Exhibit 10.4 to RAIs Annual Report
on Form 10-K for the fiscal year ended December 31, 2008). |
|
|
|
10.2
|
|
Reynolds American Inc. Annual Incentive Award Plan, as amended
and restated as of January 1, 2009 (incorporated by reference to
Exhibit 10.59 to RAIs Annual Report on Form 10-K for the fiscal
year ended December 31, 2008). |
|
|
|
10.3
|
|
Amendment No. 1 to the Reynolds American Inc. Annual Incentive
Award Plan, as amended and restated effective January 1, 2009
(incorporated by reference to Exhibit 10.2 to RAIs Form 8-K
dated February 9, 2009). |
|
|
|
10.4
|
|
Reynolds American Inc. Executive Severance Plan, as amended and
restated effective February 1, 2009 (incorporated by reference to
Exhibit 10.1 to RAIs Form 8-K dated February 9, 2009). |
|
|
|
10.5
|
|
Second Supplemental Indenture, dated February 6, 2009, to
Indenture, dated May 31, 2006, as supplemented by the First
Supplemental Indenture, dated September 30, 2006, among Reynolds
American Inc. and certain of its subsidiaries as guarantors and
The Bank of New York Mellon Trust Company, N.A., f/k/a The Bank
of New York Trust Company, N.A., as Trustee (incorporated by
reference to Exhibit 4.21 to RAIs Annual Report on Form 10-K for
the fiscal year ended December 31, 2008). |
|
|
|
10.6
|
|
Form of Performance Share Agreement (three-year vesting), dated
March 2, 2009, between Reynolds American Inc. and the grantee
named therein (incorporated by reference to Exhibit 10.1 to RAIs
Form 8-K dated March 2, 2009). |
|
|
|
10.7
|
|
Form of Performance Unit Agreement (one-year vesting), dated
February 3, 2009, between Reynolds American Inc. and the grantee
named therein. |
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31.1
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Certification of Chief Executive Officer relating to RAIs
Quarterly Report on Form 10-Q for the quarter ended March 31,
2009. |
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31.2
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Certification of Chief Financial Officer relating to RAIs
Quarterly Report on Form 10-Q for the quarter ended March 31,
2009. |
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32.1
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Certification of Chief Executive Officer and Chief Financial
Officer relating to RAIs Quarterly Report on Form 10-Q for the
quarter ended March 31, 2009, pursuant to Section 18 U.S.C.
§1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
84
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
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REYNOLDS AMERICAN INC.
(Registrant)
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Dated: May 1, 2009 |
/s/ Thomas R. Adams
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Thomas R. Adams |
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Executive Vice President and Chief Financial Officer |
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85