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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
<TABLE>
<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 JUNE 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: 101,961,511 shares of common
stock, par value $.01 per share, as of July 31, 2000
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<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income
(Unaudited) -- Three and Six Months Ended June 30, 2000 and
1999........................................................ 3
Condensed Consolidated Statements of Cash Flows
(Unaudited) -- Six Months Ended June 30, 2000 and 1999...... 4
Condensed Consolidated Balance Sheets -- June 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................................... 24
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 31
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings........................................... 32
Item 4. Submission of Matters to a Vote of Security Holders......... 33
Item 6. Exhibits and Reports on Form 8-K............................ 34
Signature............................................................ 35
</TABLE>
2
<PAGE> 3
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 SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
--------------- ---------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
NET SALES*.................................................. $2,085 $1,907 $4,007 $3,600
Costs and expenses:
Cost of products sold*.................................... 851 829 1,657 1,571
Selling, general and administrative expenses.............. 897 767 1,724 1,448
Tobacco settlement and related expenses................... (3) -- (3) --
Amortization of trademarks and goodwill................... 91 91 183 183
Headquarters close-down and related charges............... -- 143 -- 143
------ ------ ------ ------
OPERATING INCOME....................................... 249 77 446 255
Interest and debt expense................................... 43 77 86 182
Interest income............................................. (21) (30) (45) (31)
Other expense, net.......................................... 7 31 16 39
------ ------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES................................................ 220 (1) 389 65
Provision for income taxes.................................. 111 38 200 74
------ ------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS............... 109 (39) 189 (9)
Discontinued operations:
Income from operations of discontinued businesses, net of
income taxes........................................... -- 20 -- 85
Gain on discontinued businesses, net of income taxes...... -- 2,648 -- 2,648
------ ------ ------ ------
INCOME BEFORE EXTRAORDINARY ITEM....................... 109 2,629 189 2,724
Extraordinary item -- loss on early extinguishment of debt,
net of income taxes....................................... -- (250) -- (250)
------ ------ ------ ------
NET INCOME............................................. $ 109 $2,379 $ 189 $2,474
====== ====== ====== ======
BASIC INCOME PER SHARE:
Income (loss) from continuing operations.................. $ 1.08 $ (.36) $ 1.84 $ (.08)
Income from discontinued operations....................... -- 24.54 -- 25.14
Extraordinary loss........................................ -- (2.30) -- (2.30)
------ ------ ------ ------
Net income........................................... $ 1.08 $21.88 $ 1.84 $22.76
====== ====== ====== ======
DILUTED INCOME PER SHARE:
Income (loss) from continuing operations.................. $ 1.07 $ (.36) $ 1.84 $ (.08)
Income from discontinued operations....................... -- 24.54 -- 25.14
Extraordinary loss........................................ -- (2.30) -- (2.30)
------ ------ ------ ------
Net income........................................... $ 1.07 $21.88 $ 1.84 $22.76
====== ====== ====== ======
DIVIDENDS DECLARED PER SHARE................................ $ .775 $ -- $ 1.55 $ --
====== ====== ====== ======
</TABLE>
---------------
* Excludes excise taxes of $419 million and $318 million for the three months
ended June 30, 2000 and 1999, respectively, and $810 million and $578 million
for the six months ended June 30, 2000 and 1999, respectively.
See Notes to Condensed Consolidated Financial Statements
3
<PAGE> 4
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 30,
-------------------------
2000 1999
-------- ---------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income................................................ $ 189 $ 2,474
Less income from discontinued operations.................. -- 2,733
------ -------
Subtotal............................................. 189 (259)
------ -------
Adjustments to reconcile to net cash flows from (used in)
continuing operating activities:
Depreciation and amortization.......................... 244 243
Deferred income tax benefit............................ (12) (147)
Extraordinary loss on early extinguishment of debt..... -- 384
Changes in other working capital items, net............ (57) (289)
Tobacco settlement and related expenses, net of cash
payments.............................................. 69 654
Headquarters close-down and related charges, net of
cash payments......................................... -- 21
Other, net............................................. (12) (13)
------ -------
Total adjustments................................. 232 853
------ -------
Net cash flows from operating activities............. 421 594
------ -------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Proceeds from maturities of short-term investments........ 110 --
Capital expenditures...................................... (24) (20)
Net proceeds from the sale of the international tobacco
business............................................... -- 7,796
Other, net................................................ 4 --
------ -------
Net cash flows from investing activities............. 90 7,776
------ -------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................. -- 1,244
Repayments of long-term debt.............................. (27) (4,450)
Decrease in short-term borrowing.......................... -- (62)
Transfer and payments to former parent.................... -- (2,077)
Repurchase of common stock................................ (115) --
Dividends paid on common stock............................ (164) --
Other, net................................................ 8 6
------ -------
Net cash flows used in financing activities.......... (298) (5,339)
------ -------
Net cash flows related to discontinued operations........... -- 116
------ -------
Net change in cash and cash equivalents..................... 213 3,147
Cash and cash equivalents at beginning of period............ 1,177 --
------ -------
Cash and cash equivalents at end of period.................. $1,390 $ 3,147
====== =======
Income taxes paid, net of refunds........................... $ 154 $ 101
Interest paid............................................... $ 69 $ 258
Tobacco settlement and related expense payments............. $1,072 $ 416
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE> 5
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,390 $ 1,177
Short-term investments.................................... -- 110
Accounts and notes receivable, net........................ 96 84
Inventories............................................... 550 565
Deferred income taxes..................................... 436 437
Prepaid excise taxes and other............................ 111 95
------- -------
Total current assets.............................. 2,583 2,468
Property, plant and equipment, net.......................... 1,058 1,080
Trademarks, net............................................. 3,017 3,070
Goodwill, net............................................... 7,433 7,563
Other assets and deferred charges........................... 202 196
------- -------
$14,293 $14,377
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 76 $ 81
Tobacco settlement and related accruals................... 1,353 1,278
Accrued liabilities....................................... 1,247 1,273
Current maturities of long-term debt...................... 412 387
Income taxes accrued...................................... 107 49
------- -------
Total current liabilities......................... 3,195 3,068
Long-term debt (less current maturities).................... 1,600 1,653
Long-term retirement benefits............................... 598 676
Deferred income taxes....................................... 1,617 1,630
Other noncurrent liabilities................................ 292 286
Commitments and contingencies
Stockholders' equity:
Common stock (shares issued: 110,617,118 in 2000 and
109,631,397 in 1999)................................... 1 1
Paid-in capital........................................... 7,204 7,287
Retained earnings (accumulated deficit)................... -- (131)
Accumulated other comprehensive income (loss):
Cumulative minimum pension liability adjustment........ (13) (13)
Other stockholders' equity................................ (30) (25)
------- -------
7,162 7,119
Treasury stock, at cost (shares: 8,276,637 in 2000 and
2,728,630 in 1999)..................................... (171) (55)
------- -------
Total stockholders' equity........................ 6,991 7,064
------- -------
$14,293 $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 generally accepted accounting
principles 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 generally
accepted accounting principles 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 June 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. 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 three and six months ended June 30, 1999, operating results of the
discontinued operations included net sales of $1.3 billion and $3.8 billion,
respectively, and a provision for income taxes of $39 million and $87 million,
respectively.
Recently Issued and Proposed Accounting Pronouncements
During the second quarter of 1998, the Financial Accounting Standards Board
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 is in the process of reviewing the terms of all
material contracts and financial instruments to determine the impact,
6
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
if any, that adoption of SFAS No. 133, as amended, will have on its financial
position or results of operations.
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.
EITF No. 00-14 is effective for calendar year companies in the fourth quarter of
2000 and would be treated as a cumulative effect of an accounting change or
prospectively to new sales incentives offered on or after the effective date.
Prior period financial statements presented for comparative purposes would be
reclassified to comply with the income statement display requirements. RJR's
management has not yet determined the impact that adoption of EITF No. 00-14
will have on its financial position or results of operations.
Comprehensive Income
Total comprehensive income for the three months ended June 30, 2000 and
1999 was $.1 billion and $2.4 billion, respectively. Total comprehensive income
for the six months ended June 30, 2000 and 1999 was $.2 billion and $2.4
billion, 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 six months ended June 30, 2000, $20
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 June 30, 2000 was $15 million. Cash expenditures
related to the termination of employees was $62 million as of June 30, 2000.
Earnings Per Share
The components of the calculation of earnings per share were:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -------------------
2000 1999 2000 1999
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Income (loss) from continuing operations...... $ 109 $ (39) $ 189 $ (9)
Income from discontinued operations........... -- 2,668 -- 2,733
Extraordinary loss............................ -- (250) -- (250)
-------- -------- -------- --------
Net income.................................... $ 109 $ 2,379 $ 189 $ 2,474
======== ======== ======== ========
Basic weighted average shares, in thousands... 101,375 108,703 102,442 108,697
Effect of dilutive potential shares:
Restricted stock......................... 284 -- 156 --
-------- -------- -------- --------
Diluted weighted average shares, in
thousands................................... 101,659 108,703 102,598 108,697
======== ======== ======== ========
</TABLE>
During the three and six months ended June 30, 2000, approximately
1,634,000 outstanding shares of restricted stock were excluded from the basic
share calculation, as the related vesting provisions had not been met.
7
<PAGE> 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 2 -- INVENTORIES
The major components of inventories were:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
<S> <C> <C>
Leaf tobacco............................. $339 $361
Raw materials............................ 25 26
Work in process.......................... 59 48
Finished products........................ 105 105
Other.................................... 22 25
---- ----
$550 $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 second quarter of 2000, 66 new actions were served
against RJR Tobacco and/or its affiliates or indemnitees and 67 actions were
dismissed or otherwise resolved in favor of RJR Tobacco and/or its affiliates or
indemnitees without trial. On June 30, 2000, there were 535 active cases
pending, as compared with 620 on June 30, 1999 and 575 on June 30, 1998. As of
July 24, 2000, 537 active cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 536 in the United States and 1 in the Marshall
Islands. The U.S. case number does not include the 638 Broin II cases pending as
of July 24, 2000, discussed below.
The U.S. cases, exclusive of the 638 Broin II cases, are pending in 39
states and the District of Columbia. The breakdown is as follows: 110 in West
Virginia; 103 in New York; 54 in California; 43 in Florida; 29 in Louisiana; 19
in the District of Columbia; 18 in Texas; 14 in Massachusetts; 11 in each of
Alabama, Iowa and Pennsylvania; 9 in each of Mississippi, New Jersey and
Tennessee; 8 in New Mexico; 7 in Ohio; 6 in each of Illinois, Missouri and
Nevada; 5 in each of Georgia, Minnesota and Wisconsin; 4 in Oklahoma; 3 in each
of Connecticut, Indiana, Michigan, North Dakota and New Hampshire; 2 in each of
Arkansas, Arizona, Kansas, Maryland, South Carolina, South Dakota and
Washington; and 1 in each of Hawaii, Kentucky, Maine, North Carolina and Utah.
Of the 536 active U.S. cases, 137 are pending in federal court, 395 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. Five of the 536 active cases in the United
States, plus the 638 Broin II cases, involve alleged non-smokers claiming
injuries resulting from exposure to environmental tobacco smoke. Forty 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, 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 57 cases seek
8
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
recovery of the cost of Medicaid payments or other health-related costs paid for
treatment of individuals suffering from diseases or conditions allegedly related
to tobacco use. Nine, 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 nine smoking
and health cases in which RJR Tobacco was not a defendant, although, to date, no
damages have been paid and most of the verdicts have been overturned on appeal.
Two non-RJR Tobacco individual cases in which a jury found against a cigarette
manufacturer remain on appeal. In Henley v. Philip Morris, Inc., on February 9,
1999, a San Francisco state court jury awarded an individual smoker $1.5 million
in compensatory damages and $50 million in punitive damages. On April 16, 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 on March 30, 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 every individual smoker case that has gone to
trial except one, Whiteley v. Raybestos-Manhattan, Inc., a tobacco-asbestos
synergy case in which 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. On June 27, 2000, a Brooklyn, New York
state court jury found in favor of RJR Tobacco and other tobacco industry
defendants in Anderson v. Fortune Brands, Inc. Most recently, on July 12, 2000,
a Mississippi state court jury found for RJR Tobacco in Nunnally v. R. J.
Reynolds Tobacco Co.
Broin II Cases. Numerous lawsuits have been filed, mostly 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,
referred to as the Broin II cases. These lawsuits follow the settlement of the
Broin v. Philip Morris, Inc. class action, discussed below, where the industry
agreed (1) to contribute to a fund to research secondhand smoke issues and (2)
that individual lawsuits might be brought on behalf of any or all of the Broin
class members. In these lawsuits, each individual flight attendant will be
required to prove that he or she has a disease caused by exposure to secondhand
smoke in airplane cabins, and is legally entitled to recover damages from one or
more United States cigarette manufacturers, including RJR Tobacco. As of July
24, 2000, approximately 638 such suits were pending against RJR Tobacco.
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 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 and
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.
9
<PAGE> 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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. 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. Most recently, on November 22, 1999, in Thompson v. American
Tobacco Co., a federal district court refused to certify a class seeking smoking
cessation and medical monitoring programs for smokers and former smokers in
Minnesota.
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. Finally, 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.
Classes have remained certified thus far in three 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.
In addition, defendants settled one class-action suit, Broin v. Philip
Morris, Inc., on 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.
Trial in Florida state court in Engle v. R. J. Reynolds Tobacco Co., in
which a class consisting of Florida residents or their survivors who claim to
have diseases or medical conditions caused by their alleged "addiction" to
cigarettes, began in July 1998. 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 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. 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, on July 24, 2000. 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
10
<PAGE> 11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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. The federal court has scheduled a status conference
for August 8, 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
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 July 24, 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, several of 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.
11
<PAGE> 12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
The cash payments made by RJR Tobacco under the MSA and other existing
settlement agreements were approximately $1.1 billion during the six months
ended June 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, similar to the U.S. attorneys' general cases, against RJR Tobacco and
other Canadian and U.S. tobacco companies and their parent companies, including
RJR, in British Columbia Provincial Court. This lawsuit relied heavily upon
recently enacted legislation in British Columbia that is being separately
challenged by 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. On February 21, 2000,
the British Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action.
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. RJR Tobacco is awaiting the court's decision.
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 July 24, 2000, approximately 23
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, Fifth, Seventh and Ninth Circuits have all ruled in favor of the
industry in similar union cases. On January 10, 2000, the United States Supreme
Court denied petitions for certiorari filed in the 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.
12
<PAGE> 13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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. Plaintiffs are appealing this decision to the Appellate
Division of the Supreme Court of New York.
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.
Five groups of health-care insurers, as well as a private entity that
purported to self-insure its employee health-care programs, also have advanced
claims similar to those found in the union health-care cost 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 in 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. Oral argument on questions certified to the Supreme Court of
the State of Minnesota was heard on June 1, 2000. Trial is set for December 1,
2000.
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. 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. Most recently 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 January 5, 2000, a San Diego Superior Court judge dismissed certain
claims in two lawsuits: California v. Philip Morris, Inc., Superior Court, Los
Angeles County, California and California v. Brown & Williamson Tobacco Corp.,
Superior Court, San Francisco County, California. These lawsuits were brought by
the cities of Los Angeles and San Jose, on behalf of the people of California,
who claim that the tobacco industry violated State Proposition 65 by failing to
warn nonsmokers about the State of California's conclusions concerning the
dangers of environmental tobacco smoke. The judge found that the industry had
not violated Proposition 65 and dismissed those claims. The judge did not
dismiss certain other California state law claims. These cases are scheduled for
trial beginning on or about September 25, 2000.
Finally, approximately 175 lawsuits, of which 15 remain pending, have been
filed against RJR Tobacco by asbestos companies and/or asbestos-related trust
funds based on the theory that the plaintiffs "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. One of those cases,
Falise v. American Tobacco Co., was dismissed by the United States District
Court for the Eastern District of New
13
<PAGE> 14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
York on November 2, 1999, due to a lack of subject matter jurisdiction. This
case was refiled on November 11, 1999 and is scheduled for trial after September
1, 2000.
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 filed in the United States District
Court for the District of Columbia, on behalf of an estimated 520,000 tobacco
growers and quota holders in the United States. The complaint alleges that the
major tobacco companies conspired among themselves, and with 14 attorneys
general and one individual, to subvert and undermine the longstanding regulatory
system administered by the U.S. Department of Agriculture, pursuant to federal
statutes and regulations governing the production and sale of cigarette tobacco
in the United States. The suit asserts claims for violations of the Sherman
Antitrust Act, breach of fiduciary duty and fraud. The plaintiffs seek damages,
including treble damages under the antitrust statute, totaling $69 billion.
Recent and Scheduled Trials. As of July 24, 2000, 16 cases are scheduled
for trial before year-end 2000 against RJR Tobacco. Multiple health-care cost
recovery and/or contribution trials are scheduled in 2000 before the United
States District Court for the Eastern District of New York. These include the
Blue Cross and Blue Shield of New Jersey v. Philip Morris, Inc. and Falise v.
American Tobacco Co. cases. Trial in the two related Proposition 65 cases
pending in California is scheduled to begin on or about September 25, 2000. A
putative class action, Blankenship v. Philip Morris, Inc., is scheduled to begin
trial on October 2, 2000, in Wheeling, West Virginia. Two individual cases,
Little v. Brown & Williamson Tobacco Corp., in federal court in South Carolina,
and Seaborn v. R. J. Reynolds Tobacco Co., in state court in Alabama, are
scheduled to begin October 2, 2000 and October 23, 2000, respectively.
Additional cases against other tobacco company defendants also are scheduled for
trial before year-end 2000. Although trial schedules are subject to change and
many cases are dismissed before trial, it is likely that
14
<PAGE> 15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 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. The plaintiff appealed this case to the United
States Court of Appeals on July 28, 2000.
On January 21, 2000, the Republic of Ecuador filed suit against the tobacco
industry in the Circuit Court of Dade County, Florida alleging the industry
engaged in the smuggling of cigarettes to avoid Ecuadorean duties and taxes. RJR
and RJR Tobacco were not served until April 27, 2000. Defendants removed the
case to federal court on May 25, 2000. On June 7, 2000 the case was transferred
to the Judicial Panel on Multidistrict Litigation. On July 10, 2000, the federal
court remanded this action to state court. Defendants are currently appealing
the remand ruling.
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 October 2000.
---------------------
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
15
<PAGE> 16
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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.
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. Finally,
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
16
<PAGE> 17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 defense based on the running of the statute of limitations. This matter is in
its preliminary stage, as information is still being gathered about other
potentially responsible parties not yet known or notified by the EPA.
In December 1998, the EPA proposed regulations that would impose
restrictions on RJR Tobacco's use of certain fumigants used to protect stores of
tobacco from agricultural pests. If finalized in their current form, RJR Tobacco
may be unable to replace those fumigants with other cost-effective fumigants
and, as a result, could be required 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, RJR Tobacco has engaged in discussions with the EPA regarding
modification of the proposed regulations. RJR Tobacco cannot predict whether the
proposed regulations will be modified or the amount of future expenditures that
may be required to comply with these regulations as promulgated in final form.
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
tax payers, 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 of RJR and RJR Tobacco.
17
<PAGE> 18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
NOTE 4 -- STOCKHOLDERS' EQUITY
Changes in stockholders' equity for the six months ended June 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.................... -- -- 189 -- -- -- 189
Total comprehensive
income..................
Dividends declared............ -- (102) (58) -- -- -- (160)
Stock options exercised....... -- 8 -- -- -- -- 8
Restricted stock awarded...... -- 11 -- -- (11) -- --
Restricted stock amortized.... -- -- -- -- 5 -- 5
Restricted stock forfeited.... -- -- -- -- 1 (1) --
Stock repurchased............. -- -- -- -- -- (115) (115)
-- ------ ----- ---- ---- ----- ------
Balance at June 30, 2000...... $1 $7,204 $ -- $(13) $(30) $(171) $6,991
== ====== ===== ==== ==== ===== ======
<CAPTION>
COMPREHENSIVE
INCOME
-------------
<S> <C>
Balance at December 31,
1999........................
Net income.................... $189
----
Total comprehensive
income.................. $189
====
Dividends declared............
Stock options exercised.......
Restricted stock awarded......
Restricted stock amortized....
Restricted stock forfeited....
Stock repurchased.............
Balance at June 30, 2000......
</TABLE>
NOTE 5 -- STOCK PLANS
During the six months ended June 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 market price of the stock on the
grant date was charged to stockholders' equity as unearned compensation, and
will be amortized over the three-year vesting period.
During the quarter ended June 30, 2000, certain key employees exercised
stock options that provided for the issuance of approximately 311,000 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.
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.
18
<PAGE> 19
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 THREE MONTHS ENDED JUNE 30, 2000
Net sales...................................... $ -- $ 2,068 $ 19 $ (2) $2,085
Cost of products sold.......................... -- 845 6 -- 851
Selling, general and administrative expenses... 11 968 (82) -- 897
Tobacco settlement and related expenses........ -- (3) -- -- (3)
Amortization of trademarks and goodwill........ -- 65 26 -- 91
Interest and debt expense...................... 41 2 -- -- 43
Interest income................................ -- (18) (3) -- (21)
Intercompany interest expense (income)......... (2) 98 (96) -- --
Other expense (income), net.................... 7 (355) 2 353 7
------ ------- ------- ------- ------
INCOME (LOSS) BEFORE INCOME TAXES............ (57) 466 166 (355) 220
Provision for (benefit from) income taxes...... (20) 72 54 5 111
Equity income from subsidiaries................ 503 109 -- (612) --
------ ------- ------- ------- ------
NET INCOME................................... $ 466 $ 503 $ 112 $ (972) $ 109
====== ======= ======= ======= ======
FOR THE THREE MONTHS ENDED JUNE 30, 1999
Net sales...................................... $ -- $ 1,921 $ (14) $ -- $1,907
Cost of products sold.......................... -- 848 (19) -- 829
Selling, general and administrative expenses... 18 807 (58) -- 767
Amortization of trademarks and goodwill........ -- 65 26 -- 91
Headquarters close-down and related charges.... 143 -- -- -- 143
Interest and debt expense...................... 77 -- -- -- 77
Interest income................................ (3) (20) (7) -- (30)
Intercompany interest expense (income)......... (154) 185 (31) -- --
Other expense (income), net.................... 41 21 (31) -- 31
------ ------- ------- ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES........................ (122) 15 106 -- (1)
Provision for (benefit from) income taxes...... (23) 36 25 -- 38
Equity income (loss) from subsidiaries from
continuing operations........................ 60 80 -- (140) --
------ ------- ------- ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS..... (39) 59 81 (140) (39)
Income (loss) from discontinued operations, net
of taxes..................................... (606) 5,373 (2,099) -- 2,668
Equity income (loss) from subsidiaries from
discontinued operations...................... 3,274 (2,099) -- (1,175) --
------ ------- ------- ------- ------
NET INCOME (LOSS) BEFORE EXTRAORDINARY
ITEM....................................... 2,629 3,333 (2,018) (1,315) 2,629
Extraordinary item - loss on early
extinguishment of debt, net of income
taxes........................................ (250) -- -- -- (250)
------ ------- ------- ------- ------
NET INCOME (LOSS)............................ $2,379 $ 3,333 $(2,018) $(1,315) $2,379
====== ======= ======= ======= ======
</TABLE>
19
<PAGE> 20
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 SIX MONTHS ENDED JUNE 30, 2000
Net sales...................................... $ -- $3,974 $ 35 $ (2) $4,007
Cost of products sold.......................... -- 1,647 10 -- 1,657
Selling, general and administrative expenses... 17 1,855 (148) -- 1,724
Tobacco settlement and related expenses........ -- (3) -- -- (3)
Amortization of trademarks and goodwill........ -- 130 53 -- 183
Interest and debt expense...................... 84 2 -- -- 86
Interest income................................ -- (41) (4) -- (45)
Intercompany interest expense (income)......... (5) 195 (190) -- --
Other expense (income), net.................... 16 (355) 2 353 16
------ ------ ------- ------- ------
INCOME (LOSS) BEFORE INCOME TAXES.......... (112) 544 312 (355) 389
Provision for (benefit from) income taxes...... (39) 130 107 2 200
Equity income from subsidiaries................ 619 205 -- (824) --
------ ------ ------- ------- ------
NET INCOME................................. $ 546 $ 619 $ 205 $(1,181) $ 189
====== ====== ======= ======= ======
FOR THE SIX MONTHS ENDED JUNE 30, 1999
Net sales...................................... $ -- $3,576 $ 24 $ -- $3,600
Cost of products sold.......................... -- 1,569 2 -- 1,571
Selling, general and administrative expenses... 39 1,546 (137) -- 1,448
Amortization of trademarks and goodwill........ -- 130 53 -- 183
Headquarters close-down and related charges.... 143 -- -- -- 143
Interest and debt expense...................... 182 -- -- -- 182
Interest income................................ (4) (20) (7) -- (31)
Intercompany interest expense (income)......... (387) 421 (34) -- --
Other expense, net............................. 9 21 9 -- 39
------ ------ ------- ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES...................... 18 (91) 138 -- 65
Provision for income taxes..................... 14 23 37 -- 74
Equity income (loss) from subsidiaries from
continuing operations........................ (13) 101 -- (88) --
------ ------ ------- ------- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS... (9) (13) 101 (88) (9)
Income (loss) from discontinued operations, net
of taxes..................................... (577) 5,373 (2,063) -- 2,733
Equity income (loss) from subsidiaries from
discontinued operations...................... 3,310 (2,063) -- (1,247) --
------ ------ ------- ------- ------
NET INCOME (LOSS) BEFORE EXTRAORDINARY
ITEM..................................... 2,724 3,297 (1,962) (1,335) 2,724
Extraordinary item -- loss on early
extinguishment of debt, net of income
taxes........................................ (250) -- -- -- (250)
------ ------ ------- ------- ------
NET INCOME (LOSS).......................... $2,474 $3,297 $(1,962) $(1,335) $2,474
====== ====== ======= ======= ======
</TABLE>
20
<PAGE> 21
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 SIX MONTHS ENDED JUNE 30, 2000
Cash flows from (used in) operating
activities.................................. $ (105) $ 582 $ 299 $(355) $ 421
------- ------ ------- ----- -------
Cash flows from (used in) investing
activities:
Proceeds from maturities of short-term
investments............................... -- 109 1 -- 110
Other investing activities.................. 164 (20) -- (164) (20)
------- ------ ------- ----- -------
Net cash flows from investing
activities.............................. 164 89 1 (164) 90
------- ------ ------- ----- -------
Cash flows from (used in) financing
activities:
Intercompany transfers...................... 239 (285) 46 -- --
Repayments of long-term debt................ (27) -- -- -- (27)
Repurchase of common stock.................. (115) -- -- -- (115)
Dividends paid on common stock.............. (164) (164) (355) 519 (164)
Other, net.................................. 8 -- -- -- 8
------- ------ ------- ----- -------
Net cash flows from (used in) financing
activities.............................. (59) (449) (309) 519 (298)
------- ------ ------- ----- -------
Net change in cash and cash equivalents....... -- 222 (9) -- 213
Cash and cash equivalents at beginning of
period...................................... -- 1,060 117 -- 1,177
------- ------ ------- ----- -------
Cash and cash equivalents at end of period.... $ -- $1,282 $ 108 $ -- $ 1,390
======= ====== ======= ===== =======
FOR THE SIX MONTHS ENDED JUNE 30, 1999
Cash flows from operating activities.......... $ 119 $ 345 $ 246 $ -- $ 594
------- ------ ------- ----- -------
Cash flows from (used in) investing
activities:
Net proceeds from the sale of the
international tobacco business............ (35) 2,611 5,220 -- 7,796
Other, net.................................. -- (20) -- -- (20)
------- ------ ------- ----- -------
Net cash flows from (used in) investing
activities.............................. (35) 2,591 5,220 -- 7,776
------- ------ ------- ----- -------
Cash flows from (used in) financing
activities:
Proceeds from issuance of long-term debt.... 1,244 -- -- -- 1,244
Repayment of long-term debt................. (4,450) -- -- -- (4,450)
Transfer and payments to former parent...... (2,077) -- -- -- (2,077)
Intercompany transfers...................... 5,221 (763) (4,458) -- --
Other, net.................................. (56) -- -- -- (56)
------- ------ ------- ----- -------
Net cash flows used in financing
activities.............................. (118) (763) (4,458) -- (5,339)
------- ------ ------- ----- -------
Cash flows related to discontinued
operations.................................. -- -- -- -- 116
------- ------ ------- ----- -------
Net change in cash and cash equivalents....... (34) 2,173 1,008 -- 3,147
Cash and cash equivalents at beginning of
period...................................... 40 (40) -- -- --
------- ------ ------- ----- -------
Cash and cash equivalents at end of period.... $ 6 $2,133 $ 1,008 $ -- $ 3,147
======= ====== ======= ===== =======
</TABLE>
21
<PAGE> 22
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>
JUNE 30, 2000
ASSETS
Cash and cash equivalents..................... $ -- $ 1,282 $ 108 $ -- $ 1,390
Other current assets.......................... 64 1,807 64 (742) 1,193
Trademarks, net............................... -- -- 3,017 -- 3,017
Goodwill, net................................. -- 7,433 -- -- 7,433
Intercompany note receivable.................. 140 31 4,788 (4,959) --
Investment in subsidiaries.................... 10,511 6,469 -- (16,980) --
Other noncurrent assets....................... 62 1,193 5 -- 1,260
------- ------- ------ -------- -------
Total assets......................... $10,777 $18,215 $7,982 $(22,681) $14,293
======= ======= ====== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities........................... $ 1,403 $ 2,456 $ 76 $ (740) $ 3,195
Intercompany note payable..................... 48 4,524 387 (4,959) --
Long-term debt (less current maturities)...... 1,600 -- -- -- 1,600
Other noncurrent liabilities.................. 732 723 1,052 -- 2,507
Stockholders' equity.......................... 6,994 10,512 6,467 (16,982) 6,991
------- ------- ------ -------- -------
Total liabilities and stockholders'
equity............................. $10,777 $18,215 $7,982 $(22,681) $14,293
======= ======= ====== ======== =======
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 note 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
Current liabilities........................... $ 1,155 $ 2,365 $ 31 $ (483) $ 3,068
Intercompany note 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>
22
<PAGE> 23
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, RJR Acquisition Corp. will
merge with and into NGH, and NGH will become a wholly owned subsidiary of RJR.
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.
The transaction is contingent upon NGH stockholder approval, regulatory
review and approval and the successful completion of the sale of NGH's 80.5%
interest in Nabisco to Philip Morris Companies, Inc. for approximately $11.8
billion in cash. The acquisition is expected to close early in the fourth
quarter of 2000.
NOTE 8 -- SUBSEQUENT EVENT
During July 2000, RJR repurchased 390,000 shares of its common stock with a
total cost of approximately $11 million under its existing authorization of $225
million, resulting in cumulative repurchases of 8,642,139 shares with a total
cost of approximately $181 million as of July 31, 2000.
23
<PAGE> 24
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
2000 1999 2000 1999
------- ------- ------ ------
<S> <C> <C> <C> <C>
Net sales.................................. $2,085 $1,907 $4,007 $3,600
Cost of products sold (*).................. 851 829 1,657 1,571
Selling, general and administrative
expenses................................. 897 767 1,724 1,448
Tobacco settlement and related expenses.... (3) -- (3) --
------ ------ ------ ------
Operating company contribution............. $ 340 $ 311 $ 629 $ 581
====== ====== ====== ======
</TABLE>
---------------
(*) $591 million and $563 million of ongoing settlement expense was recorded in
cost of products sold for the three months ended June 30, 2000 and 1999,
respectively, and $1.1 billion was recorded during each of the six-month
periods ended June 30, 2000 and 1999. Tobacco settlement and related
expenses include only initial, up-front tobacco settlement and other related
expenses.
Net sales of $2.1 billion and $4 billion for the three months and six
months ended June 30, 2000 increased 9.3% and 11.3%, respectively, from the
comparable prior-year periods. The increase in both comparative periods was
primarily driven by favorable pricing of $217 million for the second quarter and
$392 million for the six- month period resulting from price increases in 1999
and early 2000, primarily in response to litigation settlements. Volume declines
adversely impacted net sales by $38 million in the second quarter. However,
increased volume impacted net sales $13 million favorably for the six-month
period. RJR Tobacco's total shipment volume during the quarter ended June 30,
2000 of 24.6 billion units, excluding Puerto Rico and certain other U.S.
territories' volume of approximately .3 billion units, decreased 1.8% from the
quarter ended June 30, 1999, while industry volume increased 1.4%. Shipment
volume, excluding Puerto Rico shipments, increased 0.4% during the first six
months of 2000 versus the prior-year period, while industry shipments increased
2.9% impacted by wholesale and retail buying patterns. Preliminary analysis
indicates that consumption for RJR Tobacco, and the industry, declined during
the first six months of 2000 compared to the prior-year period. Consumption is
expected to continue to decline through 2000, resulting in lower shipments for
RJR Tobacco, and the industry, compared to last year.
RJR Tobacco's full-price shipments represented 63.4% and 62.2% of total
shipments for the quarters ended June 30, 2000 and 1999, respectively, and 62.9%
and 62.1% in the six months ended June 30, 2000 and 1999, respectively.
Industry-wide, full-price shipments represented 73.5% and 73.1% of total
shipments for the quarters ended June 30, 2000 and 1999, respectively, and 73.7%
and 73.5% for the six months ended June 30, 2000 and 1999, respectively.
Shipment volume for CAMEL, excluding the non-filter style, was up 12.7% during
the quarter ended June 30, 2000 compared to the second quarter of 1999, which
significantly outperformed the industry full-price increase of 2.0%. CAMEL
shipment volume, excluding the non-filter style, was up 11.5% for the six months
ended June 30, 2000 versus the 1999 period, while the industry full-price
increase was 3.3%. CAMEL shipment volume was supported by the "Pleasure to Burn"
advertising program, the CML magalog, new specialty product promotions and, most
recently, the Turkish Gold line extension. Shipments of WINSTON's base styles
decreased 3.8% and 0.5% during the three- and six-month periods ended June 30,
2000, respectively, from the prior-year periods. New ads featuring WINSTON's
"First Cut" tobacco and emphasizing the brand's "No Bull," straight-up
positioning were introduced in the second quarter 2000. SALEM shipments were
down 3.3% and 1.5% for the three- and six-month periods ended June 30, 2000,
respectively, compared to the prior-year periods due to increased competitive
activity in the menthol segment. Shipment volume for DORAL, the
24
<PAGE> 25
industry's leading savings brand, decreased 5.0% and 1.0% during the three- and
six-month periods ended June 30, 2000, respectively, from the prior-year
periods. DORAL's performance reflected a widening price gap versus deep-discount
brands. Consistent with DORAL's disciplined discounting strategy, the brand is
refining in-store promotional efforts in order to remain competitive. DORAL's
product improvement of being "Packed Tighter to Burn Slower" as well as its
"Imagine Getting More" advertising campaign continue to differentiate it from
other savings brands.
RJR Tobacco's retail share of market averaged 23.08% during the second
quarter of 2000, a decline of 0.41 share points from the first quarter of 2000.
Compared to the second quarter of 1999, RJR Tobacco's share fell 0.87 share
points.
CAMEL, RJR Tobacco's largest full price brand, continued to show strong
growth. Retail share of market on CAMEL's non-filtered styles grew 0.05 share
points compared to the first quarter of 2000 and was up 0.32 share points to
4.95% in the most recent quarter versus the second quarter of 1999. As discussed
above, CAMEL has continued to introduce innovative marketing programs with
strong appeal among competitive adult smokers.
Base WINSTON's and SALEM's recent share performance has been impacted by
more aggressive competitive promotion levels. Base WINSTON's share averaged
4.60% in the second quarter, down slightly from its first quarter share of 4.75%
and the brand's 1999 second quarter share of 4.78%. SALEM's share averaged 3.02%
in the most recent quarter compared to 3.06% in the first quarter of 2000 and
3.17% in the second quarter of 1999. SALEM's share in the markets where the
brand has been fully repositioned has been essentially stable for the most
recent 12 months.
DORAL's retail share of market was 6.05% for the three months ending June
2000, down from 6.27% in the first quarter of 2000 and 6.43% in the second
quarter of 1999. As pointed out earlier, the declines were due to an increase in
the pricing advantage held by deep discount brands. Steps are being taken to
address the retail competitive disadvantage experienced by DORAL, WINSTON and
SALEM in recent months.
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 in inconclusive, ECLIPSE may present smokers with less
risk of cancer, chronic bronchitis and possibly emphysema when compared to other
cigarettes. RJR is continuing to evaluate the test market results.
Cost of products sold of $851 million in the second quarter of 2000
increased $22 million from the second quarter of 1999, primarily due to an
increase of $28 million in ongoing settlement costs partly offset by decreased
volume. Cost of products sold of $1.7 billion in the first six months of 2000
increased $86 million from 1999, primarily due to an increase of $73 million in
ongoing settlement costs.
Selling, general and administrative expenses of $897 million for the second
quarter of 2000 increased $130 million from the comparable prior-year quarter.
For the first six months of 2000, selling, general and administrative expenses
of $1.7 billion increased $276 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, partially offset by lower corporate
expense.
Up-front tobacco settlement and related expenses 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.
Operating company contribution increased 9.3% to $340 million for the
second quarter of 2000 and increased 8.3% to $629 million for the first six
months of 2000 when compared to the prior-year periods. These increases are
primarily due to the factors discussed above.
25
<PAGE> 26
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 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 of $43 million in the second quarter of 2000
decreased $34 million from the second quarter of 1999. For the first six months
of 2000, interest and debt expense of $86 million decreased $96 million from the
comparable prior-year period. The decrease in both periods 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 $9 million for the three-month period ended June
30, 2000, compared to the prior-year period, primarily reflecting the use of the
approximately $4 billion net pre-tax proceeds from the sale of the international
tobacco business in the second quarter of 1999. Interest income increased $14
million in the six-month period ended June 30, 2000 from the comparative period
primarily due to higher cash balances during the first quarter of 2000 in
anticipation of the 2000 MSA settlement payments. See note 1 and note 3 to the
condensed consolidated financial statements.
Other expense, net decreased $24 million and $23 million for the quarter
and six-month period ended June 30, 2000, respectively, from the comparable
prior-year periods. These decreases are 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 $111 million, or an effective rate
of 50.5%, in the second quarter of 2000 compared to $38 million recorded in the
second 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 six-month periods ended June 30,
1999 included after-tax income of $20 million and $85 million, respectively,
related to the operations of the international tobacco business and Nabisco, as
well as the $2.6 billion gain on the sale of the international tobacco business
in May of 1999, partially offset by the $322 million loss on the recognition of
Nabisco's cumulative translation adjustment account. See note 1 to the condensed
consolidated financial statements.
An extraordinary loss of approximately $384 million, $250 million
after-tax, was incurred during the three months ended June 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 to fund its share repurchase program. 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.
26
<PAGE> 27
Cash Flows
Net cash flows from operating activities of $421 million in the first six
months of 2000 decreased $173 million from the prior-year period. This decrease
primarily reflects an increase in cash payments of tobacco settlements partially
offset by increased pricing.
Net cash flows from investing activities of $90 million in the first six
months of 2000 decreased $7.7 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.
Cash flows used in financing activities of $298 million in the first six
months of 2000 decreased $5 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 six months ended June 30, 1999.
Since November 1999, RJR's board of directors has authorized the repurchase
of shares of its common stock from time to time in the open market, with a
maximum cost of $225 million, funded by cash flows from operations, for the
purpose of enhancing stockholder value. The timing of repurchases and the number
of shares repurchased will depend upon market conditions. During the first six
months of 2000, RJR repurchased 5,524,739 shares of its common stock with a
total cost of $115 million, resulting in total repurchases of 8,252,139 shares
with a total cost of $170 million since November 1999. As of July 31, 2000, RJR
had repurchased a cumulative total of 8,642,139 shares with a total cost of $181
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 full 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, some of its other
subsidiaries will also have 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 June
30, 2000, RJR had $390 million in letters of credit and no borrowings
outstanding, with the remaining $845 million of the facility available for
borrowing. RJR was in compliance with the covenants of the facility at June 30,
2000. Additionally, as of June 30, 2000, RJR had letters of credit outstanding
of approximately $3 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 June 30, 2000.
As of June 30, 2000, RJR also had $344 million of foreign currency debt,
with fixed interest rates between 5.375% and 6.875%, due in 2000, and $423
million of public notes, at fixed interest rates of 6.8% through 10%, due in
2000 through 2013.
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<PAGE> 28
Dividends
On April 19, 2000, RJR's board of directors declared a quarterly cash
dividend of $.775 per common share payable on July 3, 2000 to stockholders of
record as of June 9, 2000.
Capital Expenditures
Capital expenditures were $24 million and $20 million for the six months
ended June 30, 2000 and 1999, respectively. To support its strategic and
operating needs, RJR Tobacco plans to spend in the range of $50 million to $60
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 June 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 six
months ended June 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
28
<PAGE> 29
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
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 June 2000, the Federal Aviation Administration banned smoking on all
airline flights between the United States and other countries. Federal law
already prohibits smoking on all domestic airline flights.
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. Both the manufacturers
and the state are now seeking summary judgment from the District Court. The case
has been briefed and argued.
In 1997, Texas enacted legislation very similar to the Massachusetts law,
except that the Texas statute authorized confidentiality of trade secrets. RJR
Tobacco filed a confidential disclosure of ingredients for its brands with the
Texas Department of Health during the second quarter of 2000 in compliance with
regulations established by the state.
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 have 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, and the manufacturers are awaiting
revised proposed regulations.
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. RJR Tobacco is considering an appeal to the
Supreme Court of the United States.
29
<PAGE> 30
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 the California legislature.
A price differential exists between cigarettes manufactured for sale abroad
and cigarettes manufactured for U.S. sale, and 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 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, RJR Acquisition Corp. will
merge with and into NGH, and NGH will become a wholly owned subsidiary of RJR.
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.
The transaction is contingent upon NGH stockholder approval, regulatory
review and approval and the successful completion of the sale of NGH's 80.5%
interest in Nabisco to Philip Morris Companies, Inc. for approximately $11.8
billion in cash. The acquisition is expected to close early in the fourth
quarter of 2000.
RECENTLY ISSUED AND PROPOSED ACCOUNTING PRONOUNCEMENTS
During the second quarter of 1998, the Financial Accounting Standards Board
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
30
<PAGE> 31
2000, the FASB issued SFAS No. 138, which amended SFAS No. 133. RJR's management
is in the process of reviewing the terms of all material contracts and financial
instruments to determine the impact, if any, that adoption of SFAS No. 133, as
amended, will have on its financial position or results of operations.
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.
EITF No. 00-14 is effective for calendar year companies in the fourth quarter of
2000 and would be treated as a cumulative effect of an accounting change or
prospectively to new sales incentives offered on or after the effective date.
Prior period financial statements presented for comparative purposes would be
reclassified to comply with the income statement display requirements. RJR's
management has not yet determined the impact that adoption of EITF No. 00-14
will have 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
June 30, 2000.
31
<PAGE> 32
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 second quarter of 2000, 66 new actions were served
against RJR Tobacco and/or its affiliates or indemnitees and 67 actions were
dismissed or otherwise resolved in favor of RJR Tobacco and/or its affiliates or
indemnitees without trial. On June 30, 2000, there were 535 active cases
pending, as compared with 620 on June 30, 1999 and 575 on June 30, 1998. As of
July 24, 2000, 537 active cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 536 in the United States and 1 in the Marshall
Islands. The U.S. case number does not include the 638 Broin II cases pending as
of July 24, 2000, discussed below.
The U.S. cases, exclusive of the 638 Broin II cases, are pending in 39
states and the District of Columbia. The breakdown is as follows: 110 in West
Virginia; 103 in New York; 54 in California; 43 in Florida; 29 in Louisiana; 19
in the District of Columbia; 18 in Texas; 14 in Massachusetts; 11 in each of
Alabama, Iowa and Pennsylvania; 9 in each of Mississippi, New Jersey and
Tennessee; 8 in New Mexico; 7 in Ohio; 6 in each of Illinois, Missouri and
Nevada; 5 in each of Georgia, Minnesota and Wisconsin; 4 in Oklahoma; 3 in each
of Connecticut, Indiana, Michigan, North Dakota and New Hampshire; 2 in each of
Arkansas, Arizona, Kansas, Maryland, South Carolina, South Dakota and
Washington; and 1 in each of Hawaii, Kentucky, Maine, North Carolina and Utah.
Of the 536 active U.S. cases, 137 are pending in federal court, 395 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.
For additional information about litigation and legal proceedings, see note
3 to the condensed consolidated financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Governmental Activity" in Part I -- Financial Information.
---------------------
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. 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 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> 33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of RJR was held on April 19, 2000, in
Winston-Salem, NC, at which the following matters were submitted to a vote of
the stockholders:
(a) Votes regarding the election of three Class I directors of RJR for a term
expiring in 2003 were:
<TABLE>
<CAPTION>
NAME FOR WITHHELD
---- ---------- --------
<S> <C> <C>
Mary K. Bush 96,900,350 565,441
John T. Chain, Jr. 96,896,409 569,382
Thomas C. Wajnert 96,912,153 553,638
</TABLE>
Additional directors, whose terms of office as directors continued after
the meeting were:
<TABLE>
<CAPTION>
CLASS II DIRECTORS -- CLASS III DIRECTORS --
TERM EXPIRING IN 2001 TERM EXPIRING IN 2002
--------------------- ----------------------
<S> <C>
A. D. Frazier, Jr. Denise Ilitch Andrew
John G. Medlin, Jr. J. Schindler
Nana Mensah Joseph P. Viviano
</TABLE>
(b) Votes regarding the approval of the R.J. Reynolds Tobacco Holdings, Inc.
1999 Long-Term Incentive Plan were:
<TABLE>
<CAPTION>
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
---------- ---------- ----------- ----------------
<S> <C> <C> <C>
91,797,839 5,444,628 223,324 --
</TABLE>
(c) Votes regarding ratification of appointment of KPMG LLP as independent
auditors for fiscal year 2000 were:
<TABLE>
<CAPTION>
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
---------- ---------- ----------- ----------------
<S> <C> <C> <C>
96,771,279 594,469 100,043 --
</TABLE>
(d) Votes regarding the stockholder proposal on tobacco advertising and youth
were:
<TABLE>
<CAPTION>
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
---------- ---------- ----------- ----------------
<S> <C> <C> <C>
4,028,388 72,634,580 6,761,572 14,041,251
</TABLE>
(e) Votes regarding the stockholder proposal on youth access to tobacco products
were:
<TABLE>
<CAPTION>
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
---------- ---------- ----------- ----------------
<S> <C> <C> <C>
3,900,315 73,885,091 5,639,134 14,041,251
</TABLE>
33
<PAGE> 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
2.1 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.
10.1 Third Amendment and Consent to the Credit Agreement dated as
of July 17, 2000, among R.J. Reynolds Tobacco Holdings, Inc.
and the lending institutions party to the Credit Agreement.
10.2 Amendment to Tax Sharing Agreement dated June 25, 2000,
among Nabisco Group Holdings Corp., R.J. Reynolds Tobacco
Holdings, Inc., Nabisco Holdings Corp. and R.J. Reynolds
Tobacco Company.
10.3 Amendment effective as of June 14, 1999, to the Agreement
effective as of May 20, 1999, by and among the Pension
Benefit Guaranty Corporation, R.J. Reynolds Tobacco
Holdings, Inc. and R.J. Reynolds Tobacco Company.
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 Six Months ended June 30,
2000.
27.2 Financial Data Schedule for the Six Months ended June 30,
1999.
</TABLE>
(B) REPORTS ON FORM 8-K
During the quarter ended June 30, 2000, RJR filed no reports on Form 8-K.
34
<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: August 7, 2000
35
<PAGE> 36
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
<C> <S>
2.1 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.
10.1 Third Amendment and Consent to the Credit Agreement dated as
of July 17, 2000, among R.J. Reynolds Tobacco Holdings, Inc.
and the lending institutions party to the Credit Agreement.
10.2 Amendment to Tax Sharing Agreement dated June 25, 2000,
among Nabisco Group Holdings Corp., R.J. Reynolds Tobacco
Holdings, Inc., Nabisco Holdings Corp. and R.J. Reynolds
Tobacco Company.
10.3 Amendment effective as of June 14, 1999, to the Agreement
effective as of May 20, 1999, by and among the Pension
Benefit Guaranty Corporation, R.J. Reynolds Tobacco
Holdings, Inc. and R.J. Reynolds Tobacco Company.
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 Six Months ended June 30,
2000.
27.2 Financial Data Schedule for the Six Months ended June 30,
1999.
</TABLE>
