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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
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<S> <C>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
</TABLE>
------------------------
COMMISSION FILE NUMBER: 1-6388
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 56-0950247
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
</TABLE>
401 NORTH MAIN STREET
WINSTON-SALEM, NC 27102-2866
(Address of principal executive offices) (Zip Code)
(336) 741-5500
(Registrant's 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 [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date: 101,376,673 shares of common
stock, par value $.01 per share, as of October 20, 2000
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<PAGE> 2
INDEX
<TABLE>
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PAGE
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<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income
(Unaudited) -- Three and Nine Months Ended September 30,
2000 and 1999............................................... 3
Condensed Consolidated Statements of Cash Flows
(Unaudited) -- Nine Months Ended September 30, 2000 and
1999........................................................ 4
Condensed Consolidated Balance Sheets -- September 30, 2000
(Unaudited) and December 31, 1999........................... 5
Notes to Condensed Consolidated Financial Statements
(Unaudited)................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 25
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 32
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings........................................... 33
Item 6. Exhibits and Reports on Form 8-K............................ 34
Signature............................................................ 35
</TABLE>
2
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
NET SALES*.................................................. $2,119 $1,991 $6,126 $5,591
Costs and expenses:
Cost of products sold*.................................... 851 825 2,508 2,396
Selling, general and administrative expenses.............. 913 813 2,637 2,261
Tobacco settlement and related expenses................... -- 40 (3) 40
Amortization of trademarks and goodwill................... 91 91 274 274
Restructuring expense..................................... -- (2) -- (2)
Headquarters close-down and related charges............... -- -- -- 143
------ ------ ------ ------
OPERATING INCOME....................................... 264 224 710 479
Interest and debt expense................................... 43 43 129 225
Interest income............................................. (30) (44) (75) (75)
Other expense, net.......................................... 9 9 25 48
------ ------ ------ ------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES................................................ 242 216 631 281
Provision for income taxes.................................. 125 120 325 194
------ ------ ------ ------
INCOME FROM CONTINUING OPERATIONS...................... 117 96 306 87
Discontinued operations:
Income (loss) from operations of discontinued businesses,
net of income taxes.................................... -- (9) -- 76
Gain (loss) on discontinued businesses, net of income
taxes.................................................. -- (212) -- 2,436
------ ------ ------ ------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM................ 117 (125) 306 2,599
Extraordinary item - loss on early extinguishment of debt,
net of income taxes....................................... -- -- -- (250)
------ ------ ------ ------
NET INCOME (LOSS)...................................... $ 117 $ (125) $ 306 $2,349
====== ====== ====== ======
BASIC INCOME (LOSS) PER SHARE:
Income from continuing operations......................... $ 1.17 $ .88 $ 3.01 $ .80
Income (loss) from discontinued operations................ -- (2.03) -- 23.12
Extraordinary loss........................................ -- -- -- (2.30)
------ ------ ------ ------
Net income (loss).................................... $ 1.17 $(1.15) $ 3.01 $21.62
====== ====== ====== ======
DILUTED INCOME (LOSS) PER SHARE:
Income from continuing operations......................... $ 1.16 $ .88 $ 3.00 $ .80
Income (loss) from discontinued operations................ -- (2.03) -- 23.10
Extraordinary loss........................................ -- -- -- (2.30)
------ ------ ------ ------
Net income (loss).................................... $ 1.16 $(1.15) $ 3.00 $21.60
====== ====== ====== ======
DIVIDENDS DECLARED PER SHARE................................ $ .775 $ .775 $ 2.33 $ .775
====== ====== ====== ======
</TABLE>
---------------
* Excludes excise taxes of $418 million and $310 million for the three months
ended September 30, 2000 and 1999, respectively, and $1,228 million and $888
million for the nine months ended September 30, 2000 and 1999, respectively.
See Notes to Condensed Consolidated Financial Statements
3
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R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2000 1999
-------- ---------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income................................................ $ 306 $ 2,349
Less income from discontinued operations.................. -- 2,512
------ -------
Subtotal............................................. 306 (163)
------ -------
Adjustments to reconcile to net cash flows from (used in)
continuing operating activities:
Depreciation and amortization.......................... 364 364
Deferred income tax benefit............................ (12) (195)
Extraordinary loss on early extinguishment of debt..... -- 384
Changes in other working capital items, net............ (64) (84)
Tobacco settlement and related expenses................ 606 1,157
Headquarters close-down and related charges, net of
cash payments......................................... -- 21
Other, net............................................. (31) --
------ -------
Total adjustments................................. 863 1,647
------ -------
Net cash flows from operating activities.................. 1,169 1,484
------ -------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Proceeds from maturities of short-term investments........ 110 --
Capital expenditures...................................... (38) (30)
Net proceeds from the sale of the international tobacco
business............................................... -- 7,760
Purchases of long-term investments........................ (5) --
Other, net................................................ 7 (24)
------ -------
Net cash flows from investing activities............. 74 7,706
------ -------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................. -- 1,244
Repayments of long-term debt.............................. (46) (4,450)
Decrease in short-term borrowing.......................... -- (62)
Transfers and payments to former parent................... -- (1,968)
Repurchase of common stock................................ (170) --
Dividends paid on common stock............................ (244) --
Proceeds from exercise of stock options................... 27 1
Other, net................................................ -- 4
------ -------
Net cash flows used in financing activities.......... (433) (5,231)
------ -------
Net cash flows related to discontinued operations........... 84 (1,456)
------ -------
Net change in cash and cash equivalents..................... 894 2,503
Cash and cash equivalents at beginning of period............ 1,177 --
------ -------
Cash and cash equivalents at end of period.................. $2,071 $ 2,503
====== =======
Income taxes paid, net of refunds........................... $ 100 $ 1,873
Interest paid............................................... $ 81 $ 271
Tobacco settlement and related expense payments............. $1,141 $ 517
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
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R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2,071 $ 1,177
Short-term investments.................................... -- 110
Accounts and notes receivable, net........................ 92 84
Inventories............................................... 556 565
Deferred income taxes..................................... 431 437
Prepaid excise taxes and other............................ 149 95
------- -------
Total current assets.............................. 3,299 2,468
Property, plant and equipment, net.......................... 1,051 1,080
Trademarks, net............................................. 2,991 3,070
Goodwill, net............................................... 7,368 7,563
Other assets and deferred charges........................... 204 196
------- -------
$14,913 $14,377
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 66 $ 81
Tobacco settlement and related accruals................... 1,914 1,278
Accrued liabilities....................................... 1,191 1,273
Current maturities of long-term debt...................... 418 387
Income taxes accrued...................................... 183 49
------- -------
Total current liabilities......................... 3,772 3,068
Long-term debt (less current maturities).................... 1,576 1,653
Long-term retirement benefits............................... 584 676
Deferred income taxes....................................... 1,713 1,630
Other noncurrent liabilities................................ 266 286
Commitments and contingencies
Stockholders' equity:
Common stock (shares issued: 111,317,625 in 2000 and
109,631,397 in 1999)................................... 1 1
Paid-in capital........................................... 7,238 7,287
Retained earnings (accumulated deficit)................... 39 (131)
Accumulated other comprehensive income (loss): cumulative
minimum pension liability adjustment................... (13) (13)
Other stockholders' equity................................ (37) (25)
------- -------
7,228 7,119
Treasury stock, at cost (shares: 9,943,780 in 2000 and
2,728,630 in 1999)..................................... (226) (55)
------- -------
Total stockholders' equity........................ 7,002 7,064
------- -------
$14,913 $14,377
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5
<PAGE> 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- INTERIM REPORTING
Basis of Presentation
The condensed consolidated financial statements include the accounts of
R.J. Reynolds Tobacco Holdings, Inc., referred to as RJR, and its subsidiaries,
including R. J. Reynolds Tobacco Company, referred to as RJR Tobacco.
The accompanying unaudited, interim condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America for interim financial information, and
in management's opinion, contain all adjustments, consisting only of normal
recurring items, necessary for a fair statement of the results for the periods
presented. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America 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. The results for the
interim periods ended September 30, 2000 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2000.
The condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related footnotes
which appear in RJR's Annual Report on Form 10-K for the year ended December 31,
1999. Certain reclassifications were made to conform prior periods' financial
statements to the current presentation. All dollar amounts are in millions
unless otherwise noted.
During 1999, RJR and Nabisco Group Holdings Corp., referred to as NGH,
completed a series of transactions to reorganize their businesses and capital
structures. On May 12, 1999, RJR and RJR Tobacco substantially completed the
sale of the international tobacco business to Japan Tobacco Inc. As a result of
this sale, RJR Tobacco's business consists exclusively of the manufacture and
sale of cigarettes in the United States and its territories, commonwealths,
protectorates and possessions. A portion of the proceeds from the sale of the
international tobacco business were used by RJR to repurchase approximately $4
billion of its debt, which resulted in an approximately $384 million, $250
million after-tax, extraordinary loss from the early extinguishment of debt. On
May 18, 1999, RJR transferred its approximately 80.5% interest in Nabisco
Holdings Corp., referred to as Nabisco, to NGH through a merger transaction. On
June 14, 1999, NGH distributed all of the outstanding shares of RJR common stock
to NGH common stockholders of record as of May 27, 1999. Shares of RJR began
trading separately on June 15, 1999.
The account balances and activities of the international tobacco business
and Nabisco are segregated and reported as discontinued operations in the
accompanying condensed consolidated financial statements. In addition, financial
data for all prior periods has been restated to give effect to the number of
shares issued in connection with the distribution of RJR common stock to the
stockholders of its former parent, NGH.
For the nine months ended September 30, 1999, operating results of the
discontinued operations included net sales of $3.8 billion and, for the three
and nine months ended September 30, 1999, a provision for (benefit from) income
taxes of $(53) million and $34 million, respectively.
Recently Issued Accounting Pronouncements
In May 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force reached a consensus on Issue No. 00-14, "Accounting for Certain Sales
Incentives," which addresses the accounting for sales incentives, rebates,
coupons and free products or services. RJR has adopted EITF No. 00-14 as of
October 1, 2000 and believes that adoption of EITF No. 00-14 will not have a
material impact on its financial position or net income for the year ended
December 31, 2000. Income statements, including those presented for comparative
purposes, will include the reclassification of certain program costs as a
revenue reduction rather than a cost, in compliance with the display
requirements.
6
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
During the second quarter of 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." In June 1999, the FASB issued SFAS No. 137, which amended SFAS No.
133 to delay its effective date by one year. RJR will adopt SFAS No. 133 on
January 1, 2001. SFAS No. 133 requires that all derivative instruments be
recorded on the consolidated balance sheet at their fair value. Changes in the
fair value of derivatives will be recorded each period in earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. In June 2000,
the FASB issued SFAS No. 138, which amended SFAS No. 133. RJR's management has
reviewed the terms of all current material contracts and financial instruments
with terms through January 1, 2001, and believes that adoption of SFAS No. 133,
as amended, will not have a material impact on its financial position or results
of operations.
Comprehensive Income
Total comprehensive income (loss) for the three months ended September 30,
2000 and 1999 was $117 million and $(127) million, respectively. Total
comprehensive income for the nine months ended September 30, 2000 and 1999 was
$306 million and $2,261 million, respectively. Total comprehensive income
includes net income, foreign currency translation adjustments and minimum
pension liability adjustments.
Tobacco Settlement and Related Expenses
During 1998, RJR Tobacco recorded pre-tax charges totaling $1.4 billion for
tobacco settlement and related expenses of which $151 million was for employee
severance and related benefits. During the nine months ended September 30, 2000,
$25 million of this reserve was utilized for employee severance and related
benefits and $3 million was reversed reflecting a less-than-expected volume
decline that resulted in a corresponding less-than-expected related workforce
reduction. The remaining reserve balance at September 30, 2000 was $10 million.
Cash expenditures related to the termination of employees were $67 million as of
September 30, 2000.
Earnings Per Share
The components of the calculation of earnings per share were:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- -------------------
2000 1999 2000 1999
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Income from continuing operations............. $ 117 $ 96 $ 306 $ 87
Income (loss) from discontinued operations.... -- (221) -- 2,512
Extraordinary loss............................ -- -- -- (250)
-------- -------- -------- --------
Net income (loss)............................. $ 117 $ (125) $ 306 $ 2,349
======== ======== ======== ========
Basic weighted average shares, in thousands... 100,212 108,589 101,699 108,661
Effect of dilutive potential shares:
Options.................................. 399 185 133 88
Restricted stock......................... 457 36 256 12
-------- -------- -------- --------
Diluted weighted average shares, in
thousands................................... 101,068 108,810 102,088 108,761
======== ======== ======== ========
</TABLE>
During the three and nine months ended September 30, 2000, approximately
1,628,000 outstanding shares of restricted stock were excluded from the basic
share calculation, as the related vesting provisions had not been met.
7
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 2 -- INVENTORIES
The major components of inventories were:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
Leaf tobacco......................... $338 $361
Raw materials........................ 23 26
Work in process...................... 53 48
Finished products.................... 116 105
Other................................ 26 25
---- ----
$556 $565
==== ====
</TABLE>
NOTE 3 -- CONTINGENCIES
TOBACCO LITIGATION
Overview. Various legal actions, proceedings and claims, including legal
actions claiming that lung cancer and other diseases, as well as addiction, have
resulted from the use of, or exposure to, RJR Tobacco's products, are pending or
may be instituted against RJR or its affiliates, including RJR Tobacco, or
indemnitees. During the third quarter of 2000, 1,157 new actions, 1,100 of which
were filed in state court in West Virginia in two complaints by the same law
firm, were served against RJR Tobacco and/or its affiliates or indemnitees, and
43 actions were dismissed or otherwise resolved in favor of RJR Tobacco and/or
its affiliates or indemnitees without trial. On September 30, 2000, there were
1,649 active cases pending, as compared with 561 on September 30, 1999 and 614
on September 30, 1998. As of October 17, 2000, 1,640 active cases were pending
against RJR Tobacco and/or its affiliates or indemnitees: 1,639 in the United
States and 1 in the Marshall Islands. The U.S. case number does not include the
3,128 Broin II cases pending as of October 17, 2000, discussed below.
The U.S. cases, exclusive of the Broin II cases, are pending in 39 states
and the District of Columbia. The breakdown is as follows: 1,216 in West
Virginia; 113 in New York; 52 in California; 45 in Florida; 30 in Louisiana; 19
in the District of Columbia; 13 in Texas; 11 in each of Massachusetts and New
Jersey; 10 in each of Alabama and Iowa; 9 in Pennsylvania; 8 in each of
Mississippi, New Mexico, Tennessee and Wisconsin; 7 in each of Illinois and
Missouri; 5 in each of Michigan and Nevada; 4 in each of Georgia, Minnesota and
Ohio; 3 in each of Connecticut, Indiana, North Dakota, New Hampshire and
Oklahoma; 2 in each of Arizona, Kansas, South Carolina, South Dakota and
Washington; and 1 in each of Hawaii, Kentucky, Maryland, Maine, North Carolina,
Oregon and Utah. Of the 1,639 active U.S. cases, 137 are pending in federal
court, 1,498 in state court and 4 in tribal court. Most of these cases were
brought by individual plaintiffs, but many of these cases seek recovery on
behalf of third parties or large classes of claimants.
Theories of Recovery. The plaintiffs seek recovery on a variety of legal
theories, including strict liability in tort, design defect, negligence, special
duty, voluntary undertaking, breach of warranty, failure to warn, fraud,
misrepresentation, unfair trade practices, conspiracy, aiding and abetting,
unjust enrichment, antitrust, Racketeer Influenced and Corrupt Organizations
Act, indemnity, medical monitoring and common law public nuisance. Punitive
damages, often in amounts ranging into the hundreds of millions or even billions
of dollars, are specifically pleaded in a number of cases, in addition to
compensatory and other damages. Six of the 1,639 active cases in the United
States, plus the 3,128 Broin II cases, involve alleged non-smokers claiming
injuries resulting from exposure to environmental tobacco smoke. Forty-three
cases purport to be class actions on behalf of thousands of individuals.
Purported classes include individuals claiming to be addicted to cigarettes,
individuals and their estates claiming illness and death from cigarette smoking,
persons making claims based on alleged exposure to environmental tobacco smoke,
African-American smokers claiming their civil rights have been violated by the
sale of menthol cigarettes,
8
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
purchasers of cigarettes claiming to have been defrauded and seeking to recover
their costs and Blue Cross and Blue Shield subscribers seeking reimbursement for
premiums paid. Approximately 59 cases seek recovery of the cost of
Medicaid/Medicare payments or other health-related costs paid for treatment of
individuals suffering from diseases or conditions allegedly related to tobacco
use. Nine cases, brought by entities administering asbestos liability, seek
contribution for the costs of settlements and judgments.
Defenses. The defenses raised by RJR Tobacco and/or its affiliates,
including RJR, include, where applicable, preemption by the Federal Cigarette
Labeling and Advertising Act of some or all such claims arising after 1969, the
lack of any defect in the product, assumption of the risk, contributory or
comparative fault, lack of proximate cause and statutes of limitations or
repose. RJR has asserted additional defenses, including jurisdictional defenses,
in many of these cases in which it is named.
Industry Trial Results. Juries have found for plaintiffs in five smoking
and health cases in which RJR Tobacco was not a defendant, although, to date, no
damages have been paid. Three of the verdicts have been overturned on appeal.
The remaining two individual cases in which a jury found against a cigarette
manufacturer remain on appeal. In February 1999, in Henley v. Philip Morris,
Inc., a San Francisco state court jury awarded an individual smoker $1.5 million
in compensatory damages and $50 million in punitive damages. In April 1999, the
trial judge reduced the punitive damages award to $25 million, but otherwise
denied Philip Morris' post-trial motions challenging the verdict. Philip Morris
is appealing the verdict. In Williams v. Philip Morris, Inc., an Oregon state
court jury returned a verdict against Philip Morris in March 1999, in the amount
of $800,000 in actual damages, $21,500 in medical expenses and $79 million in
punitive damages. The judge in this case reduced the punitive damages to $32
million. Philip Morris' appeal is pending.
RJR Tobacco has prevailed in all individual smoker cases that have gone to
trial except two. In Whiteley v. Raybestos-Manhattan, Inc., a tobacco-asbestos
synergy case brought in San Francisco Superior Court, the jury found against RJR
Tobacco and Philip Morris on March 20, 2000, and awarded $1.7 million in
compensatory damages. On March 27, 2000, the same jury awarded $20 million in
punitive damages, $10 million against RJR Tobacco and $10 million against Philip
Morris. RJR Tobacco and Philip Morris have filed their notice of appeal. In
Jones v. R. J. Reynolds Tobacco Co., a wrongful death case, a Tampa state court
jury found against RJR Tobacco on October 12, 2000. Although the jury found that
RJR Tobacco was negligent and liable, it did not find that RJR Tobacco was part
of a conspiracy to defraud. The jury awarded approximately $200,000 in
compensatory damages; however, the jury did not award punitive damages. On
October 23, 2000, RJR Tobacco filed a motion for judgment notwithstanding the
verdict, or, in the alternative, for a new trial. Oral argument on this motion
has been set for December 1, 2000. If this motion is unsuccessful, RJR Tobacco
intends to appeal the verdict.
Broin II Cases. As of October 17, 2000, approximately 3,128 lawsuits,
referred to as the Broin II cases, have been filed in Florida, by individual
flight attendants, for personal injury as a result of illness allegedly caused
by exposure to secondhand tobacco smoke in airline cabins. These lawsuits were
filed pursuant to the terms of the settlement of the Broin v. Philip Morris,
Inc. class action, discussed below. On October 3, 2000, Judge Robert Kaye
entered an order applicable to all Broin II cases that, as a result of the terms
of the Broin settlement agreement, the individual Broin II plaintiffs will not
be required to prove the elements of strict liability, breach of warranty or
negligence. Rather, under this order, they will be required only to prove that
their alleged adverse health effects were actually caused by environmental
tobacco smoke exposure. If plaintiffs meet that burden, the defendants will have
the burden of disproving causation, strict liability, breach of warranty and
negligence. If defendants fail to meet that burden, the remaining issue will be
damages. RJR Tobacco does not believe the order is correct under Florida law or
that it accurately reflects the intent of the Broin II settlement agreement. RJR
Tobacco intends to appeal the order at the earliest appropriate time.
Class-Action Suits. In May 1996, in an early class-action case, Castano v.
American Tobacco Co., the Fifth Circuit Court of Appeals overturned the
certification of a nationwide class of persons whose
9
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
claims related to alleged addiction to tobacco. Since this ruling by the Fifth
Circuit, most class-action suits have sought certification of statewide, rather
than nationwide, classes.
Class-action suits based on claims similar to those asserted in Castano
have been brought against RJR Tobacco, and in some cases RJR, in state or
federal courts in Alabama, Arkansas, California, the District of Columbia,
Florida, Hawaii, Illinois, Indiana, Iowa, Louisiana, Maryland, Massachusetts,
Michigan, Minnesota, Missouri, New Mexico, Nevada, New Jersey, New York, North
Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Utah,
Virginia and West Virginia. In addition, a class action filed in Tennessee seeks
reimbursement of Blue Cross and Blue Shield premiums paid by subscribers
throughout the United States, and class-action suits against RJR Tobacco in New
Jersey, Pennsylvania and Ohio claim that the marketing of "light" and
"ultralight" cigarettes is deceptive. Plaintiffs have made similar claims in
other lawsuits elsewhere. Other types of class-action suits also have been filed
in additional jurisdictions. Most of these suits assert claims on behalf of
classes of individuals who claim to be addicted, injured or at greater risk of
injury by the use of tobacco or exposure to environmental tobacco smoke, or who
are the legal survivors of such persons. A number of unions and other third
party payors have filed health-care cost recovery actions in the form of class
actions. These cases are discussed separately below. Class certification motions
are pending in several state and federal courts, including in the United States
District Court for the Eastern District of New York in Simon v. Philip Morris
Inc., a purported nationwide class of smokers.
Few smoker class-action complaints have been certified, or if certified,
have survived on appeal. All 11 of the federal courts that have considered the
issue, including two courts of appeals, have rejected class certification in
smoker cases.
Similarly, most state courts have refused to certify smoker class actions.
On January 10, 2000, in Taylor v. American Tobacco Co., a Michigan state court
judge denied certification of another smoker class action. On April 3 and April
10, 2000, a California state court judge denied certification in two separate
state court actions, Daniels v. Philip Morris Cos., Inc. and Brown v. American
Tobacco Co., and, on May 16, 2000, in Richardson v. Philip Morris Inc., the
highest state court in Maryland reversed a trial court's decision to certify a
class of individual smokers. Finally, on September 19, 2000, in Walls v.
American Tobacco Co., an Oklahoma state court answered a series of state law
questions, certified to the state court by the federal court where the purported
class was filed, in such a way that led the parties to stipulate that the case
should not be certified as a class action in federal court and that the
individual plaintiffs would dismiss their federal court cases without prejudice.
On October 19, 2000, the federal court issued its order refusing to certify the
case as a class action, and dismissed the individual plaintiffs' cases.
Classes have remained certified thus far in four state court class action
cases. On November 5, 1998, in Scott v. American Tobacco Co., a Louisiana state
appeals court affirmed the certification of a medical monitoring and/or smoking
cessation class of Louisiana residents who were smokers on or before May 24,
1996. On February 26, 1999, the Louisiana Supreme Court denied the defendants'
petition for writ of certiorari and/or review. This case is scheduled to begin
trial on January 15, 2001. On August 16, 2000, a West Virginia state court
conditionally certified, only to the extent of medical monitoring, a class of
West Virginia residents. The plaintiffs have proposed that the class include all
West Virginia residents who (1) on or after January 1, 1995, smoked cigarettes
supplied by defendants; (2) have at least a five-pack year smoking history; and
(3) do not receive health care paid or reimbursed by the State of West Virginia.
Trial is scheduled to begin December 4, 2000.
In addition, defendants settled one class-action suit, Broin v. Philip
Morris, Inc., in October 1997. The Florida Court of Appeal denied challenges to
this settlement on March 24, 1999, and subsequently denied motions to
reconsider. On September 7, 1999, the Florida Supreme Court dismissed all
proceedings, and the settlement and judgment became final. The Broin II cases,
discussed above, arose out of the settlement of this case.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
Trial began in July 1998 in Florida state court in Engle v. R. J. Reynolds
Tobacco Co., in which a class consisting of Florida residents, or their
survivors, claim to have diseases or medical conditions caused by their alleged
"addiction" to cigarettes. The trial was divided into three phases. On July 7,
1999, the jury found against RJR Tobacco and the other cigarette manufacturer
defendants in the initial phase, which included common issues related to certain
elements of liability, general causation and a potential award of or entitlement
to punitive damages. The second phase of the trial, which consisted of the
claims of three of the named class representatives, began on November 1, 1999.
On April 7, 2000, the jury returned a verdict against all defendants. They
awarded plaintiff Mary Farnan $2.85 million, the estate of plaintiff Angie Della
Vecchia $4.23 million and plaintiff Frank Amodeo $5.831 million. The jury also
found, however, that Frank Amodeo knew or should have known of his claim prior
to May 5, 1990. The legal effect of that finding is to bar his claim based on
the applicable statute of limitations. In the second phase, the trial court also
ordered the jury to determine punitive damages, if any, on a class-wide basis.
On July 14, 2000, the jury returned a punitive damages verdict of approximately
$145 billion against all the defendants, with approximately $36.3 billion being
assigned to RJR Tobacco. On July 24, 2000, the defendants, including RJR
Tobacco, filed numerous post-verdict motions, including motions for a new trial
and to reduce the amount of the punitive damages verdict. Under the trial plan,
the third phase will address all other class members' claims, including issues
of specific causation, reliance and affirmative defenses, in individual trials
before separate juries.
On July 14, 2000, the Southeastern Iron Workers Union filed a motion to
intervene in the Engle case, seeking to protect its members' subrogation rights
under the federal Employment Retirement Income and Security Act. Based on the
federal question raised in that motion, RJR Tobacco and the other defendants
removed the case to federal court in Miami on July 24, 2000. The removal stays
all state court proceedings unless and until the federal court decides to return
the case to the state court. Oral argument on the motion to remand is scheduled
for November 7, 2000.
Compensatory damages, if any, would not have to be paid to any plaintiff
until the end of his or her trial and the appellate process. As currently
structured, punitive damages, if any, will not be awarded to any individual
plaintiff until the completion of both the second and third phases of Engle. RJR
Tobacco does not believe it would be necessary to post bond to stay execution of
any judgment awarding punitive damages until a judgment is entered awarding
punitive damages to an individual plaintiff. However, in a worst case scenario,
the court could enter a judgment for punitive damages on behalf of the entire
class in an amount not capable of being bonded, possibly resulting in efforts to
execute on the judgement before it can be reviewed on appeal. RJR Tobacco
believes that the entry of a judgment for punitive damages on behalf of the
entire class would be contrary to U.S. and Florida law and will take all
appropriate actions to prevent this scenario from occurring.
On May 9, 2000, the State of Florida enacted legislation that, among other
things, limits the size of a bond that must be posted in order to stay execution
of a judgment for punitive damages in a certified class action to the lower of
(1) the amount of punitive damages plus twice the statutory rate of interest or
(2) ten percent of the defendant's net worth, provided that in no case shall the
amount of the required bond exceed $100 million. Although the legislation is
intended to apply to the Engle case, RJR Tobacco cannot predict the outcome of
any possible challenges to the legislation's validity. In addition, four states,
Georgia, Kentucky, North Carolina and Virginia, have enacted legislation that
limits the size of the bond required to stay execution of a punitive damages
verdict pending appeal, but does not affect the underlying verdict.
Governmental Health-Care Cost Recovery Cases. In June 1994, the
Mississippi attorney general brought an action, Moore v. American Tobacco Co.,
against various industry members, including RJR Tobacco. This case was brought
on behalf of the state to recover state funds paid for health care and medical
and other assistance to state citizens suffering from diseases and conditions
allegedly related to tobacco use. By making the state the plaintiff in the case
and basing its claims on economic loss rather than personal injury, the state
sought to avoid the defenses otherwise available against an individual
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
plaintiff. Most other states, through their attorneys general or other state
agencies, sued RJR Tobacco and other U.S. cigarette manufacturers based on
similar theories. The cigarette manufacturer defendants, including RJR Tobacco,
settled the first four of these cases scheduled to come to trial, those of
Mississippi, Florida, Texas and Minnesota, by separate agreements between each
state and those manufacturers in each case.
On November 23, 1998, the major U.S. cigarette manufacturers, including RJR
Tobacco, 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. The MSA
became effective on November 12, 1999, when final approval of the settlement was
achieved in 80% of the settling jurisdictions. As of October 17, 2000, final
approval had been achieved in 50 settling jurisdictions. The MSA settled all the
health-care cost recovery actions brought by, or on behalf of, the settling
jurisdictions and contains releases of various additional present and future
claims.
In each state where final approval has been obtained, the MSA released RJR
Tobacco, its indemnitees and RJR from: (1) 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 (2) all monetary claims 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.
The cash payments made by RJR Tobacco under the MSA and other existing
settlement agreements were approximately $1.1 billion during the nine months
ended September 30, 2000 and $1.6 billion in the 12 months ended December 31,
1999. RJR Tobacco estimates these payments in 2000 will exceed $2.2 billion and
in future years will exceed $2 billion per year. However, these payments will be
subject to adjustments based upon, among other things, the volume of cigarettes
sold by RJR Tobacco, RJR Tobacco's market share and inflation.
On April 20, 1999, the Canadian Province of British Columbia brought a case
in British Columbia Provincial Court, similar to the U.S. attorneys' general
cases, against RJR Tobacco and certain other Canadian and U.S. tobacco companies
and their parent companies, including RJR. This lawsuit relied heavily upon
special legislation enacted in British Columbia that was separately challenged
by various Canadian tobacco companies. An agreement was reached with the
government in British Columbia to litigate the separate constitutional
challenges prior to the health-care cost recovery action itself. On February 21,
2000, the British Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action. That decision was not appealed by the
government, so the dismissal is final.
On September 22, 1999, the U.S. Department of Justice brought an action in
the United States District Court for the District of Columbia against various
industry members, including RJR Tobacco. The government seeks to recover federal
funds expended in providing health care to smokers who have developed diseases
and injuries alleged to be smoking-related, and, in addition, seeks, pursuant to
the federal RICO statute, disgorgement of profits the government contends were
earned as a consequence of a RICO racketeering "enterprise." On December 27,
1999, defendants filed a motion to dismiss challenging all counts included in
the action brought by the DOJ. On June 6, 2000, the trial court heard oral
argument on the motion. On September 28, 2000, federal court Judge Gladys
Kessler of the United States District Court for the District of Columbia granted
the non-Liggett defendants' motion to dismiss the following counts of
plaintiff's complaint: (1) Medical Care Recovery Act claim and (2) Medicare
Secondary Payer claim. The court, however, denied the motion with respect to the
RICO claims. On October 13, 2000, the United States filed a motion to limit
Judge Kessler's September 28, 2000 order to claims for payments under Medicare
and the Federal Employee Health Benefits Act.
Union Cases. Although the MSA settled some of the most potentially
burdensome health-care cost recovery actions, many other such cases have been
brought by other types of plaintiffs. As of October 17,
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
2000, approximately 21 lawsuits by union trust funds against cigarette
manufacturers and others are pending. The funds seek recovery of payments made
by them for medical expenses of their participant union members and their
dependents allegedly injured by cigarettes. The claims in these cases are almost
identical, and several purport to be class actions on behalf of all union trust
funds in a particular state.
The defendants in these actions argue, among other things, that one who
pays an injured person's medical expenses is legally too remote to maintain an
action against the person allegedly responsible for the injury. In addition,
they argue that the traditional subrogation remedy cannot be supplanted by a
direct right of action for the trust fund that strips defendants of the defenses
they would ordinarily have against the allegedly injured individual.
On March 29, 1999, in the first of these cases to be considered by a
federal court of appeals, Steamfitters Local Union 420 v. Philip Morris, Inc.,
the U.S. Court of Appeals for the Third Circuit affirmed a district court ruling
dismissing a case on remoteness grounds. Since then, the U.S. Courts of Appeals
for the Second, Third, Fifth, Seventh, Eighth, Ninth and Eleventh Circuits have
all ruled in favor of the industry in similar union cases. Most recently, on
August 22, 2000, the Eleventh Circuit ruled that the district court did not err
in dismissing the plaintiff's complaint and in denying the plaintiff's leave to
amend the complaint in United Food and Commercial Workers Unions and Employers
Health and Welfare Fund v. Philip Morris, Inc. On September 1, 2000, in Lyons v.
Philip Morris, Inc., the Eighth Circuit affirmed the trial court's dismissal. On
January 10, 2000, the United States Supreme Court denied petitions for
certiorari filed in cases from the Second, Third and Ninth Circuits.
Numerous trial court judges also have dismissed union trust fund cases on
remoteness grounds. Nonetheless, some union, or other third party payor, cases
have survived motions to dismiss and may proceed to trial. On August 2, 1999, a
federal district court in New York denied defendants' motions to dismiss in two
separate cases heard together, National Asbestos Workers Medical Fund v. Philip
Morris, Inc. and Blue Cross and Blue Shield of New Jersey, Inc. v. Philip
Morris, Inc. On December 21, 1999, the federal district court in the District of
Columbia denied defendants' motions to dismiss in three cases consolidated for
pretrial purposes: Service Employees International Union Health and Welfare Fund
v. Philip Morris, Inc., S.E.I.U. Local 74 Welfare Fund v. Philip Morris, Inc.
and Holland v. Philip Morris, Inc. The latter set of cases is on appeal to the
United States Court of Appeals for the District of Columbia.
On March 3, 2000, a New York state court granted motions to dismiss 10
union cases, Eastern States Health & Welfare Fund v. Philip Morris, Inc.,
brought by 14 union trust funds seeking to recover money paid for medical bills
incurred by their participants and beneficiaries who suffer from alleged
tobacco-caused diseases. This case is on appeal to the Appellate Division of the
Supreme Court of New York. Most recently, in Steamfitters Local Union No. 614
Health and Welfare Fund v. Philip Morris, Inc., the Tennessee Court of Appeals
affirmed the trial court's dismissal of the antitrust claim and found the
remaining claims of the plaintiffs' complaint were too remote to permit
recovery.
The first and only union case to go to trial to date was Iron Workers Local
No. 17 v. Philip Morris, Inc. On March 18, 1999, the jury returned a unanimous
verdict for the defendants, including RJR Tobacco. The plaintiffs dismissed
their appeal of the verdict.
Other Health-Care Cost Recovery and Aggregated Claims Plaintiffs. Native
American tribes have filed similar cases, out of which four remain pending in
tribal courts, one in federal court in New Mexico and one class action in San
Diego Superior Court. On November 12, 1999, in Table Bluff Reservation v. Philip
Morris, Inc., a federal district court dismissed the plaintiffs' lawsuit.
Plaintiffs have appealed this ruling to the United States Court of Appeals for
the Ninth Circuit. On July 11, 2000, in Lower Brule Sioux Tribe v. American
Tobacco Co., the Lower Brule Sioux Tribe voluntarily dismissed its suit in
tribal court.
Groups of health-care insurers, as well as a private entity that purported
to self-insure its employee health-care programs, have also advanced claims
similar to those found in the union health-care cost
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
recovery actions. Two of these "insurer" cases, Williams & Drake v. American
Tobacco Co. and Regence Blueshield v. Philip Morris, Inc., were dismissed in
their entirety on remoteness grounds by federal district courts in Pennsylvania
and Washington. These cases are on appeal to the Third and Ninth Circuits,
respectively. In a third case, Group Health Plan, Inc. v. Philip Morris, Inc., a
federal district judge in Minnesota dismissed all claims, except a state
antitrust claim and a conspiracy claim. On February 22, 2000, on plaintiffs'
motion, the federal district court certified two questions to the Minnesota
Supreme Court relating to the pleading requirements that apply to certain state
law statutory claims asserted by plaintiffs in the Group Health action. On June
1, 2000, the certified questions were argued before the Minnesota Supreme Court,
and a decision is pending.
Other cost recovery suits have been brought by, among others, foreign
countries, local governmental jurisdictions, taxpayers on behalf of a government
jurisdiction, a university and hospitals. On November 4, 1999, in Allegheny
General Hospital v. Philip Morris, Inc., the U.S. District Court for the Western
District of Pennsylvania dismissed a third-party payor lawsuit filed against the
tobacco industry by a number of hospital and health-care facilities. Plaintiff
appealed this ruling to the United States Court of Appeals for the Third
Circuit, which affirmed the trial court's dismissal on October 6, 2000. On
December 14, 1999, a federal district court in Washington dismissed a similar
case, Association of Washington Public Hospital Districts v. Philip Morris, Inc.
Plaintiffs have appealed this ruling to the United States Court of Appeals for
the Ninth Circuit. On May 30, 2000, in A.O. Fox Memorial Hospital v. American
Tobacco Co., Inc., a group of approximately 175 hospitals filed suit against the
tobacco industry seeking repayment from cigarette companies for costs expended
to treat smoking-related illnesses. On August 7, 2000, a federal district court
in Washington, D.C. dismissed an international health-care cost recovery action
entitled Ontario v. Imperial Tobacco, Ltd. Plaintiffs are appealing the
dismissal to the United States Court of Appeals for the District of Columbia.
On January 5, 2000, a San Diego Superior Court judge dismissed certain
claims in two lawsuits: California v. Philip Morris, Inc. and California v.
Brown & Williamson Tobacco Corp. These lawsuits were brought by the cities of
Los Angeles and San Jose, respectively, on their own behalf and on behalf of the
people of California. The Los Angeles lawsuit was also brought on behalf of a
private entity purporting to represent both itself and the general public of the
State of California. Similarly, the San Jose lawsuit was also brought on behalf
of an individual purporting to represent the public interest and the people of
the State of California. Both lawsuits asserted substantially equivalent claims,
including claims that the tobacco industry defendants violated State Proposition
65 by failing to warn nonsmokers about the State of California's conclusions
concerning the dangers of environmental tobacco smoke. The lawsuits also
asserted that the defendants had committed unfair, fraudulent and unlawful
business practices by deceiving and/or failing to warn the public regarding the
alleged health hazards of environmental tobacco smoke.
The court ruled that the manufacturer and retailer defendants did not have
a duty to warn under Proposition 65 and dismissed those claims from both
lawsuits. The judge did not, however, dismiss the remaining state law claims.
Subsequently, Los Angeles voluntarily dismissed its remaining claims, leaving
only the private entity as a plaintiff in that lawsuit. Later, the parties to
the San Jose lawsuit reached agreement on the terms of a settlement that has
been approved by the California attorney general as being in the public
interest. The remaining parties to the Los Angeles lawsuit separately also
reached agreement on a settlement that is contingent on the court approving both
the San Jose and the Los Angeles settlements. Both settlements will be submitted
to the court for approval by November 3, 2000, and a ruling is expected by
November 20, 2000.
Finally, nine lawsuits are pending against RJR Tobacco in which asbestos
companies and/or asbestos-related trust funds allege that they "overpaid" claims
brought against them to the extent that tobacco use, not asbestos exposure, was
the cause of the alleged personal injuries for which they paid compensation.
Falise v. American Tobacco Co. was dismissed by the United States District Court
for the Eastern District of New York on November 2, 1999, due to a lack of
subject matter jurisdiction. This case was refiled on November 11, 1999. Jury
selection in this case has been scheduled for November 27, 2000, with opening
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
arguments to begin December 4, 2000. Other such cases pending in New York,
Mississippi and California might go to trial in 2001.
Antitrust Cases. Approximately 35 lawsuits have been filed by tobacco
wholesalers, or indirect purchasers, who are suing United States cigarette
manufacturers, including RJR Tobacco, and its parent company, RJR, 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, as a result of which plaintiffs suffered economic injury. In all
cases, plaintiffs are asking the court to certify the lawsuits as class actions,
and to allow the respective plaintiffs to pursue the lawsuits as representatives
of other persons in the United States, and throughout the world, that purchased
cigarettes directly from one or more of the defendants. The federal cases have
been consolidated and sent by the Judicial Panel on Multidistrict Litigation for
pretrial in the United States District Court for the Northern District of
Georgia.
On March 2, 2000, Liggett Group Inc. filed an antitrust action against RJR
Tobacco in the U.S. District Court for the District of New Jersey. Subsequently,
the court granted RJR Tobacco's motion to transfer this action to the United
States District Court for the Middle District of North Carolina. The suit
alleges that RJR Tobacco's "Every-Day-Low-Price" merchandising program, which
provides consumer discounts in retail establishments that choose to offer RJR
Tobacco products as their lowest-priced cigarettes, is a violation of the
Sherman Antitrust Act and New Jersey antitrust laws. RJR Tobacco believes that
its program is pro-competitive and that the court will find Liggett's
allegations to be without merit.
On July 30, 1999, Cigarettes Cheaper!, a retailer, filed an antitrust
counterclaim against RJR Tobacco in a gray market trademark suit originally
brought by RJR Tobacco in the United States District Court for the Northern
District of Illinois. Cigarettes Cheaper! alleges that it was denied promotional
resources in violation of the Robinson-Patman Act. The district court declined
to dismiss the counterclaim. Discovery is ongoing.
On May 10, 2000, the Customer Company, a retailer affiliated with
Cigarettes Cheaper!, filed a substantially similar antitrust claim against RJR
Tobacco in the United States District Court for the Northern District of
California. Discovery has not commenced.
Tobacco Growers' Case. On February 16, 2000, a class action complaint,
Deloach v. Philip Morris Cos., Inc., was brought against RJR Tobacco, other
cigarette manufacturers and others, in the United States District Court for the
District of Columbia on behalf of a putative class of all tobacco growers and
tobacco allotment holders, some 5,930 of which are actually named in the first
amended complaint. Plaintiffs' current theory, as reflected in their second
amended complaint, which was filed on September 2, 2000, is that the defendants,
Philip Morris, Inc., RJR Tobacco, Brown & Williamson Tobacco Corp. and Lorillard
Tobacco Co., engaged in bid-rigging of American tobacco auctions, both burley
and flue-cured, beginning at least by 1996 and continuing to present.
Defendants' actions are alleged to have held the auction prices of tobacco at
artificially low prices resulting in damage to tobacco growers and allotment
holders. In addition, plaintiffs allege that defendants have engaged in a
conspiracy to force the elimination or destruction of the federal government's
tobacco quota and price support program through an alleged illegal group
boycott. On October 9, 2000, defendants filed a motion to dismiss the second
amended complaint and a motion to transfer venue to the United States District
Court for the Middle District of North Carolina.
Scheduled Trials. As of October 17, 2000, RJR Tobacco is a defendant in
three cases scheduled for trial before year-end 2000, an individual smoker case
in state court in Brooklyn, New York, an asbestos contribution case in federal
court in Brooklyn, New York and a class action in state court in West Virginia.
RJR Tobacco is a defendant in 29 cases currently scheduled for trial in the
first half of 2001. These cases include: 10 Broin II cases; 11 individual smoker
cases; 4 asbestos contribution cases; 3 health care cost recovery cases; and 1
medical monitoring class action.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
Although trial schedules are subject to change and many cases are dismissed
before trial, it is likely that there will be an increased number of tobacco
cases, some involving claims for possibly billions of dollars, against RJR
Tobacco and RJR coming to trial over the next year.
Other Developments. RJR Tobacco is aware of a grand jury investigation
being conducted in North Carolina that relates to the cigarette business of
certain of its former affiliates. In connection with this investigation, RJR
Tobacco responded to a document subpoena dated July 7, 1999 and is in the
process of responding to an additional document subpoena dated June 1, 2000.
On December 22, 1998, Northern Brands International, Inc., a now inactive
tobacco subsidiary that was part of the business of R.J. Reynolds International
B.V., a former Netherlands subsidiary of RJR Tobacco which was managed by a
former affiliate, RJR-MacDonald, Inc., and which was sold to Japan Tobacco Inc.
on May 12, 1999, entered into a plea agreement with the United States Attorney
for the Northern District of New York. Northern Brands was charged with aiding
and abetting certain customers who brought merchandise into the United States
"by means of false and fraudulent practices . . . ." RJR-MacDonald, Inc., Japan
Tobacco's international operating company in Canada, is cooperating with an
investigation now being conducted by the Royal Canadian Mounted Police relating
to the same events that gave rise to the Northern Brands investigation.
On December 21, 1999, the government of Canada filed a lawsuit in the
United States District Court for Northern District of New York against RJR
Tobacco, RJR, several currently and formerly related companies and the Canadian
Tobacco Manufacturers Council. The lawsuit alleges that, beginning in 1991, the
defendants conspired with known distributors and smugglers to illegally import
into Canada tobacco products originally earmarked for export from Canada, in a
fashion that avoided the imposition of certain excise and retail taxes and duty
payments. Although the international tobacco business was sold, RJR Tobacco
retained certain liabilities relating to the events disclosed above. On June 30,
2000, this case was dismissed by the United States District Court for the
Northern District of New York. Plaintiff appealed the dismissal to the United
States Court of Appeals on July 28, 2000. Oral argument of the appeal is
expected to be heard on or after January 8, 2001.
On or about October 30, 1998, a boat manufacturer, American Marine
Holdings, Inc., filed suit against RJR Tobacco claiming that one of its boats
was not properly identified in RJR Tobacco cigarette advertising. The plaintiff
claims, among other things, violations of the Lanham Act and breach of an
alleged oral contract and seeks in excess of $20 million in damages. Discovery
has been completed and trial is scheduled for January 2001.
---------------------
Litigation is subject to many uncertainties, and it is possible that some
of the tobacco-related legal actions, proceedings or claims could be decided
against RJR Tobacco or its affiliates, including RJR, or indemnitees.
Determinations of liability or adverse rulings against other cigarette
manufacturers that are defendants in similar actions, even if such rulings are
not final, could adversely affect the litigation against RJR Tobacco or its
affiliates or indemnitees and could encourage an increase in the number of such
claims. 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 at which new lawsuits are filed against RJR Tobacco and
RJR, a significant increase in litigation and/or in adverse outcomes for tobacco
defendants could have an adverse effect on either or both of these entities. RJR
Tobacco and RJR each believe that they have a number of valid defenses to any of
those actions and intend to defend those actions vigorously.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
RJR believes that, notwithstanding the quality of defenses available to it
and RJR Tobacco in litigation matters, it is possible that the results of
operations or cash flows of RJR in particular quarterly or annual periods or
RJR's financial condition could be materially affected by the ultimate outcome
of certain pending litigation matters, including bonding and litigation costs.
RJR's management is unable to predict the outcome of the litigation or to derive
a meaningful estimate of the amount or range of any possible loss in any
particular quarterly or annual period or in the aggregate.
ENVIRONMENTAL MATTERS
RJR 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.
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.
RJR has been named in an insurance coverage suit brought by another company
named as a potentially responsible party under CERCLA with respect to a
superfund site in Hawaii at which a former subsidiary of RJR had operations. In
this lawsuit, Del Monte Fresh Produce v. Fireman's Fund Insurance, filed August
13, 1997 in the First Circuit Court of the State of Hawaii, the plaintiff seeks
declaratory judgment that it is entitled to insurance coverage for the site or,
in the alternative, that RJR is obligated to indemnify the plaintiff under the
terms of the agreement by which RJR sold that company in 1989. The Fireman's
Fund Insurance Company has filed a motion for summary judgment that has not yet
been heard.
Del Monte Corporation has been named a defendant in two lawsuits related to
the same Hawaii superfund site, Board of Water Supply of the City and County of
Honolulu v. Shell Oil Company and Akee v. The Dow Chemical Co., filed in the
First Circuit Court of the State of Hawaii on September 27, 1999, and October 7,
1999, respectively. Also, Del Monte Corporation has received a demand for
indemnity from an entity that was a chemical supplier to Del Monte Corporation
and is named a defendant in one of these lawsuits. Del Monte Corporation has
sought indemnity from RJR under the terms of the agreement by which RJR sold Del
Monte Corporation in 1989. In connection with any liability RJR may incur
arising out of these claims, the buyers of the Del Monte fresh fruit business
are obligated to indemnify RJR under the terms of the agreement by which RJR
sold the Del Monte fresh fruit business in 1989. RJR has provided notice of
these claims to the buyers, and their successors, of the Del Monte fresh fruit
business and has asserted its right to be indemnified by the buyers for any
liability arising out of such claims. Pursuant to the distribution agreement,
dated as of May 12, 1999, among RJR, RJR Tobacco and NGH, RJR has also provided
notice of these claims to NGH and has asserted its right to be indemnified by
NGH for any liability arising out of such claims.
RJR Tobacco has been notified by the EPA of its potential liability under
CERCLA for a superfund site in Greer, South Carolina. The notice and demand for
reimbursement of costs incurred by the EPA was sent to a group of companies
previously involved as potentially responsible parties in another superfund
site, which includes RJR Tobacco. The EPA alleges that some waste from the
cleanup of the other site was transported to the site in question. RJR Tobacco
has executed a tolling agreement with the EPA. This tolling agreement provides
for entry into good faith negotiations with the EPA, and is not an admission of
fact or liability. It also should have no impact on any defense RJR Tobacco may
assert, other than a
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
defense based on the running of the statute of limitations. This matter is in
its preliminary stage, as information is still being gathered from other
potentially responsible parties recently notified by the EPA.
In December 1998, the EPA proposed regulations that would have imposed
restrictions on RJR Tobacco's use of certain fumigants used to protect stores of
tobacco from agricultural pests. Those proposed regulations would have required
RJR Tobacco to make significant expenditures to comply with the EPA regulations,
or risk the loss of substantial stores of tobacco to agricultural pests.
Together with other users of stored agricultural commodities and the
manufacturers of the fumigants, RJR Tobacco has engaged in discussions with the
EPA regarding modification of the proposed regulations to continue protection of
stored agricultural products from pests while ensuring the highest degree of
worker and bystander safety. It is expected that the EPA will finalize new
regulations for use of these fumigants during the Spring of 2001. It appears
likely that RJR Tobacco will be able to continue fumigation of stored tobacco
under new label conditions. Although some future expenditures may be required to
comply with the EPA regulations as they are finalized, RJR Tobacco does not
expect that those expenditures will be significant.
RJR and its subsidiaries have been engaged in a continuing program to
assure compliance with federal, state and local environmental laws and
regulations. Although it is difficult to identify precisely the portion of
capital expenditures or other costs attributable to compliance with
environmental laws and regulations and to estimate the cost of resolving these
CERCLA matters, RJR does not expect such expenditures or other costs to have a
material adverse effect on the business, results of operations or financial
condition of RJR or its subsidiaries.
OTHER CONTINGENCIES
Until the spin-off of RJR by NGH, RJR and RJR Tobacco were members of the
consolidated group of NGH for U.S. federal income tax purposes. Each member of a
consolidated group is liable for the U.S. federal income tax liability of other
members of the group, as well as for pension and benefit funding liabilities of
the other group members. RJR continues to be liable for these NGH liabilities
for the period prior to the spin-off.
In connection with the spin-off, RJR, NGH and Nabisco entered into (1) a
tax sharing agreement which generally seeks to allocate tax liabilities ratably
based upon RJR's taxable income and that of NGH had the parties been separate
taxpayers, and (2) a distribution agreement which seeks to allocate pension and
benefit funding liabilities. In the tax sharing agreement, NGH also agreed to
indemnify RJR for taxes arising from the spin-off or the Nabisco transfer,
although RJR would be responsible for taxes if its own act, omission or
misrepresentation caused such tax liability to arise. If NGH were unable to
satisfy its obligations under these agreements, RJR would be responsible for
satisfying them.
In connection with the sale of the international tobacco business to Japan
Tobacco on May 12, 1999, RJR and RJR Tobacco agreed to indemnify Japan Tobacco
against (1) 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, (2) any
liabilities, costs and expenses that Japan Tobacco or any of its affiliates,
including the acquired entities, may incur after the sale in respect of any of
RJR's or RJR Tobacco's employee benefit and welfare plans and (3) any
liabilities, costs and expenses incurred by Japan Tobacco or any of its
affiliates arising out of certain activities of Northern Brands. Although it is
impossible to predict the final outcome of the Northern Brands litigation or the
amount of liabilities, costs and expenses, if any, RJR and RJR Tobacco may be
required to indemnify Japan Tobacco in connection with the matters described in
the preceding sentence. A significant adverse outcome regarding any of these
items could have an adverse effect on either or both RJR and RJR Tobacco.
18
<PAGE> 19
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 4 -- STOCKHOLDERS' EQUITY
Changes in stockholders' equity for the nine months ended September 30,
2000 were:
<TABLE>
<CAPTION>
ACCUMULATED
RETAINED OTHER
EARNINGS COMPREHENSIVE OTHER TOTAL
COMMON PAID-IN (ACCUMULATED INCOME STOCKHOLDERS' TREASURY STOCKHOLDERS'
STOCK CAPITAL DEFICIT) (LOSS) EQUITY STOCK EQUITY
------ ------- ------------ ------------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1999... $1 $7,287 $(131) $(13) $(25) $ (55) $7,064
Net income..................... -- -- 306 -- -- -- 306
Total comprehensive
income...................
Dividends declared............. -- (102) (136) -- -- -- (238)
Stock options exercised........ -- 27 -- -- -- -- 27
Tax benefit on stock options
exercised.................... -- 2 -- -- -- -- 2
Restricted stock award......... -- 24 -- -- (24) -- --
Restricted stock
amortization................. -- -- -- -- 11 -- 11
Restricted stock forfeited..... -- -- -- -- 1 (1) --
Stock repurchased.............. -- -- -- -- -- (170) (170)
-- ------ ----- ---- ---- ----- ------
Balance at September 30,
2000......................... $1 $7,238 $ 39 $(13) $(37) $(226) $7,002
== ====== ===== ==== ==== ===== ======
<CAPTION>
COMPREHENSIVE
INCOME
-------------
<S> <C>
Balance at December 31, 1999...
Net income..................... $306
----
Total comprehensive
income................... $306
====
Dividends declared.............
Stock options exercised........
Tax benefit on stock options
exercised....................
Restricted stock award.........
Restricted stock
amortization.................
Restricted stock forfeited.....
Stock repurchased..............
Balance at September 30,
2000.........................
</TABLE>
NOTE 5 -- STOCK PLANS
During the nine months ended September 30, 2000, RJR granted approximately
674,000 shares of restricted stock to eligible employees under the 1999
Long-Term Incentive Plan. These shares may not be disposed of or transferred
during the three-year restricted period. These restrictions will lapse in 2003,
unless the related shares are forfeited. The fair value of the grant was charged
to stockholders' equity as unearned compensation, and will be amortized over the
three-year vesting period.
During the nine months ended September 30, 2000, certain employees and
former employees exercised stock options that provided for the issuance of
approximately 1,011,300 shares of common stock. Since RJR has elected to follow
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its employee stock options, no compensation expense has been
recorded relating to stock options.
19
<PAGE> 20
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 6 -- CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
RJR has not presented separate financial statements and other disclosures
concerning RJR Tobacco because management has determined that such information
is not material to holders of its registered notes. RJR Tobacco is a wholly
owned subsidiary of RJR, and has fully and unconditionally guaranteed the
registered notes.
The following condensed consolidating financial statements of RJR include
the accounts and activities of RJR, the issuer of the registered notes; RJR
Tobacco, the guarantor of the registered notes; the subsidiaries of RJR and RJR
Tobacco that are not guarantors of the registered notes; and elimination
adjustments.
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
ISSUER GUARANTOR NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------ --------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
Net sales...................................... $ -- $2,154 $ -- $ (35) $2,119
Cost of products sold.......................... -- 896 (8) (37) 851
Selling, general and administrative expenses... 11 981 (79) -- 913
Amortization of trademarks and goodwill........ -- 65 26 -- 91
Interest and debt expense...................... 42 1 -- -- 43
Interest income................................ -- (28) (2) -- (30)
Intercompany interest expense (income)......... (2) 100 (98) -- --
Intercompany dividend.......................... (84) (100) -- 184 --
Other expense (income), net.................... 8 1 (2) 2 9
----- ------ ---- ----- ------
INCOME BEFORE INCOME TAXES................. 25 238 163 (184) 242
Provision for (benefit from) income taxes...... (26) 92 60 (1) 125
Equity income from subsidiaries................ 249 103 -- (352) --
----- ------ ---- ----- ------
NET INCOME................................. $ 300 $ 249 $103 $(535) $ 117
===== ====== ==== ===== ======
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999
Net sales...................................... $ -- $1,974 $ 17 $ -- $1,991
Cost of products sold.......................... -- 824 1 -- 825
Selling, general and administrative expenses... 4 884 (75) -- 813
Tobacco settlement and related expenses........ -- 40 -- -- 40
Amortization of trademarks and goodwill........ -- 65 26 -- 91
Restructuring expense.......................... -- (2) -- -- (2)
Interest and debt expense...................... 43 -- -- -- 43
Interest income................................ -- (32) (12) -- (44)
Intercompany interest expense (income)......... (3) 99 (96) -- --
Other expense (income), net.................... 8 (25) 26 -- 9
----- ------ ---- ----- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES...................... (52) 121 147 -- 216
Provision for income taxes..................... -- 48 72 -- 120
Equity income from subsidiaries from continuing
operations................................... 148 75 -- (223) --
----- ------ ---- ----- ------
INCOME FROM CONTINUING OPERATIONS.......... 96 148 75 (223) 96
Income (loss) from discontinued operations, net
of taxes..................................... 68 (386) 97 -- (221)
Equity income (loss) from subsidiaries from
discontinued operations...................... (289) 97 -- 192 --
----- ------ ---- ----- ------
NET INCOME (LOSS).......................... $(125) $ (141) $172 $ (31) $ (125)
===== ====== ==== ===== ======
</TABLE>
20
<PAGE> 21
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
ISSUER GUARANTOR NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------ --------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
Net sales...................................... $ -- $6,128 $ 35 $ (37) $6,126
Cost of products sold.......................... -- 2,543 2 (37) 2,508
Selling, general and administrative expenses... 28 2,836 (227) -- 2,637
Tobacco settlement and related expenses........ -- (3) -- -- (3)
Amortization of trademarks and goodwill........ -- 195 79 -- 274
Interest and debt expense...................... 126 3 -- -- 129
Interest income................................ -- (69) (6) -- (75)
Intercompany interest expense (income)......... (7) 295 (288) -- --
Intercompany dividend.......................... (84) (455) -- 539 --
Other expense, net............................. 24 1 -- -- 25
------ ------ ------ ------- ------
INCOME (LOSS) BEFORE INCOME TAXES.......... (87) 782 475 (539) 631
Provision for (benefit from) income taxes...... (65) 222 167 1 325
Equity income from subsidiaries................ 868 308 -- (1,176) --
------ ------ ------ ------- ------
NET INCOME................................. $ 846 $ 868 $ 308 $(1,716) $ 306
====== ====== ====== ======= ======
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
Net sales...................................... $ -- $5,550 $ 41 $ -- $5,591
Cost of products sold.......................... -- 2,393 3 -- 2,396
Selling, general and administrative expenses... 43 2,430 (212) -- 2,261
Tobacco settlement and related expenses........ -- 40 -- -- 40
Amortization of trademarks and goodwill........ -- 195 79 -- 274
Restructuring expense.......................... -- (2) -- -- (2)
Headquarters close-down and related charges.... 143 -- -- -- 143
Interest and debt expense...................... 225 -- -- -- 225
Interest income................................ (4) (52) (19) -- (75)
Intercompany interest expense (income)......... (390) 520 (130) -- --
Other expense (income), net.................... 17 (4) 35 -- 48
------ ------ ------ ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES...................... (34) 30 285 -- 281
Provision for income taxes..................... 14 71 109 -- 194
Equity income from subsidiaries from continuing
operations................................... 135 176 -- (311) --
------ ------ ------ ------- ------
INCOME FROM CONTINUING OPERATIONS.......... 87 135 176 (311) 87
Income (loss) from discontinued operations, net
of taxes..................................... (509) 1,166 1,855 -- 2,512
Equity income from subsidiaries from
discontinued operations...................... 3,021 1,855 -- (4,876) --
------ ------ ------ ------- ------
NET INCOME BEFORE EXTRAORDINARY ITEM....... 2,599 3,156 2,031 (5,187) 2,599
Extraordinary item -- loss on early
extinguishment of debt, net of income
taxes........................................ (250) -- -- -- (250)
------ ------ ------ ------- ------
NET INCOME................................. $2,349 $3,156 $2,031 $(5,187) $2,349
====== ====== ====== ======= ======
</TABLE>
21
<PAGE> 22
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
ISSUER GUARANTOR NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------- --------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
Cash flows from operating activities.......... $ 1,042 $1,371 $ 470 $(1,714) $ 1,169
Cash flows from (used in) investing
activities:
Proceeds from maturities of short-term
investments............................... -- 109 1 -- 110
Intercompany transfers...................... (175) 294 -- (119) --
Other, net.................................. (535) (190) 44 645 (36)
------- ------ ------- ------- -------
Net cash flows from (used in) investing
activities.............................. (710) 213 45 526 74
------- ------ ------- ------- -------
Cash flows from (used in) financing
activities:
Intercompany payables....................... (2) (119) 88 33 --
Repayments of long-term debt................ (46) -- -- -- (46)
Repurchase of common stock.................. (170) -- -- -- (170)
Dividends paid on common stock.............. (244) (244) (455) 699 (244)
Other, net.................................. 27 (301) (155) 456 27
------- ------ ------- ------- -------
Net cash flows used in financing
activities.............................. (435) (664) (522) 1,188 (433)
------- ------ ------- ------- -------
Net cash flows related to discontinued
operations.................................. 103 (19) -- -- 84
------- ------ ------- ------- -------
Net change in cash and cash equivalents....... -- 901 (7) -- 894
Cash and cash equivalents at beginning of
period...................................... -- 1,060 117 -- 1,177
------- ------ ------- ------- -------
Cash and cash equivalents at end of period.... $ -- $1,961 $ 110 $ -- $ 2,071
======= ====== ======= ======= =======
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
Cash flows from (used in) operating
activities.................................. $ (42) $ (273) $ 227 $ -- $ (88)
Cash flows from (used in) investing
activities:
Net proceeds from the sale of the
international tobacco business............ (35) 2,611 5,184 -- 7,760
Other, net.................................. -- (30) (24) -- (54)
------- ------ ------- ------- -------
Net cash flows from (used in) investing
activities.............................. (35) 2,581 5,160 -- 7,706
------- ------ ------- ------- -------
Cash flows from (used in) financing
activities:
Intercompany transfers...................... 5,281 (295) (4,986) -- --
Proceeds from issuance of long-term debt.... 1,244 -- -- -- 1,244
Repayment of long-term debt................. (4,450) -- -- -- (4,450)
Transfers and payments to former parent..... (1,968) -- -- -- (1,968)
Other, net.................................. (57) -- -- -- (57)
------- ------ ------- ------- -------
Net cash flows from (used in) financing
activities.............................. 50 (295) (4,986) -- (5,231)
------- ------ ------- ------- -------
Cash flows related to discontinued
operations.................................. -- -- 116 -- 116
------- ------ ------- ------- -------
Net change in cash and cash equivalents....... (27) 2,013 517 -- 2,503
Cash and cash equivalents at beginning of
period...................................... 40 (40) -- -- --
------- ------ ------- ------- -------
Cash and cash equivalents at end of period.... $ 13 $1,973 $ 517 $ -- $ 2,503
======= ====== ======= ======= =======
</TABLE>
22
<PAGE> 23
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
CONDENSED CONSOLIDATING BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
ISSUER GUARANTOR NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------- --------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
SEPTEMBER 30, 2000
ASSETS
Cash and cash equivalents..................... $ -- $ 1,961 $ 110 $ -- $ 2,071
Other current assets.......................... 14 1,725 80 (591) 1,228
Trademarks, net............................... -- -- 2,991 -- 2,991
Goodwill, net................................. -- 7,368 -- -- 7,368
Intercompany notes receivable................. 140 44 4,530 (4,714) --
Investment in subsidiaries.................... 10,576 6,470 -- (17,046) --
Other noncurrent assets....................... 57 1,193 5 -- 1,255
------- ------- ------ -------- -------
Total assets......................... $10,787 $18,761 $7,716 $(22,351) $14,913
======= ======= ====== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Tobacco settlement and related accruals....... $ -- $ 1,914 $ -- $ -- $ 1,914
Other current liabilities..................... 1,327 1,041 81 (591) 1,858
Intercompany notes payable.................... 50 4,546 118 (4,714) --
Long-term debt (less current maturities)...... 1,576 -- -- -- 1,576
Other noncurrent liabilities.................. 832 684 1,047 -- 2,563
Stockholders' equity.......................... 7,002 10,576 6,470 (17,046) 7,002
------- ------- ------ -------- -------
Total liabilities and stockholders'
equity............................. $10,787 $18,761 $7,716 $(22,351) $14,913
======= ======= ====== ======== =======
DECEMBER 31, 1999
ASSETS
Cash and cash equivalents..................... $ -- $ 1,060 $ 117 $ -- $ 1,177
Other current assets.......................... 2 1,608 164 (483) 1,291
Trademarks, net............................... -- -- 3,070 -- 3,070
Goodwill, net................................. -- 7,563 -- -- 7,563
Intercompany notes receivable................. 143 31 4,574 (4,748) --
Investment in subsidiaries.................... 10,401 6,764 -- (17,165) --
Other noncurrent assets....................... 81 1,191 4 -- 1,276
------- ------- ------ -------- -------
Total assets......................... $10,627 $18,217 $7,929 $(22,396) $14,377
======= ======= ====== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Tobacco settlement and related accruals....... $ -- $ 1,278 $ -- $ -- $ 1,278
Other current liabilities..................... 1,155 1,087 31 (483) 1,790
Intercompany notes payable.................... 53 4,664 31 (4,748) --
Long-term debt (less current maturities)...... 1,653 -- -- -- 1,653
Other noncurrent liabilities.................. 702 787 1,103 -- 2,592
Stockholders' equity.......................... 7,064 10,401 6,764 (17,165) 7,064
------- ------- ------ -------- -------
Total liabilities and stockholders'
equity............................. $10,627 $18,217 $7,929 $(22,396) $14,377
======= ======= ====== ======== =======
</TABLE>
23
<PAGE> 24
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 7 -- ACQUISITION
On June 25, 2000, RJR, RJR Acquisition Corp., a wholly owned subsidiary of
RJR, and NGH entered into an agreement and plan of merger, referred to as the
Merger Agreement, which provides for RJR to acquire 100% of the outstanding
voting stock of NGH. Under the Merger Agreement, as amended, NGH will merge with
and into RJR Acquisition Corp. As a result of the merger, each outstanding share
of NGH common stock will be converted into the right to receive $30 in cash. The
aggregate purchase price for the acquisition is approximately $9.8 billion. Net
cash proceeds to RJR from the transaction are anticipated to be approximately
$1.4 billion to $1.5 billion.
NGH's stockholders approved the sale of NGH's 80.5% interest in Nabisco to
Philip Morris for approximately $11.7 billion in cash, and the subsequent
acquisition of NGH by RJR, at the special meeting of NGH's stockholders held on
October 27, 2000. The acquisition of Nabisco by Philip Morris has received
approval from the European Commission and remains under review by U.S. antitrust
authorities. Both transactions are expected to close during the fourth quarter
of 2000.
24
<PAGE> 25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion and analysis of the consolidated financial
condition and results of operations of RJR. It should be read in conjunction
with the financial information included in the condensed consolidated financial
statements.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net sales................................... $2,119 $1,991 $6,126 $5,591
Cost of products sold *..................... 851 825 2,508 2,396
Selling, general and administrative
expenses.................................. 913 813 2,637 2,261
Tobacco settlement and related expenses..... -- 40 (3) 40
------ ------ ------ ------
Operating company contribution.............. $ 355 $ 313 $ 984 $ 894
====== ====== ====== ======
</TABLE>
---------------
* $605 million and $564 million of ongoing settlement expense was recorded in
cost of products sold for the three months ended September 30, 2000 and 1999,
respectively, and $1.7 billion and $1.6 billion was recorded during the
nine-month periods ended September 30, 2000 and 1999, respectively. Tobacco
settlement and related expenses include only initial, up-front tobacco
settlement and other related expenses.
Net sales of $2.1 billion and $6.1 billion for the three months and nine
months ended September 30, 2000 increased 6.4% and 9.6%, respectively, from the
comparable prior-year periods. The increase in both comparative periods was
driven by favorable pricing of $188 million for the third quarter and $580
million for the nine-month period, resulting from price increases in 1999 and
2000. Volume declines adversely impacted net sales by $70 million in the third
quarter and $57 million for the nine-month period. RJR Tobacco's total shipment
volume during the quarter ended September 30, 2000 of 24.7 billion units,
excluding Puerto Rico and certain other U.S. territories' volume of
approximately .4 billion units, decreased 3.3% from the quarter ended September
30, 1999, while industry volume decreased 3.5%. Shipment volume, excluding
Puerto Rico shipments, decreased 0.9% during the first nine months of 2000
versus the prior-year period, while industry shipments increased 0.7%.
Preliminary analysis indicates that consumption of products of RJR Tobacco, and
the industry, declined during the first nine months of 2000 compared with the
prior-year period. Consumption is expected to continue to decline through 2000
compared with last year.
RJR Tobacco's full-price shipments represented 63.8% and 63.2% of total
shipments for the quarters ended September 30, 2000 and 1999, respectively, and
63.2% and 62.4% in the nine months ended September 30, 2000 and 1999,
respectively. Industry-wide, full-price shipments represented 73.5% and 73.1% of
total shipments for the quarters ended September 30, 2000 and 1999,
respectively, and 73.6% and 73.4% for the nine months ended September 30, 2000
and 1999, respectively. Overall, RJR Tobacco's full-price shipments during the
quarter ended September 30, 2000 were down 2.3% compared with the prior-year
quarter, while the industry decline was 3.0%. Shipment volume for CAMEL,
excluding the non-filter style, was up 7.4% compared with the third quarter of
1999, which surpassed the industry full-price performance. CAMEL shipments,
excluding the non-filter style, were up 9.9% for the nine months ended September
30, 2000 versus the 1999 period, while the industry full-price increase was
1.0%. CAMEL shipments were supported by the Turkish Gold 85-millimeter line
extension introduced in the second quarter of 2000. RJR plans to expand Turkish
Gold with the fourth-quarter launch of a 100-millimeter brand style. Shipments
of WINSTON's base styles decreased 2.3% and 1.1% during the three- and nine-
month periods ended September 30, 2000, respectively, from the prior-year
periods. SALEM shipments were down 7.8% and 3.7% for the three- and nine-month
periods ended September 30, 2000, respectively, compared with the prior-year
periods due to increased competitive activity in the menthol segment. In order
to strengthen SALEM's retail position, 100-millimeter SALEM in the innovative
slide box will be
25
<PAGE> 26
introduced in November 2000 in the brand's emphasis markets. Shipments for
DORAL, the industry's leading savings brand, decreased 5.0% and 2.4% during the
three- and nine-month periods ended September 30, 2000, respectively, from the
prior-year periods. DORAL's performance reflected a wider price gap versus
deep-discount brands. Consistent with DORAL's disciplined discounting strategy,
the brand has refined its in-store promotional efforts in order to remain
competitive.
RJR Tobacco's retail share of market averaged 23.75% during the third
quarter of 2000, an increase of 0.67 share points from the second quarter of
2000, and was down slightly from 23.84% in the third quarter of 1999.
CAMEL, RJR Tobacco's largest full price brand, continued to show strong
growth. Retail share of market on CAMEL, excluding the non-filtered style, grew
0.36 share points compared with the second quarter of 2000 and was up 0.59 share
points to 5.31% in the most recent quarter versus the third quarter of 1999.
CAMEL has continued to introduce innovative marketing programs with strong
appeal among adult smokers of competitive brands.
Base WINSTON's retail share of 4.78% in the third quarter was up from its
second quarter share of 4.60%, supported by enhanced retail promotional
coverage, and was down slightly from the brand's 1999 third quarter share of
4.82%. SALEM's share averaged 2.99% in the most recent quarter compared with
3.02% in the second quarter of 2000 and 3.15% in the third quarter of 1999,
reflecting the increased competitive activity in the menthol segment.
DORAL's retail share of market was 6.15% for the three months ended
September 2000, up from 6.05% in the second quarter of 2000, benefiting from
defensive promotional efforts. Compared with the prior-year quarter, DORAL was
down 0.11 share points.
In April 2000, RJR expanded its test market of ECLIPSE to include the
Dallas/Fort Worth area, through direct mail and internet sales to age-verified,
adult smokers. ECLIPSE is a cigarette that primarily heats rather than burns
tobacco, greatly reducing second-hand smoke, while leaving no ashes, stains or
lingering odor. Additionally, using a four-step scientific methodology, RJR
Tobacco has concluded that while the effect of ECLIPSE on the risk of
cardiovascular disease is inconclusive, ECLIPSE may present smokers with less
risk of cancer, chronic bronchitis and possibly emphysema when compared with
other cigarettes. RJR is continuing to evaluate the test market results.
Cost of products sold of $851 million in the third quarter of 2000
increased $26 million from the third quarter of 1999, primarily due to an
increase of $41 million in ongoing settlement costs, partly offset by decreased
volume. Cost of products sold of $2.5 billion in the first nine months of 2000
increased $112 million from 1999, primarily due to an increase of $114 million
in ongoing settlement costs.
Selling, general and administrative expenses of $913 million for the third
quarter of 2000 increased $100 million from the comparable prior-year quarter.
For the first nine months of 2000, selling, general and administrative expenses
of $2.6 billion increased $376 million from the prior-year period. These changes
over the prior-year periods were primarily due to increased promotional expense,
composed mainly of competitive discounts.
Up-front tobacco settlement and related expenses in the first nine months
of 2000 reflect a $3 million reversal of the liability for employee severance
and related benefits during the second quarter of 2000. This reversal reflects a
less-than-expected volume decline that resulted in a corresponding
less-than-expected related workforce reduction. During the three and nine months
ended September 30, 1999, RJR Tobacco recorded a charge of $40 million, $24
million after-tax, related to the tobacco growers' settlement.
Operating company contribution increased 13.4% to $355 million for the
third quarter of 2000 and increased 10.1% to $984 million for the first nine
months of 2000 when compared with the prior-year periods. These increases are
primarily due to the factors discussed above.
During the second quarter of 1999, RJR recorded a charge of $143 million,
$93 million after-tax, in connection with the elimination of its New York
corporate headquarters. The elimination of headquarters resulted from the
reorganization transactions described in note 1 to the condensed consolidated
financial
26
<PAGE> 27
statements. Total cash expenditures related to this charge were $122 million.
Approximately $127 million of the charge was for severance and related benefits
for approximately 100 employees at the New York headquarters. The remainder of
the charge was primarily related to contractual lease termination payments and
the write-off of leasehold improvements and abandoned equipment.
Interest and debt expense was $43 million in the third quarter of both 2000
and 1999. For the first nine months of 2000, interest and debt expense of $129
million decreased $96 million from the comparable prior-year period. This
decrease resulted from the repurchase of approximately $4 billion of debt,
partly offset by the issuance of $1.25 billion of debt, during the second
quarter of 1999.
Interest income decreased $14 million for the three-month period ended
September 30, 2000, compared with the prior-year period, primarily reflecting
higher cash balances during the third quarter of 1999 in anticipation of tax
payments associated with the sale of the international tobacco business in the
second quarter of 1999. Interest income was $75 million in each of the
nine-month periods ended September 30, 2000 and 1999. See note 1 to the
condensed consolidated financial statements.
Other expense, net was $9 million for each of the quarters ended September
30, 2000 and 1999. Other expense, net decreased $23 million for the nine-month
period ended September 30, 2000 from the comparable prior-year period. This
decrease was primarily the result of higher 1999 charges related to the
spin-off. See note 1 to the condensed consolidated financial statements.
RJR Tobacco recorded a tax provision of $125 million, or an effective rate
of 51.7%, in the third quarter of 2000 compared with $120 million recorded in
the third quarter of 1999. The effective tax rates exceed the federal statutory
rate of 35% primarily due to the impact of certain nondeductible items,
including goodwill amortization, and to a lesser extent, state taxes.
Discontinued operations for the three- and nine-month periods ended
September 30, 1999 included after-tax income (loss) of $(9) million and $76
million, respectively, related to the operations of the international tobacco
business and Nabisco. The nine months of 1999 also included a $2.6 billion gain
on the sale of the international tobacco business, net of a $322 million loss on
the recognition of Nabisco's cumulative translation adjustment account, reduced
by $212 million in the third quarter of 1999 primarily for taxes, other than
income. See note 1 to the condensed consolidated financial statements.
An extraordinary loss of approximately $384 million, $250 million
after-tax, was incurred during the nine months ended September 30, 1999 in
connection with the repurchase of approximately $4 billion of debt securities.
See note 1 to the condensed consolidated financial statements.
LIQUIDITY AND FINANCIAL CONDITION
Liquidity
At present, the principal sources of liquidity for RJR Tobacco's business
and operating needs are internally generated funds from its operations and
available borrowings through RJR. RJR Tobacco believes that cash flows from
operating activities will be sufficient for the foreseeable future to meet its
obligations under the MSA and other existing settlement agreements, to fund its
budgeted capital expenditures and to provide funding to RJR. This funding is
primarily utilized by RJR to make its required debt-service payments, to pay
dividends to RJR stockholders and, from time to time, to fund share repurchase
programs. RJR and RJR Tobacco cannot predict cash requirements related to any
future settlements and judgements, including cash required to bond any appeals,
if necessary, and make no assurance that those requirements will be able to be
met.
Cash Flows
Net cash flows from operating activities of $1.2 billion in the first nine
months of 2000 decreased $315 million from the prior-year period. This decrease
primarily reflects an increase in cash payments of tobacco settlements partially
offset by increased pricing.
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<PAGE> 28
Net cash flows from investing activities of $74 million in the first nine
months of 2000 decreased $7.6 billion from the comparable prior-year period.
This decrease primarily results from the receipt of the net proceeds from the
sale of the international tobacco business during the second quarter of 1999.
Net cash flows used in financing activities of $433 million in the first
nine months of 2000 decreased $4.8 billion from the comparable prior-year
period. This decrease in funds used was primarily due to the repayment of
long-term debt and transfers and payments to NGH during the nine months ended
September 30, 1999.
Net cash flows from discontinued operations were related to the sale of the
international tobacco business in 1999, and a refund of related taxes during the
third quarter of 2000.
Since November 1999, RJR's board of directors has authorized two programs
for the repurchase of shares of its common stock, from time to time, in the open
market for purposes of enhancing stockholder value. The programs were funded by
cash flows from operations. During the first nine months of 2000, RJR
repurchased 7,185,839 shares of its common stock with a total cost of $170
million, which completed both repurchase programs and resulted in the cumulative
repurchase of 9,913,239 shares at a cost of $225 million.
Debt
In May 1999, RJR entered into a 30-month $1.235 billion revolving credit
facility with a syndicate of banks. RJR can use the facility to obtain loans or
letters of credit, at its option. RJR Tobacco has guaranteed RJR's obligations
under this revolving credit facility. If RJR's new senior unsecured debt is
rated below BBB- by S&P or Baa3 by Moody's, additional RJR subsidiaries will be
required to guarantee the facility. If RJR falls below these thresholds for both
of these rating agencies, or falls two levels below these thresholds for either
rating agency, RJR and the guarantors will have to pledge their assets to secure
their obligations. RJR is not generally required to maintain compensating
balances; however, commitment fees of 1% of the notional amount are payable
quarterly. This facility also limits RJR's ability to pay dividends, repurchase
stock, incur indebtedness, engage in transactions with affiliates, create liens,
acquire, sell or dispose of specific assets and engage in specified mergers or
consolidations. Borrowings under the revolving credit facility bear interest at
rates that vary with the prime rate or LIBOR. At September 30, 2000, RJR had
$372 million in letters of credit and no borrowings outstanding, with the
remaining $863 million of the facility available for borrowing. Additionally, as
of September 30, 2000, RJR had letters of credit outstanding of approximately $4
million that were not backed by the revolving credit facility.
In 1999, RJR issued $1.25 billion in debt securities of $550 million in
principal amount of 7 3/8% notes due in 2003, $500 million in principal amount
of 7 3/4% notes due in 2006 and $200 million in principal amount of 7 7/8% notes
due in 2009. The net proceeds received were used for general corporate purposes.
These notes are senior unsecured obligations and, unlike RJR's other non-bank
debt, are guaranteed by RJR Tobacco. In addition, any other subsidiaries of RJR
that in the future guarantee the $1.235 billion revolving credit facility will
also be required to guarantee these notes. Generally, the terms of the notes
restrict the issuance of guarantees by subsidiaries, the pledge of collateral,
sale/leaseback transactions and the transfer of all or substantially all of the
assets of RJR and its subsidiaries. RJR was in compliance with all covenants and
restrictions imposed by its indebtedness at September 30, 2000.
As of September 30, 2000, RJR also had $345 million of foreign currency
debt, with fixed interest rates between 5.375% and 6.875%, due in 2000, and $404
million of public notes, at fixed interest rates of 6.8% through 10%, due in
2001 through 2013.
Dividends
On September 6, 2000, RJR's board of directors declared a quarterly cash
dividend of $.775 per common share payable on October 2, 2000 to stockholders of
record as of September 18, 2000.
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<PAGE> 29
Capital Expenditures
Capital expenditures were $38 million and $30 million for the nine months
ended September 30, 2000 and 1999, respectively. To support its strategic and
operating needs, RJR Tobacco plans to spend in the range of $60 million to $65
million for capital expenditures during 2000 funded primarily by cash flows from
operations. There were no material long-term commitments for capital
expenditures as of September 30, 2000.
Litigation and Settlements
Numerous legal actions, proceedings and claims are pending or may be
instituted against RJR, its affiliates, including RJR Tobacco, or its
indemnitees that allege damages arising out of the use of, or exposure to, RJR
Tobacco's products. For discussion of litigation and legal proceedings pending
against RJR or its affiliates, including RJR Tobacco, or its indemnitees, see
Part II -- Other Information, Item 1 -- Legal Proceedings and note 3 to the
condensed consolidated financial statements. RJR believes that, notwithstanding
the quality of defenses available to it and its affiliates in litigation
matters, it is possible that the results of operations or cash flows of RJR in
particular quarterly or annual periods or RJR's financial condition could be
materially affected by the ultimate outcome of various pending or future
litigation matters, including litigation costs. RJR's management is unable to
predict the outcome of the litigation or to derive a meaningful estimate of the
amount or range of any possible loss in any particular quarterly or annual
period or in the aggregate.
In November 1998, RJR Tobacco 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 3 to the condensed
consolidated financial statements, the MSA imposes a stream of future payment
obligations on RJR Tobacco and the other major U.S. cigarette manufacturers and
places significant restrictions on their ability to market and sell cigarettes
in the future. The cash payments made by RJR Tobacco under the MSA and other
existing settlement agreements were approximately $1.1 billion during the nine
months ended September 30, 2000 and $1.6 billion in the 12 months ended December
31, 1999. RJR Tobacco estimates these payments in 2000 will exceed $2.2 billion
and in future years will exceed $2.0 billion per year. However, these payments
will be subject to adjustments based upon, among other things, the volume of
cigarettes sold by RJR Tobacco, RJR Tobacco's market share and inflation. RJR
Tobacco cannot predict the impact on its business, competitive position and
results of operations of the MSA and the other existing settlement agreements,
the business activity restrictions to which it is subject under these agreements
or the price increases that it may be required to make as a result of these
agreements.
Governmental Activity
The advertising, sale and use of cigarettes have been subject to
substantial regulation by government and health officials for many years.
Together with manufacturers' price increases in recent years and substantial
increases in state and federal excise taxes on cigarettes, these developments
have had and will likely continue to have an adverse effect on cigarette sales.
In December 1992, the U.S. Environmental Protection Agency issued a report
that classified environmental tobacco smoke as a Group A (known human)
carcinogen. RJR Tobacco and others filed suit to challenge the validity of the
EPA report. On July 17, 1998, a U.S. District Court judge held that the EPA's
classification of environmental tobacco smoke was invalid and vacated those
portions of the report dealing with lung cancer. The EPA has appealed, and oral
argument was held before the Court of Appeals for the Fourth Circuit on June 7,
1999. RJR Tobacco is awaiting the Court's decision.
In March 1994, the U.S. Occupational Safety and Health Administration
announced proposed regulations that would restrict smoking in the workplace to
designated smoking rooms that are separately exhausted to the outside. RJR
Tobacco submitted comments on the proposed regulations during the comment period
that closed in February 1996, but no regulation has been adopted to date.
Although RJR Tobacco cannot predict the form or timing of any regulations that
may be finally adopted by OSHA, if the
29
<PAGE> 30
proposed regulations are adopted, RJR Tobacco expects that many employers who
have not already done so would prohibit smoking in the workplace rather than
make expenditures necessary to establish designated smoking areas to accommodate
smokers. Because many employers currently do not permit smoking in the
workplace, RJR Tobacco cannot predict the effect of any regulations that may be
adopted, but incremental restrictions on smokers could have an adverse effect on
cigarette sales of all manufacturers.
In July 1996, Massachusetts enacted legislation requiring manufacturers of
tobacco products sold in Massachusetts to report yearly, beginning December 15,
1997, the ingredients of each brand sold. The statute also requires the
reporting of nicotine yield ratings in accordance with procedures established by
the state. The legislation contemplates public disclosure of all ingredients in
descending quantitative order, a trade-secret disclosure that RJR Tobacco
believes could damage the competitive position of its brands. RJR Tobacco,
together with other cigarette manufacturers, filed suit in the U.S. District
Court for the District of Massachusetts seeking to have the statute declared
invalid. The court granted a preliminary injunction that enjoined Massachusetts
officials from enforcing the law relating to ingredient reporting. That decision
was upheld by the Court of Appeals for the First Circuit. In September 2000, the
district court permanently enjoined enforcement of the law and issued a judgment
in favor of the cigarette manufacturers. Massachusetts has given notice of its
intention to appeal that judgment.
In August 1998, the Massachusetts Department of Public Health issued
regulations for public comment that would require annual reporting, beginning
July 1, 2000, on a brand-by-brand basis of 43 smoke constituents in both
mainstream smoke and sidestream smoke. RJR Tobacco, together with other
cigarette manufacturers, filed comments with the MDPH on October 9, 1998. RJR
Tobacco and the other manufacturers believe that the MDPH lacks legal authority
to promulgate these regulations. Nevertheless, RJR Tobacco and the other
manufacturers conducted a cooperative benchmarking study to address certain MDPH
concerns. The benchmarking study obtained smoke constituent information on a
representative number of cigarette brand styles. The final report, including all
data, has been presented to the MDPH. The MDPH has announced its intention to
promulgate additional regulations requiring further testing of cigarette brands,
but no additional regulations have either been formally proposed for public
comment or finalized.
On May 21, 1999, RJR Tobacco, Lorillard Tobacco Company, Brown & Williamson
Tobacco Corporation and Philip Morris, Inc. filed lawsuits in the U.S. District
Court for the District of Massachusetts to enjoin implementation of certain
Massachusetts Attorney General regulations concerning the advertisement and
display of tobacco products. The regulations go beyond those required by the
MSA. RJR Tobacco is challenging regulations that ban all self-service cigarette
sales; prohibit cigarette manufacturers from offering promotional items tied to
cigarette sales; prohibit mail distribution of cigarettes in exchange for
coupons and proofs of purchase; and prohibit point-of-sale advertising less than
five feet above ground in any retail outlet that is not limited to adults only.
RJR Tobacco is also challenging the regulation that bans all cigarette
advertising visible within 1,000 feet of any public playground, public park or
school. This provision would effectively ban outdoor advertising in all but the
most rural areas of the state. Although RJR Tobacco believed that it had strong
arguments that the regulations violate constitutional provisions concerning free
speech, equal protection, due process, the Commerce Clause and federal
preemption, the district court ruled against the industry on January 25, 2000,
and the U.S. Court of Appeals for the First Circuit affirmed the District
Court's decision on July 17, 2000. On October 16, 2000, RJR Tobacco and the
other plaintiffs filed a petition for a writ of certiorari seeking review of the
matter before the U.S. Supreme Court.
In June 2000, the New York state legislature passed legislation charging
the state's Office of Fire Prevention and Control with developing standards for
"fire safe" or self-extinguishing cigarettes. The OFPC has until July 1, 2002 to
issue final regulations. Six months from the issuance of the standards, but no
later than January 1, 2003, all cigarettes offered for sale in New York state
will be required to be manufactured to those standards. RJR Tobacco is offering
to share its ignition propensity research with the state. Similar legislation is
being considered by other state legislatures.
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<PAGE> 31
A price differential exists between cigarettes manufactured for sale abroad
and cigarettes manufactured for U.S. sale; consequently, a domestic "gray
market" has developed in cigarettes manufactured for sale abroad. These
cigarettes compete with the cigarettes RJR Tobacco manufactures for domestic
sale. Forty-five states have enacted legislation prohibiting the sale and
distribution of gray market cigarettes. Similarly, federal legislation
prohibiting the sale and distribution of gray market cigarettes became effective
on January 1, 2000. In addition, RJR Tobacco has taken legal action against
certain distributors and retailers who engage in such practices.
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.
Environmental Matters
RJR 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. RJR and its subsidiaries have
been engaged in a continuing program to assure compliance with these
environmental laws and regulations. Although it is difficult to identify
precisely the portion of capital expenditures or other costs attributable to
compliance with environmental laws and regulations, RJR and its subsidiaries do
not expect such expenditures or other costs to have a material adverse effect on
their businesses or financial condition.
For further discussion of environmental matters involving RJR and its
affiliates, including RJR Tobacco, or its indemnitees, see note 3 to the
condensed consolidated financial statements.
NGH Acquisition
On June 25, 2000, RJR, RJR Acquisition Corp., a wholly owned subsidiary of
RJR, and NGH entered into the Merger Agreement, which provides for RJR to
acquire 100% of the outstanding voting stock of NGH. Under the Merger Agreement,
as amended, NGH will merge with and into RJR Acquisition Corp. As a result of
the merger, each outstanding share of NGH common stock will be converted into
the right to receive $30 in cash. The aggregate purchase price for the
acquisition is approximately $9.8 billion. Net cash proceeds to RJR from the
transaction are anticipated to be approximately $1.4 billion to $1.5 billion.
NGH's stockholders approved the sale of NGH's 80.5% interest in Nabisco to
Philip Morris for approximately $11.7 billion in cash, and the subsequent
acquisition of NGH by RJR, at the special meeting of NGH's stockholders held on
October 27, 2000. The acquisition of Nabisco by Philip Morris has received
approval from the European Commission and remains under review by U.S. antitrust
authorities. Both transactions are expected to close during the fourth quarter
of 2000.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2000, the FASB's Emerging Issues Task Force reached a consensus on
Issue No. 00-14, "Accounting for Certain Sales Incentives," which addresses the
accounting for sales incentives, rebates, coupons and free products or services.
RJR has adopted EITF No. 00-14 as of October 1, 2000 and believes that adoption
of EITF No. 00-14 will not have a material impact on its financial position or
net income for the year ended December 31, 2000. Income statements, including
those presented for comparative purposes, will include the reclassification of
certain program costs as a revenue reduction rather than a cost, in compliance
with the display requirements.
During the second quarter of 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." In June 1999,
the FASB issued SFAS No. 137, which amended SFAS No. 133 to delay its effective
date by one year. RJR will adopt SFAS No. 133 on January 1, 2001. SFAS No. 133
requires that all derivative instruments be recorded on the consolidated balance
sheet at
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<PAGE> 32
their fair value. Changes in the fair value of derivatives will be recorded each
period in earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. In June 2000, the FASB issued SFAS No. 138, which amended
SFAS No. 133. RJR's management has reviewed the terms of all current material
contracts and financial instruments with terms through January 1, 2001, and
believes that adoption of SFAS No. 133, as amended, will not have a material
impact on its financial position or results of operations.
---------------------
Statements included in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" which 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. Forward-looking statements
regarding RJR's future performance and financial results include certain risks
and uncertainties that could cause actual results to differ materially from
those described in the forward-looking statements. These risks include the
substantial and increasing regulation and taxation of the cigarette industry;
various legal actions, proceedings and claims arising out of the tobacco
business and claimed health effects of cigarettes that are pending or may be
instituted against RJR or its subsidiaries; the substantial payment obligations
and limitations on the advertising and marketing of cigarettes under various
litigation settlement agreements; the continuing decline in volume in the
domestic cigarette industry; competition from other cigarette manufacturers; the
success of new product innovations and acquisitions; the effect of market
conditions on the performance of pension assets; and the ratings of RJR
securities. Due to these uncertainties and risks, readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date of this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact RJR's consolidated
financial position, results of operations or cash flows due to adverse changes
in financial market prices and rates. RJR is exposed to foreign currency rate
risk and interest rate risk directly related to its normal investing and funding
activities. RJR has established various policies and procedures to manage its
exposure to market risks and uses major institutions with high credit ratings to
minimize credit risk. RJR does not use derivative financial instruments for
trading or speculative purposes.
RJR uses the value-at-risk model to statistically measure the maximum fair
value, cash flows or earnings loss over one year from adverse changes in foreign
exchange rates and interest rates. The computation assumes a 95% confidence
level under normal market conditions.
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURES
RJR believes that near-term changes, if any, in foreign currency rates or
interest rates will not have a material impact on its future earnings, fair
values or cash flows, based on historical movements in foreign currency rates
and interest rates, and the fair value of market-rate sensitive instruments at
September 30, 2000.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
TOBACCO-RELATED LITIGATION
Various legal actions, proceedings and claims, including legal actions
claiming that lung cancer and other diseases, as well as addiction, have
resulted from the use of, or exposure to, RJR Tobacco's products, are pending or
may be instituted against RJR or its affiliates, including RJR Tobacco, or
indemnitees. During the third quarter of 2000, 1,157 new actions, 1,100 of which
were filed in state court in West Virginia in two complaints by the same law
firm, were served against RJR Tobacco and/or its affiliates or indemnitees, and
43 actions were dismissed or otherwise resolved in favor of RJR Tobacco and/or
its affiliates or indemnitees without trial. On September 30, 2000, there were
1,649 active cases pending, as compared with 561 on September 30, 1999 and 614
on September 30, 1998. As of October 17, 2000, 1,640 active cases were pending
against RJR Tobacco and/or its affiliates or indemnitees: 1,639 in the United
States and 1 in the Marshall Islands. The U.S. case number does not include the
3,128 Broin II cases pending as of October 17, 2000, discussed in note 3 to the
condensed consolidated financial statements.
The U.S. cases, exclusive of the Broin II cases, are pending in 39 states
and the District of Columbia. The breakdown is as follows: 1,216 in West
Virginia; 113 in New York; 52 in California; 45 in Florida; 30 in Louisiana; 19
in the District of Columbia; 13 in Texas; 11 in each of Massachusetts and New
Jersey; 10 in each of Alabama and Iowa; 9 in Pennsylvania; 8 in each of
Mississippi, New Mexico, Tennessee and Wisconsin; 7 in each of Illinois and
Missouri; 5 in each of Michigan and Nevada; 4 in each of Georgia, Minnesota and
Ohio; 3 in each of Connecticut, Indiana, North Dakota, New Hampshire and
Oklahoma; 2 in each of Arizona, Kansas, South Carolina, South Dakota and
Washington; and 1 in each of Hawaii, Kentucky, Maryland, Maine, North Carolina,
Oregon and Utah. Of the 1,639 active U.S. cases, 137 are pending in federal
court, 1,498 in state court and 4 in tribal court. Most of these cases were
brought by individual plaintiffs, but many of these cases seek recovery on
behalf of third parties or large classes of claimants.
---------------------
Litigation is subject to many uncertainties, and it is possible that some
of the tobacco-related legal actions, proceedings or claims could be decided
against RJR Tobacco or its affiliates, including RJR, or indemnitees.
Determinations of liability or adverse rulings against other cigarette
manufacturers that are defendants in similar actions, even if those rulings are
not final, could adversely affect the litigation against RJR Tobacco or its
affiliates or indemnitees and could encourage an increase in the number of those
claims. There have been a number of political, legislative, regulatory and other
developments relating to the tobacco industry and cigarette smoking that 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 these events on pending
litigation and the rate at which new lawsuits are filed against RJR Tobacco and
RJR, a significant increase in litigation and/or in adverse outcomes for tobacco
defendants could have an adverse effect on any one or all of these entities. RJR
Tobacco and RJR each believe that they have a number of valid defenses to any of
those actions and intends to defend those actions vigorously.
RJR believes that, notwithstanding the quality of defenses available to it
and RJR Tobacco in litigation matters, it is possible that the results of
operations or cash flows of RJR in particular quarterly or annual periods or
RJR's financial condition could be materially affected by the ultimate outcome
of certain pending litigation matters, including bonding and litigation costs.
RJR's management is unable to predict the outcome of the litigation or to derive
a meaningful estimate of the amount or range of any possible loss in any
particular quarterly or annual period or in the aggregate.
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<PAGE> 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
2.1 Amendment No. 1, dated September 20, 2000, to the Agreement
and Plan of Merger dated as of June 25, 2000, among Nabisco
Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc.
and RJR Acquisition Corp.
2.2 Letter dated October 19, 2000, from R.J. Reynolds Tobacco
Holdings, Inc. to Nabisco Group Holdings Corp., electing
that Nabisco Group Holdings Corp. be merged with and into
RJR Acquisition Corp. under the Agreement and Plan of Merger
dated as of June 25, 2000, as amended, among Nabisco Group
Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
Acquisition Corp.
2.3 Letter dated October 27, 2000, from R.J. Reynolds Tobacco
Holdings, Inc. to Nabisco Group Holdings Corp., agreeing
that it will pay or cause to be paid to stockholders of
Nabisco Group Holdings Corp., in circumstances described in
Section 2.02(b) of the Agreement and Plan of Merger dated as
of June 25, 2000, as amended, among Nabisco Group Holdings
Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
Acquisition Corp., an amount equal to 100% of the difference
between the Net Proceeds (as defined in the Agreement and
Plan of Merger) and $11.729 billion.
12.1 Computation of Ratio of Earnings to Fixed Charges/Deficiency
in the Coverage of Fixed Charges by Earnings before Fixed
Charges.
27.1 Financial Data Schedule for the Nine Months ended September
30, 2000.
27.2 Financial Data Schedule for the Nine Months ended September
30, 1999.
</TABLE>
(B) REPORTS ON FORM 8-K
During the quarter ended September 30, 2000, RJR filed no reports on Form
8-K.
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<PAGE> 35
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
(Registrant)
/s/ KENNETH J. LAPIEJKO
--------------------------------------
Kenneth J. Lapiejko
Executive Vice President and Chief
Financial Officer
Date: November 3, 2000
35
<PAGE> 36
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
2.1 Amendment No. 1, dated September 20, 2000, to the Agreement
and Plan of Merger dated as of June 25, 2000, among Nabisco
Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc.
and RJR Acquisition Corp.
2.2 Letter dated October 19, 2000, from R.J. Reynolds Tobacco
Holdings, Inc. to Nabisco Group Holdings Corp., electing
that Nabisco Group Holdings Corp. be merged with and into
RJR Acquisition Corp. under the Agreement and Plan of Merger
dated as of June 25, 2000, as amended, among Nabisco Group
Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
Acquisition Corp.
2.3 Letter dated October 27, 2000, from R.J. Reynolds Tobacco
Holdings, Inc. to Nabisco Group Holdings Corp., agreeing
that it will pay or cause to be paid to stockholders of
Nabisco Group Holdings Corp., in circumstances described in
Section 2.02(b) of the Agreement and Plan of Merger dated as
of June 25, 2000, as amended, among Nabisco Group Holdings
Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
Acquisition Corp., an amount equal to 100% of the difference
between the Net Proceeds (as defined in the Agreement and
Plan of Merger) and $11.729 billion.
12.1 Computation of Ratio of Earnings to Fixed Charges/Deficiency
in the Coverage of Fixed Charges by Earnings before Fixed
Charges
27.1 Financial Data Schedule for the Nine Months ended September
30, 2000.
27.2 Financial Data Schedule for the Nine Months ended September
30, 1999.
</TABLE>
