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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
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COMMISSION FILE NUMBER: 1-6388
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-0950247
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
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: 103,384,750 shares of common
stock, par value $.01 per share, as of April 30, 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 Months Ended March 31, 2000 and 1999.... 3
Condensed Consolidated Statements of Cash Flows
(Unaudited) - Three Months Ended March 31, 2000 and 1999.... 4
Condensed Consolidated Balance Sheets - March 31, 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 20
and Results of Operations...................................
Item 3. Quantitative and Qualitative Disclosures About Market 26
Risk........................................................
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................... 27
Item 6. Exhibits and Reports on Form 8-K............................ 28
Signature............................................................ 29
</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
MONTHS ENDED
MARCH 31,
---------------
2000 1999
------ ------
<S> <C> <C>
NET SALES*.................................................. $1,922 $1,693
Costs and expenses:
Cost of products sold*.................................... 820 753
Selling, general and administrative expenses.............. 813 670
Amortization of trademarks and goodwill................... 92 92
------ ------
OPERATING INCOME....................................... 197 178
Interest and debt expense................................... 43 105
Interest income............................................. (24) (1)
Other expense, net.......................................... 9 8
------ ------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES................................................. 169 66
Provision for income taxes.................................. 89 36
------ ------
INCOME FROM CONTINUING OPERATIONS...................... 80 30
Discontinued operations:
Income from operations of discontinued businesses, net of
income taxes........................................... - 65
------ ------
NET INCOME............................................. $ 80 $ 95
====== ======
BASIC INCOME PER SHARE:
Income from continuing operations......................... $ .77 $ .28
Income from discontinued operations....................... - .60
------ ------
Net income............................................. $ .77 $ .88
====== ======
DILUTED INCOME PER SHARE:
Income from continuing operations......................... $ .77 $ .28
Income from discontinued operations....................... - .60
------ ------
Net income............................................. $ .77 $ .88
====== ======
DIVIDENDS DECLARED PER SHARE................................ $ .775 $ -
====== ======
</TABLE>
- ---------------------
* Excludes excise taxes of $391 million and $260 million for the three months
ended March 31, 2000 and 1999, respectively.
See Notes to Condensed Consolidated Financial Statements
3
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R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
MARCH 31,
----------------
2000 1999
------ -----
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income................................................ $ 80 $ 95
Less income from discontinued operations.................. - 65
------ -----
Subtotal............................................... 80 30
------ -----
Adjustments to reconcile to net cash flows from (used in)
continuing operating activities:
Depreciation and amortization.......................... 122 121
Deferred income tax benefit............................ (5) (46)
Changes in other working capital items, net............ 68 (45)
Tobacco settlement and related expenses................ 387 191
Other, net............................................. 3 (3)
------ -----
Total adjustments................................. 575 218
------ -----
Net cash flows from continuing operating activities.... 655 248
Net cash flows used in discontinued operations............ - (171)
------ -----
Net cash flows from operating activities.................. 655 77
------ -----
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Proceeds from maturities of short-term investments........ 110 -
Capital expenditures...................................... (11) (10)
Other, net................................................ 2 -
------ -----
Net cash flows from (used in) investing activities..... 101 (10)
------ -----
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Repayments of long-term debt.............................. (23) -
Decrease in short-term borrowing.......................... - (62)
Repurchase of common stock................................ (70) -
Dividends paid on common stock............................ (84) -
------ -----
Net cash flows used in financing activities............ (177) (62)
------ -----
Net change in cash and cash equivalents................ 579 5
Cash and cash equivalents at beginning of period............ 1,177 -
------ -----
Cash and cash equivalents at end of period.................. $1,756 $ 5
====== =====
Income taxes paid, net of refunds........................... $ 17 $ -
Interest paid............................................... $ 13 $ 125
Tobacco settlement and related expense payments............. $ 166 $ 316
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
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R.J. REYNOLDS TOBACCO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,756 $ 1,177
Short-term investments.................................... - 110
Accounts and notes receivable, net........................ 83 84
Inventories............................................... 550 565
Deferred income taxes..................................... 435 437
Prepaid excise taxes and other............................ 103 95
------- -------
Total current assets.............................. 2,927 2,468
Property, plant and equipment, net.......................... 1,068 1,080
Trademarks, net............................................. 3,043 3,070
Goodwill, net............................................... 7,498 7,563
Other assets and deferred charges........................... 193 196
------- -------
$14,729 $14,377
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 60 $ 81
Tobacco settlement and related accruals................... 1,665 1,278
Accrued liabilities....................................... 1,273 1,273
Current maturities of long-term debt...................... 364 387
Income taxes accrued...................................... 126 49
------- -------
Total current liabilities......................... 3,488 3,068
Long-term debt (less current maturities).................... 1,653 1,653
Long-term retirement benefits............................... 677 676
Deferred income taxes....................................... 1,623 1,630
Other noncurrent liabilities................................ 292 286
Commitments and contingencies
Stockholders' equity:
Common stock (shares issued: 110,301,454 in 2000 and
109,631,397 in 1999)................................... 1 1
Paid-in capital........................................... 7,218 7,287
Retained earnings (accumulated deficit)................... (51) (131)
Accumulated other comprehensive income (loss):
Cumulative minimum pension liability adjustment........ (13) (13)
Other stockholders' equity................................ (33) (25)
------- -------
7,122 7,119
Treasury stock, at cost (shares: 6,394,524 in 2000 and
2,728,630 in 1999)..................................... (126) (55)
------- -------
Total stockholders' equity........................ 6,996 7,064
------- -------
$14,729 $14,377
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5
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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 period ended March 31, 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 period's 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 months ended March 31, 1999, operating results of the
discontinued operations included net sales of $2.528 billion and a provision for
income taxes of $48 million.
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 must adopt SFAS No. 133 no later than 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. On March 3, 2000, the FASB issued a proposed
SFAS, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which would amend SFAS No. 133. The proposed amendment addresses
certain implementation issues. RJR's management is evaluating the impact, if
any, that adoption of SFAS No. 133 will have on its financial position or
results of operations.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
Comprehensive Income
Total comprehensive income (loss) for the three months ended March 31, 2000
and 1999 was $80 million and $(11) million, respectively. Total comprehensive
income includes net income (loss), foreign currency translation adjustments and
minimum pension liability adjustments.
Tobacco Settlement and Related Expenses
During 1998, RJR Tobacco recorded pre-tax charges totaling $1.442 billion
for tobacco settlement and related expenses. During the three months ended March
31, 2000, $12 million of this reserve was utilized for employee severance and
related benefits, resulting in a remaining reserve balance of $26 million. Cash
expenditures related to the termination of employees are expected to be
approximately $80 million, of which $54 million was paid as of March 31, 2000.
Earnings Per Share
The components of the calculation of earnings per share were:
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
MARCH 31,
-------------------
2000 1999
-------- --------
<S> <C> <C>
Income from continuing operations........................... $ 80 $ 30
Income from discontinued operations......................... - 65
-------- --------
Net income.................................................. $ 80 $ 95
======== ========
Weighted average shares, in thousands, used in:
Basic earnings per share.................................. $103,510 $108,691
Effect of dilutive potential shares:
Restricted stock..................................... 26 -
-------- --------
Diluted earnings per share................................ $103,536 $108,691
======== ========
</TABLE>
During the three months ended March 31, 2000, approximately 1,631,000
outstanding shares of restricted stock were excluded from the share calculation,
as the related vesting provisions had not been met.
NOTE 2 - INVENTORIES
The major components of inventories were:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
--------- ------------
<S> <C> <C>
Leaf tobacco................................................ $344 $361
Raw materials............................................... 25 26
Work in process............................................. 52 48
Finished products........................................... 106 105
Other....................................................... 23 25
---- ----
$550 $565
==== ====
</TABLE>
7
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 first quarter of 2000, 52 new actions were served
against RJR Tobacco and/or its affiliates or indemnitees, and 57 actions were
dismissed or otherwise resolved in favor of RJR Tobacco and/or its affiliates or
indemnitees without trial. On March 31, 2000, there were 536 active cases
pending, as compared with 647 on March 31, 1999 and 550 on March 31, 1998. As of
April 26, 2000, 533 active cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 532 in the United States; and 1 in the Marshall
Islands. The U.S. case number does not include the 624 Broin II cases pending as
of April 26, 2000, discussed below.
The U.S. cases, exclusive of the 624 Broin II cases, are pending in 40
states and the District of Columbia. The breakdown is as follows: 109 in West
Virginia; 104 in New York; 53 in California; 40 in Florida; 36 in Massachusetts;
27 in Louisiana; 17 in the District of Columbia; 16 in Texas; 10 in each of
Alabama and Mississippi; 9 in Iowa; 8 in each of New Jersey and New Mexico; 7 in
Pennsylvania; 6 in each of Nevada and Tennessee; 5 in each of Georgia, Illinois,
Minnesota, Missouri and Ohio; 4 in South Dakota; 3 in each of Indiana, Michigan,
North Dakota and Wisconsin; 2 in each of Arkansas, Arizona, Connecticut, Kansas,
Maryland, New Hampshire, Oklahoma, Rhode Island, South Carolina and Washington;
1 in each of Hawaii, Kentucky, Maine, North Carolina and Utah. Of the 532 active
U.S. cases, 137 are pending in federal court, 390 in state court and 5 in tribal
court. Most of these cases were brought by individual plaintiffs, but many other
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. Fifteen of the 532 active cases in the United
States, plus the 624 Broin II cases, involve alleged non-smokers claiming
injuries resulting from exposure to environmental tobacco smoke. Thirty-three
cases purport to be class actions on behalf of thousands of individuals.
Purported classes include individuals claiming to be addicted to cigarettes,
individuals and their estates claiming illness and death from cigarette smoking,
persons making claims based on alleged exposure to environmental tobacco smoke,
African-American smokers claiming their civil rights have been violated by the
sale of menthol cigarettes, 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 52 cases seek
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
8
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
cigarette manufacturer remain on appeal. In Henley v. Philip Morris, Inc., a San
Francisco state court jury awarded an individual smoker $1.5 million in
compensatory damages and $50 million in punitive damages. On April 16, 1999, the
trial judge reduced the punitive damages award to $25 million, but otherwise
denied Philip Morris' motions. 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 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 post-trial motions and will appeal if those motions are unsuccessful.
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 to contribute to a fund to research secondhand smoke issues, and 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 that they are legally entitled to recover damages from one
or more United States cigarette manufacturers, including RJR Tobacco. As of
April 26, 2000, approximately 624 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. 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 are
the legal survivors of those persons.
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, eight out of 12 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.
Finally, 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.
9
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
Plaintiffs have been successful thus far in four state court class-action
cases. In Richardson v. Philip Morris, Inc., a Maryland state court granted
class certification in 1998. The Maryland Court of Appeals reheard argument on
this issue on April 6, 2000. All activity in this case is stayed pending the
court's decision. In addition, on November 5, 1998, 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, Scott v. American Tobacco Co. 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 January 15, 2001. Finally, 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 continues 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 has been certified. The trial is 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. The trial court
has ordered that the jury shall determine punitive damages, if any, on a
class-wide basis. The punitive damages portion of the second phase is scheduled
to begin May 15, 2000, and is expected to last several weeks. The third phase
will address all other class members' claims in individual trials before
separate juries.
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,
at the end of the second phase the court could enter a judgment for punitive
damages on behalf of the entire class in an amount not capable of being bonded,
resulting in the possible execution of the judgment before it could 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.
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, but does not affect the underlying verdict,
pending appeal. As of May 9, 2000, similar legislation was being considered in
Florida.
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
10
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 April 26, 2000, final
approval had been achieved in 47 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.
The cash payments made by RJR Tobacco under the MSA and other existing
settlement agreements were approximately $166 million during the three months
ended March 31, 2000 and $1.6 billion in 1999. RJR Tobacco estimates those
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 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. Oral argument on the motion is currently
scheduled for June 2, 2000.
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 April 26, 2000, approximately 24
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 participants' union members and their dependents allegedly injured by
cigarettes. The claims in these cases are almost identical, and approximately
seven of the cases 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
11
<PAGE> 12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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.
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, six in tribal courts 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
plaintiffs' lawsuit. Plaintiffs have appealed this ruling to the United States
Court of Appeals for the Ninth Circuit.
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.
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. Most
recently, on December 14, 1999, a federal district court in Washington dismissed
a similar case, Association of Washington Public Hospital Districts v. Philip
Morris, Inc. Plaintiffs have appealed this ruling to the United States Court of
Appeals for the Ninth Circuit.
On 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
12
<PAGE> 13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 did not dismiss
certain other California state law claims.
Finally, approximately 175 lawsuits, of which 17 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 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 on July 5, 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.
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. 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.
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 violation of Section 2 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 April 26, 2000, 18 cases are scheduled
for trial before year-end 2000 against RJR Tobacco. On May 1, 2000, final jury
selection began in an individual smoker case in state court in Brooklyn, New
York, in which RJR Tobacco is a defendant, Anderson v. Fortune Brands, Inc. This
case is expected to last five to seven weeks. In addition, the Engle case in
Florida continues, and multiple health-care cost recovery and/or contribution
trials are scheduled in 2000 before Judge Weinstein of the United States
District Court for the Eastern District of New York. A putative class action is
scheduled to begin trial on October 2, 2000 in West Virginia, Blankenship v.
Philip Morris, Inc. The class certification hearing in that case is scheduled
for July 17, 2000. Additional cases against other tobacco company defendants are
also 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
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.
13
<PAGE> 14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
Other Developments. RJR Tobacco is aware of a grand jury investigation
being conducted in North Carolina that relates to the cigarette business of its
former affiliates. In connection with this investigation, RJR Tobacco responded
to a document subpoena dated July 7, 1999.
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 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
is underway.
---------------------
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. There has been a number of political, legislative, regulatory and other
developments relating to the tobacco industry and cigarette smoking that have
received wide media attention, the various litigation settlements and the
release and wide availability of various industry documents referred to above.
These developments may negatively affect the outcomes of tobacco-related legal
actions and encourage the commencement of additional similar litigation.
Although it is impossible to predict the outcome of such events on pending
litigation and the rate at which new lawsuits are filed against RJR Tobacco and
RJR, a significant increase in litigation and/or in adverse outcomes for tobacco
defendants could have an adverse effect on either or both of these entities. RJR
Tobacco and RJR each believe that they have a number of valid defenses to any
such actions and intend to defend such 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 the
financial condition of RJR could be materially affected by the ultimate outcome
of certain pending litigation matters, including bonding and litigation costs.
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.
14
<PAGE> 15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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.
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
15
<PAGE> 16
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(CONTINUED)
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 notably
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 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 against in connection with the matters
prescribed in the preceding outcome, a significant adverse outcome regarding any
of these items could have an adverse effect on either or both of RJR and RJR
Tobacco.
NOTE 4 - STOCK PLANS
On February 2, 2000, RJR granted 670,057 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.
NOTE 5 - 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.
16
<PAGE> 17
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 MARCH 31, 2000
Net sales...................................... $ - $1,906 $ 16 $ - $1,922
Cost of products sold.......................... - 815 5 - 820
Selling, general and administrative expenses... 6 874 (67) - 813
Amortization of trademarks and goodwill........ - 65 27 - 92
Interest and debt expense...................... 43 - - - 43
Interest income................................ - (23) (1) - (24)
Intercompany interest expense (income)......... (3) 97 (94) - -
Other expense, net............................. 9 - - - 9
----- ------ ---- ----- ------
INCOME (LOSS) BEFORE INCOME TAXES............ (55) 78 146 - 169
Provision for (benefit from) income taxes...... (19) 58 53 (3) 89
Equity income from subsidiaries................ 116 96 - (212) -
----- ------ ---- ----- ------
NET INCOME................................... $ 80 $ 116 $ 93 $(209) $ 80
===== ====== ==== ===== ======
FOR THE THREE MONTHS ENDED MARCH 31, 1999
Net sales...................................... $ - $1,655 $ 38 $ - $1,693
Cost of products sold.......................... - 735 18 - 753
Selling, general and administrative expenses... 21 725 (76) - 670
Amortization of trademarks and goodwill........ - 65 27 - 92
Interest and debt expense...................... 105 - - - 105
Interest income................................ (1) - - - (1)
Intercompany interest expense (income)......... (233) 236 (3) - -
Other expense (income), net.................... (32) - 40 - 8
----- ------ ---- ----- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES........................ 140 (106) 32 - 66
Provision for (benefit from) income taxes...... 37 (13) 12 - 36
Equity income (loss) from subsidiaries from
continuing operations........................ (73) 21 - 52 -
----- ------ ---- ----- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS..... 30 (72) 20 52 30
Income from discontinued operations, net of
taxes........................................ 29 - 36 - 65
Equity income from subsidiaries from
discontinued operations...................... 36 36 - (72) -
----- ------ ---- ----- ------
NET INCOME (LOSS)............................ $ 95 $ (36) $ 56 $ (20) $ 95
===== ====== ==== ===== ======
</TABLE>
17
<PAGE> 18
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 THREE MONTHS ENDED MARCH 31, 2000
Cash flows from operating activities........... $ 170 $ 471 $ 98 $(84) $ 655
Cash flows from (used in) investing activities:
Proceeds from maturities of short-term
investments................................ - 109 1 - 110
Other investing activities................... - (9) - - (9)
----- ------ ----- ---- ------
Net cash flows from investing activities... - 100 1 - 101
----- ------ ----- ---- ------
Cash flows used in financing activities:
Intercompany transfers....................... 7 101 (108) - -
Repayments of long-term debt................. (23) - - - (23)
Repurchase of common stock................... (70) - - - (70)
Dividend paid on common stock................ (84) (84) - 84 (84)
----- ------ ----- ---- ------
Net cash flows used in financing
activities............................... (170) 17 (108) 84 (177)
----- ------ ----- ---- ------
Net change in cash and cash equivalents.... - 588 (9) - 579
Cash and cash equivalents at beginning of
period....................................... - 1,060 117 - 1,177
----- ------ ----- ---- ------
Cash and cash equivalents at end of period..... $ - $1,648 $ 108 $ - $1,756
===== ====== ===== ==== ======
FOR THE THREE MONTHS ENDED MARCH 31, 1999
Cash flows from operating activities........... $ 40 $ 213 $(176) $ - $ 77
Cash flows used in investing activities........ - (10) - - (10)
Cash flows from (used in) financing activities:
Intercompany transfers..................... 29 (206) 177 - -
Decrease in short-term borrowing........... (62) - - - (62)
----- ------ ----- ---- ------
Net cash flows from (used in) financing
activities............................ (33) (206) 177 - (62)
----- ------ ----- ---- ------
Net change in cash and cash
equivalents........................... 7 (3) 1 - 5
Cash and cash equivalents at beginning of
period....................................... 40 (40) - - -
----- ------ ----- ---- ------
Cash and cash equivalents at end of period..... $ 47 $ (43) $ 1 $ - $ 5
===== ====== ===== ==== ======
</TABLE>
18
<PAGE> 19
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>
MARCH 31, 2000
ASSETS
Cash and cash equivalents..................... $ - $ 1,648 $ 108 $ - $ 1,756
Other current assets.......................... 4 1,690 48 (571) 1,171
Trademarks, net............................... - - 3,043 - 3,043
Goodwill, net................................. - 7,498 - - 7,498
Intercompany note receivable.................. 139 31 4,679 (4,849) -
Investment in subsidiaries.................... 10,414 6,686 - (17,100) -
Other noncurrent assets....................... 72 1,183 6 - 1,261
------- ------- ------ -------- -------
Total assets......................... $10,629 $18,736 $7,884 $(22,520) $14,729
======= ======= ====== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities........................... $ 1,224 $ 2,759 $ 76 $ (571) $ 3,488
Intercompany note payable..................... 56 4,765 28 (4,849) -
Long-term debt (less current maturities)...... 1,653 - - - 1,653
Other noncurrent liabilities.................. 700 798 1,094 - 2,592
Stockholders' equity.......................... 6,996 10,414 6,686 (17,100) 6,996
------- ------- ------ -------- -------
Total liabilities and stockholders'
equity............................. $10,629 $18,736 $7,884 $(22,520) $14,729
======= ======= ====== ======== =======
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>
NOTE 6 - SUBSEQUENT EVENT
During April 2000, RJR repurchased 523,000 shares of its common stock with
a total cost of approximately $10 million under its existing authorization of
$225 million, resulting in cumulative repurchases of 6,893,656 shares with a
total cost of approximately $135 million as of April 30, 2000.
19
<PAGE> 20
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 ENDED
MARCH 31,
---------------
2000 1999
------ ------
<S> <C> <C>
Net sales................................................... $1,922 $1,693
Cost of products sold(1).................................... 820 753
Selling, general and administrative expenses................ 813 670
------ ------
Operating company contribution.............................. $ 289 $ 270
====== ======
</TABLE>
- ---------------------
(1) $552 million and $507 million of ongoing settlement expense was recorded in
cost of products sold for the three months ended March 31, 2000 and 1999,
respectively.
Net sales of $1.9 billion for the three months ended March 31, 2000
increased 13.5% from the comparable prior-year period. This increase was
primarily due to favorable pricing of $175 million and increased volume of $50
million. Price increases in 1999 and early 2000, primarily in response to
litigation settlements, drove the favorable pricing variance. RJR Tobacco's
total shipment volume during the quarter ended March 31, 2000 of 23 billion
units, excluding Puerto Rico and certain other U.S. territories' volume of
approximately .3 billion units, increased 2.9% from the quarter ended March 31,
1999, while industry volume increased 4.6%. Although RJR Tobacco's comparative
increase in shipment volume resulted from lower shipments in the first quarter
1999, driven by wholesale and retail inventory reductions, preliminary analysis
indicates that consumption for RJR Tobacco, and the industry, declined during
the first quarter of 2000 compared to the prior-year quarter. 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 62.4% and 61.9% of total
shipments for the quarters ended March 31, 2000 and 1999, respectively, whereas
industry-wide, full-price shipments represented 73.9% of total shipments for
each of the quarters ended March 31, 2000 and 1999. Shipment volume for CAMEL,
excluding the non-filter style, was up 10.2% during the first quarter of 2000
compared to the first quarter of 1999, which significantly outperformed the
industry full-price increase of 4.6%. CAMEL shipment volume was supported by new
programs such as the inventive "Pleasure to Burn" advertising campaign.
Shipments of the WINSTON styles supported by the "No Bull" positioning increased
3.4% during the three-month period ended March 31, 2000 from the comparable
prior-year period. WINSTON's performance coincides with the launch of a new
continuity program, the "Winston Racing Nation," which celebrates the lifestyle
and passion of motorsports fans nationwide. SALEM shipments were up 0.6% for the
three-month period ended March 31, 2000 compared to the prior-year period.
Volume for DORAL, the industry's leading savings brand, increased 3.7% from the
first quarter of 1999, while the industry savings category increased 4.6%.
During the first quarter 2000, DORAL announced it had begun adding more tobacco
to each cigarette resulting in a longer-lasting cigarette. The new "Packed
Tighter to Burn Slower" advertising campaign highlights this product
improvement.
RJR Tobacco's total retail share of market declined by .82 share points to
23.49% at March 31, 2000 compared to 24.31% at March 31, 1999. In line with RJR
Tobacco's strategy to stabilize, then grow, market share on its four investment
brands, the combined share of CAMEL, WINSTON, SALEM and DORAL has been stable
since the second quarter of 1999.
CAMEL's retail market share, excluding the non-filter style, grew .25 share
points during the first quarter of 2000 compared to the first quarter of 1999.
CAMEL finished the quarter at 4.90% share of
20
<PAGE> 21
market versus 4.65% at March 31, 1999. Base WINSTON's retail share of market was
4.75% and has remained relatively stable since the second quarter of 1999.
SALEM's retail share of market, although generally stable since March 1999, has
declined slightly in recent months reflecting increased competition in the
menthol market. DORAL's market share was 6.27% and 6.32% in the quarters ended
March 31, 2000 and 1999, respectively.
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 ECLIPSE may present smokers with less risk of cancer,
chronic bronchitis and possibly emphysema, when compared to other cigarettes.
Cost of products sold of $820 million in the first quarter of 2000
increased $67 million from the first quarter of 1999, primarily due to an
increase of $45 million in ongoing settlement costs and increased volume.
Selling, general and administrative expenses of $813 million for the first
quarter of 2000 increased $143 million from the comparable prior-year quarter
primarily due to increased promotional expense, composed mainly of competitive
discounts, partially offset by lower corporate expense.
Operating company contribution increased 7% to $289 million for the first
quarter of 2000 when compared to the prior-year period. The increase in the
current quarter is primarily due to the factors discussed above.
Interest and debt expense of $43 million in the first quarter of 2000
decreased $62 million, or 59%, from the first quarter of 1999. The decrease
resulted from the repurchase of approximately $4 billion of debt, partially
offset by the issuance of $1.25 billion of debt, both of which occurred in 1999.
Interest income increased $23 million from the prior-year quarter. This
increase is primarily the result of the investment of the net proceeds from the
sale of the international tobacco business in the second quarter of 1999 and
higher cash balances required for the April 2000 MSA settlement payment. See
note 1 and note 3 to the condensed consolidated financial statements.
RJR Tobacco recorded a tax provision of $89 million, or an effective rate
of 52.7%, in the first quarter of 2000 compared to $36 million, or an effective
rate of 54.5%, recorded in the first 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 in the first quarter of 1999 included after-tax
income from operations of $65 million related to the international tobacco
business and Nabisco. 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.
21
<PAGE> 22
Cash Flows
Net cash flows from operating activities were $655 million in the first
three months of 2000 and $77 million in the comparable 1999 period. This
increase primarily reflects a decrease in cash payments of tobacco settlements,
higher shipment volume and increased pricing. Additionally, cash flows during
the prior-year quarter were adversely impacted by $171 million net cash flows
used in discontinued operations. Net cash flows from investing activities were
$101 million in the first three months of 2000 compared to $10 million used in
the prior-year period, primarily due to proceeds from the maturity of short-term
investments in the first quarter of 2000. Cash flows used in financing
activities were $177 million and $62 million for the three months ended March
31, 2000 and 1999, respectively. The increase in funds used was primarily due to
the repurchase of common stock and the payment of dividends during the first
quarter of 2000.
In November 1999, RJR's board of directors authorized the repurchase of
shares of its common stock from time to time in the open market, with a maximum
cost of $125 million, funded by cash flows from operations, for the purpose of
enhancing stockholder value. During the first quarter of 2000, RJR repurchased
3,643,256 shares of its common stock with a total cost of $70 million, resulting
in total repurchases of 6,370,656 shares with a total cost of $125 million at
March 31, 2000. In February 2000, RJR's board of directors authorized an
additional $100 million for share repurchases. The timing of repurchases and the
number of shares repurchased will depend upon market conditions. As of April 30,
2000, RJR had repurchased a total of 6,893,656 shares with a total cost of $135
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 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 March
31, 2000, RJR had $399 million in letters of credit and no borrowings
outstanding, with the remaining $836 million of the facility available for
borrowing. RJR was in compliance with the covenants of the facility at March 31,
2000. Additionally, as of March 31, 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 2003, $500 million in principal amount of
7 3/4% notes due 2006 and $200 million in principal amount of 7 7/8% notes due
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 March 31, 2000.
As of March 31, 2000, RJR also had $345 million of foreign currency debt,
with fixed interest rates between 5.375% and 6.875%, due in 2000, and $427
million of public notes, at fixed interest rates of 6.8% through 10%, due in
2000 through 2013.
22
<PAGE> 23
Dividends
On February 2, 2000, RJR's board of directors declared a quarterly cash
dividend of $.775 per common share payable on April 3, 2000 to stockholders of
record as of March 10, 2000. 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 $11 million and $10 million for the quarters
ended March 31, 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 March 31, 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 its results of operations or cash flows in
particular quarterly or annual periods could be materially affected by the
ultimate outcome of various pending or future litigation matters, including
litigation costs. RJR 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 $166 million during the three
months ended March 31, 2000 and $1.6 billion in 1999. RJR Tobacco estimates
those 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 August 1996, the U.S. Food and Drug Administration promulgated
regulations asserting jurisdiction over cigarettes as "medical devices" under
the provisions of the Food, Drug and Cosmetic Act. These regulations included
severe restrictions on the distribution, marketing and advertising of
cigarettes, and required the industry to comply with a wide range of labeling,
reporting, record keeping, manufacturing and other requirements. In August 1998,
the Court of Appeals for the Fourth Circuit ruled that the FDA does not have the
authority to regulate tobacco products and declared the FDA's regulations
invalid. On March 21, 2000, the U.S. Supreme Court affirmed the Fourth Circuit's
ruling. On March 31, 2000, the FDA announced that it was withdrawing its
purported regulations.
23
<PAGE> 24
In December 1992, the U.S. Environmental Protection Agency issued a report
that classified environmental tobacco smoke as a Group A (known human)
carcinogen. RJR Tobacco and others filed suit to challenge the validity of the
EPA report. On July 17, 1998, a U.S. District Court judge held that the EPA's
classification of environmental tobacco smoke was invalid and vacated those
portions of the report dealing with lung cancer. The EPA has appealed, and oral
argument was held before the Court of Appeals for the Fourth Circuit on June 7,
1999. RJR Tobacco is awaiting the Court's decision.
In March 1994, the U.S. Occupational Safety and Health Administration
announced proposed regulations that would restrict smoking in the workplace to
designated smoking rooms that are separately exhausted to the outside. 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. 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. Because many employers currently do not
permit smoking in the workplace, RJR Tobacco cannot predict the effect of any
regulations that may be adopted, but incremental restrictions on smokers could
have an adverse effect on cigarette sales of all manufacturers.
In July 1996, Massachusetts enacted legislation requiring manufacturers of
tobacco products sold in Massachusetts to report yearly, beginning December 15,
1997, the ingredients of each brand sold. The statute also requires the
reporting of nicotine yield ratings in accordance with procedures established by
the state. The legislation contemplates public disclosure of all ingredients in
descending quantitative order; a trade-secret disclosure that RJR Tobacco
believes could damage the competitive position of its brands. RJR Tobacco,
together with other cigarette manufacturers, filed suit in the U.S. District
Court for the District of Massachusetts seeking to have the statute declared
invalid. The court granted a preliminary injunction that enjoined Massachusetts
officials from enforcing the law relating to ingredient reporting. That decision
was upheld by the Court of Appeals for the First Circuit. 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 expects to file 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 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 MDOH on October 9, 1998. RJR Tobacco and the other
manufacturers believe that the MDOH lacks legal authority to promulgate these
regulations. Nevertheless, RJR Tobacco and the other manufacturers have
conducted a cooperative benchmarking study to address certain MDOH concerns. The
benchmarking study obtained smoke constituent information on a representative
number of cigarette brand styles. The MDOH has agreed not to amend or finalize
these regulations until it has reviewed the results of the manufacturers' study.
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. RJR Tobacco believes that it has strong arguments
that the regulations
24
<PAGE> 25
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. The matter is on appeal to the U.S.
Court of Appeals for the First Circuit, which has stayed implementation of the
challenged regulations. The court heard arguments in April 2000. RJR Tobacco is
awaiting the court's decision.
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. Thirty-seven 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 or its subsidiaries do
not expect such expenditures or other costs to have a material adverse effect on
its business 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.
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 must adopt SFAS No. 133 no later than 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. On March 3, 2000, the FASB issued a proposed
SFAS, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which would amend SFAS No. 133. The proposed amendment addresses
certain implementation issues. RJR's management is evaluating the impact, if
any, that adoption of SFAS No. 133 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
25
<PAGE> 26
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 ratings of RJR securities; and the level of
savings associated with the reorganization of the businesses of RJR. 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
March 31, 2000.
26
<PAGE> 27
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 first quarter of 2000, 52 new actions were served
against RJR Tobacco and/or its affiliates or indemnitees, and 57 actions were
dismissed or otherwise resolved in favor of RJR Tobacco and/or its affiliates or
indemnitees without trial. On March 31, 2000, there were 536 active cases
pending, as compared with 647 on March 31, 1999 and 550 on March 31, 1998. As of
April 26, 2000, 533 active cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 532 in the United States; and 1 in the Marshall
Islands. The U.S. case number does not include the 624 Broin II cases pending as
of April 26, 2000. The Broin II lawsuits have been filed, mostly in Florida, by
flight attendants for personal injury as a result of illness allegedly caused by
exposure to secondhand tobacco smoke in airline cabins. These lawsuits follow
the settlement of the Broin v. Philip Morris, Inc. class action, where the
industry agreed to contribute to a fund to research secondhand smoke issues, and
that individual lawsuits might be brought on behalf of any or all of the Broin
class members.
The U.S. cases, exclusive of the 624 Broin II cases, are pending in 40
states and the District of Columbia. The breakdown is as follows: 109 in West
Virginia; 104 in New York; 53 in California; 40 in Florida; 36 in Massachusetts;
27 in Louisiana; 17 in the District of Columbia; 16 in Texas; 10 in each of
Alabama and Mississippi; 9 in Iowa; 8 in each of New Jersey and New Mexico; 7 in
Pennsylvania; 6 in each of Nevada and Tennessee; 5 in each of Georgia, Illinois,
Minnesota, Missouri and Ohio; 4 in South Dakota; 3 in each of Indiana, Michigan,
North Dakota and Wisconsin; 2 in each of Arkansas, Arizona, Connecticut, Kansas,
Maryland, New Hampshire, Oklahoma, Rhode Island, South Carolina and Washington;
1 in each of Hawaii, Kentucky, Maine, North Carolina and Utah. Of the 532 active
U.S. cases, 137 are pending in federal court, 390 in state court and 5 in tribal
court. Most of these cases were brought by individual plaintiffs, but many other
cases seek recovery on behalf of third parties or large classes of claimants.
Litigation is subject to many uncertainties and it is possible that some of
the tobacco-related legal actions, proceedings or claims could be decided
against RJR Tobacco or its affiliates, including RJR, or indemnitees.
Determinations of liability or adverse rulings against other cigarette
manufacturers that are defendants in similar actions, even if those rulings are
not final, could adversely affect the litigation against RJR Tobacco or its
affiliates or indemnitees and could encourage an increase in the number of those
claims. There have been a number of political, legislative, regulatory and other
developments relating to the tobacco industry and cigarette smoking that have
received wide media attention, including the Master Settlement Agreement
referred to above. These developments may negatively affect the outcomes of
tobacco-related legal actions and encourage the institution 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 believes that it has 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 pending litigation matters, including bonding and litigation costs.
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.
27
<PAGE> 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------------------------------------------------------
<C> <S>
10.1 Amended and Restated Equity Incentive Award Plan for
Directors of R.J. Reynolds Tobacco Holdings, Inc. and
Subsidiaries.
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule for the Three Months ended March 31,
2000.
27.2 Financial Data Schedule for the Three Months ended March 31,
1999.
</TABLE>
(B) REPORTS ON FORM 8-K
RJR filed a Form 8-K, dated February 2, 2000 and amended on March 13, 2000,
indicating a change in independent accountants for the year ended December 31,
2000.
28
<PAGE> 29
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: May 9, 2000
29
<PAGE> 30
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------------------------------------------------------
<C> <S>
10.1 Amended and Restated Equity Incentive Award Plan for
Directors of R.J. Reynolds Tobacco Holdings, Inc. and
Subsidiaries.
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule for the Three Months ended March 31,
2000.
27.2 Financial Data Schedule for the Three Months ended March 31,
1999.
</TABLE>
<PAGE> 1
EXHIBIT 10.1
AMENDED AND RESTATED
EQUITY INCENTIVE AWARD PLAN FOR
DIRECTORS OF
R.J. REYNOLDS TOBACCO HOLDINGS, INC. AND SUBSIDIARIES
(EFFECTIVE APRIL 19, 2000)
R.J. Reynolds Tobacco Holdings, Inc., a Delaware corporation, hereby
adopts this Amended and Restated Equity Incentive Award Plan for Directors of
R.J. Reynolds Tobacco Holdings, Inc. and Subsidiaries. The purposes of this Plan
are as follows:
(1) To further the growth, development and financial success of
Holdings by providing additional incentives to its Directors by assisting them
to become owners of capital stock of Holdings and thus to benefit directly from
its growth, development and financial success.
(2) To enable Holdings to obtain and retain the services of, and
business relationships with, the type of Directors considered essential to the
long range success of Holdings by providing and offering them an opportunity to
become owners of capital stock of Holdings.
ARTICLE I
DEFINITIONS
SECTION 1.1 - GENERAL
Whenever the following terms are used in this Plan they shall have the
meaning specified below unless the context clearly indicates to the contrary.
SECTION 1.2 - BOARD
"Board" shall mean the Board of Directors of Holdings.
SECTION 1.3 - CODE
"Code" shall mean the Internal Revenue Code of 1986, as amended.
SECTION 1.4 - COMMITTEE
"Committee" shall mean the Corporate Governance and Nominating
Committee of the Board.
1
<PAGE> 2
SECTION 1.5 - COMMON STOCK
"Common Stock" shall mean the Common Stock, par value $0.01 per share,
of Holdings.
SECTION 1.6 - DIRECTOR
"Director" shall mean a member of the Board.
SECTION 1.7 - ELIGIBLE DIRECTOR
"Eligible Director" shall mean a Director who has never been an
employee or officer of Holdings or any Subsidiary.
SECTION 1.8 - GRANT
"Grant" shall mean an award made to a Participant pursuant to the Plan.
SECTION 1.9 - HOLDINGS
"Holdings" shall mean R.J. Reynolds Tobacco Holdings, Inc., a Delaware
corporation.
SECTION 1.10 - OPTION
"Option" shall mean an option granted under the Plan to purchase Common
Stock. Options include only options which are not intended to be "incentive
stock options" under Section 422 of the Code.
SECTION 1.11 - OPTION PRICE
"Option Price" shall have the meaning given in Section 4.2.
SECTION 1.12 - OPTIONEE
"Optionee" shall mean a Director to whom an Option is granted under the
Plan.
SECTION 1.13 - PARTICIPANT
"Participant" shall mean a Director to whom a Grant has been made.
SECTION 1.14 - PLAN
"Plan" shall mean the Equity Incentive Award Plan for Directors of R.J.
Reynolds Tobacco Holdings, Inc. and Subsidiaries.
2
<PAGE> 3
SECTION 1.15 - SECRETARY
"Secretary" shall mean the Secretary of Holdings.
SECTION 1.16 - STOCK AWARD
"Stock Award" shall mean the annual award, either in the form of
deferred stock units or shares of Common Stock, made pursuant to ARTICLE VI.
SECTION 1.17 - SUBSIDIARY
"Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with Holdings if each of the corporations, or if each
group of commonly controlled corporations, other than the last corporation in an
unbroken chain then owns stock possessing 50% or more of the total combined
voting power of all classes of stock in one of the other corporations in such
chain.
ARTICLE II
SHARES SUBJECT TO PLAN
SECTION 2.1 - SHARES SUBJECT TO PLAN
The shares of stock subject to Grant shall be shares of Common Stock.
The aggregate number of shares of Common Stock which are available for Grants
under the Plan shall not exceed 500,000. Shares related to Grants that are
forfeited, terminated, canceled, expire unexercised, settled in cash in lieu of
stock or in such manner that all or some of the shares of Common Stock covered
by a Grant are not issued to a Participant, shall immediately become available
for Grants.
ARTICLE III
GRANTING OF OPTIONS
SECTION 3.1 - ELIGIBILITY
Any Eligible Director of Holdings or of any Subsidiary shall be
eligible to be granted Options as set forth in this Article III.
SECTION 3.2 - GRANTING OF OPTIONS TO DIRECTORS
Each Eligible Director who is elected to serve on the Board on or after
June 15, 1999 shall be granted an Option to purchase an aggregate 10,000 shares
of Common Stock. Such Option shall be granted only once to each Eligible
Director as soon as practicable following the Director's initial election to
serve on the Board and shall be subject to the terms and conditions set forth in
Article IV.
3
<PAGE> 4
ARTICLE IV
TERMS OF OPTIONS FOR DIRECTORS
SECTION 4.1 - OPTION AGREEMENT
The grant of Options to Eligible Directors shall be evidenced by a
Stock Option Agreement, which shall be executed by the Optionee and an
authorized officer of Holdings and which shall incorporate the terms and
conditions of this Article IV and such other terms and conditions as the
Committee shall determine, consistent with the Plan.
SECTION 4.2 - OPTION PRICE
The exercise price of each share of Common Stock subject to an Option
shall be the final closing price of a share of Common Stock (as reported on the
New York Stock Exchange consolidated tape) on the date of grant.
SECTION 4.3 - COMMENCEMENT OF EXERCISABILITY
An Option shall not be exercisable prior to six months after the date
of grant, and thereafter shall be exercisable in full, subject to applicable
securities regulations.
SECTION 4.4 - EXPIRATION OF OPTION
An Option shall expire and may not be exercised to any extent after the
expiration of ten years from the date the Option was granted.
ARTICLE V
EXERCISE OF OPTIONS
SECTION 5.1 - PERSONS ELIGIBLE TO EXERCISE
During the lifetime of the Optionee but before the expiration of an
Option granted to him, only he or his guardian may exercise the Option, or any
portion thereof. After the death of the Optionee, any exercisable portion of an
Option may, prior to the time when such portion becomes unexercisable under
Section 4.4, be exercised by his personal representative or by any person
empowered to do so under the deceased Optionee's will or under the then
applicable laws of descent and distribution.
SECTION 5.2 - PARTIAL EXERCISE
At any time and from time to time prior to the time when any
exercisable Option or exercisable portion thereof expires or becomes
unexercisable under Section 4.4, such Option or portion thereof may be exercised
in whole or in part; provided, however, that Holdings shall not be required to
issue fractional shares.
4
<PAGE> 5
SECTION 5.3 - MANNER OF EXERCISE
An exercisable Option, or any exercisable portion thereof, may be
exercised solely by delivering to the Secretary or his office all of the
following prior to the time when such Option or such portion becomes
unexercisable:
(a) Notice in writing signed by the Optionee or other person then
entitled to exercise such Option or portion thereof, stating that such
Option or portion thereof is exercised;
(b) Full payment of the Option Price (in cash, by check or by a
combination thereof) for the shares with respect to which such Option
or portion thereof is thereby exercised, together with payment or
arrangement for payment of any federal income or other tax required to
be withheld by Holdings with respect to such shares. Payment of the
Option Price may also be made by tender of an amount equal to the full
exercise price which has been borrowed from Holdings or one of its
Subsidiaries if the Participant also authorizes the concurrent sale of
the exercised Common Stock by a broker (through an arrangement
established by Holdings, or one of its Subsidiaries, for Participants)
and repays the borrowing, all in accordance with any applicable
guidelines of the Committee;
(c) Such representations and documents as the Committee reasonably
deems necessary or advisable to effect compliance with all applicable
provisions of the Securities Act of 1933, as amended and any other
federal, state or foreign securities laws or regulations. The Committee
may, in its absolute discretion, also take whatever additional actions
it deems appropriate to effect such compliance, including, without
limitation, placing legends on share certificates and issuing
stop-transfer orders to transfer agents and registrars; and
(d) In the event that the Option or portion thereof shall be
exercised pursuant to Section 5.1 by any person or persons other than
the Optionee, appropriate proof of the right of such person or persons
to exercise the Option or portion thereof.
SECTION 5.4 - RIGHTS AS STOCKHOLDERS
The holders of Options shall not be, nor have any of the rights or
privileges of, stockholders of Holdings in respect of any shares purchasable
upon the exercise of any part of an Option unless and until certificates
representing such shares have been issued by Holdings to such holders.
SECTION 5.5 - TRANSFER RESTRICTIONS
The Committee, in its absolute discretion, may impose such restrictions
on the transferability of the shares purchasable upon the exercise of an Option
as it deems appropriate, and any such restriction shall be set forth in the
respective Stock Option Agreement and may be referred to on the certificates
evidencing such shares.
5
<PAGE> 6
ARTICLE VI
STOCK AWARDS
SECTION 6.1 - GRANTING OF ANNUAL STOCK AWARDS
(a) Each Eligible Director shall receive an annual Stock Award as
of the date of such Director's initial election to serve on the Board and,
thereafter, as of the date of Holdings' annual meeting of stockholders, provided
that the Director serves on the Board immediately following such date (an
"Annual Stock Award"). The Annual Stock Award for 1999 shall be made as of June
15, 1999 or, if later, the date of the Director's election or re-election to
serve on the Board.
(b) Except as provided in Section 6.1(c) below, the Annual Stock
Award shall be made in the form of deferred stock units, as described in Section
6.3. Each Eligible Director shall receive an Annual Stock Award of 1,000
deferred stock units.
(c) Notwithstanding the foregoing, commencing with the Annual
Stock Award for 2000, an Eligible Director may elect to receive the Annual Stock
Award in the form of 1,000 shares of Common Stock. The election to receive
shares of Common Stock must be made in writing by December 31 of the year
preceding the year during which the Annual Stock Award would otherwise be
granted or, if later, within thirty days after the date a Director becomes a
Director. An election to receive shares of Common Stock shall be irrevocable by
the Director and shall be effective only for the year immediately the date on
which it was filed.
SECTION 6.2 - GRANT OF QUARTERLY STOCK AWARDS
(a) Each Eligible Director shall receive a quarterly Stock Award
on the last day of each calendar quarter, provided that the Director has served
on the Board at any time during such calendar quarter (a "Quarterly Stock
Award").
(b) The Quarterly Stock Award shall be made in the form of
deferred stock units, as described in Section 6.3. The number of deferred stock
units to be credited to a Director's account on the last day of each calendar
quarter shall be determined pursuant to the following formula: $10,000 divided
by the average of the closing price of a share of Common Stock (as reported on
the New York Stock Exchange consolidated tape for each business day during the
last month of such calendar quarter). In the event a Director has served on the
Board for less than an entire quarter, the number of deferred stock units to be
credited to his or her account on the last day of such quarter shall be prorated
based on the actual number of days of his or her service on the Board during the
quarter.
6
<PAGE> 7
SECTION 6.3 - DEFERRED STOCK UNITS
Each deferred stock unit shall be equal in value to one share of Common
Stock. As of the date any dividend is paid to shareholders of Common Stock, the
Director shall be credited with additional deferred stock units equal to the
number of shares of Common Stock (including fractions of a share) that could
have been purchased at the closing price of Common Stock on such date with the
dividend paid on the number of shares of Common Stock to which the Director's
deferred stock units are then equivalent. In case of dividends paid in property,
the dividend shall be deemed to be the fair market value of the property at the
time of distribution of the dividend, as determined by the Committee.
SECTION 6.4 - DISTRIBUTION OF DEFERRED STOCK UNITS
(a) Unless a Director has elected to receive installment payments
as provided below, payment of a Director's deferred stock units shall be made in
one lump-sum as soon as practicable following the end of the year in which the
Director ceases to be a Director.
At the election of the Director made in writing and delivered to the
Committee at any time on or before December 1 of the year of termination of the
Director's service as a Director, distribution of all of his or her deferred
stock units, commencing as soon as practicable following the end of the year in
which the Director ceases to be a Director, shall be made in any number of
annual installments not exceeding ten. Any such election, unless made
irrevocable by its terms, may be changed by written notice to the Committee at
any time prior to December 1 of the year of a Director's termination of service
as a Director.
(b) Distribution of a Director's deferred stock units received in
connection with such Director's Quarterly Stock Awards shall be made only in
cash. Distribution of a Director's deferred stock units received in connection
with such Director's Annual Stock Awards shall be made in cash or stock. If
distribution is made in cash, the amount of distribution shall be determined by
multiplying the number of deferred stock units attributable to the installment
by the average of the closing price in Common Stock on each business day in the
month of December immediately prior to the year in which the installment is to
be paid.
SECTION 6.5 - INSTALLMENT AMOUNT
In the event a Participant has elected to receive distribution of his
or her deferred stock units in more than one installment, the amount of each
installment shall be determined by multiplying the current number of deferred
stock units by a fraction, the numerator of which is one, and the denominator of
which is the number of installments yet to be paid.
7
<PAGE> 8
SECTION 6.6 - DISTRIBUTION UPON DEATH
In the event of the death of a Participant, whether before or after
ceasing to serve as a Director, any deferred stock units to which he or she was
entitled, shall be converted to cash and distributed in a lump sum to such
person or persons or the survivors thereof, including corporations,
unincorporated associations or trusts, as the Participant may have designated.
All such designations shall be made in writing signed by the Participant and
delivered to the Committee. A Participant may from time to time revoke or change
any such designation by written notice to the Committee. If there is no
unrevoked designation on file with the Committee at the time of the
Participant's death, or if the person or persons designated therein shall have
all predeceased the Participant or otherwise ceased to exist, such distributions
shall be made in accordance with the Participant's will or in the absence of a
will, to the administrator of the Participant's estate. Any distribution under
this Section 6.6 shall be made as soon as practicable following the end of the
fiscal quarter in which the Committee is notified of the Participant's death. In
this case, a Participant's deferred stock units shall be converted to cash by
multiplying the number of whole and fractional shares of Common Stock to which
the Participant's deferred stock units are equivalent by the average of the
Closing Price of Common Stock on each business day during the last month of the
calendar quarter prior to the date of death.
SECTION 6.7 - WITHHOLDING TAXES
The Company shall deduct from all distributions under the Plan any
taxes required to be withheld by federal, state, or local governments.
SECTION 6.8 - TERMS AND CONDITIONS
All Stock Awards shall be subject to the terms and conditions of this
Article VI and such other terms and conditions as the Committee shall determine,
consistent with the Plan.
ARTICLE VII
ADMINISTRATION
SECTION 7.1 - COMPENSATION COMMITTEE
The Plan shall be administered by the Corporate Governance and
Nominating Committee of the Board.
SECTION 7.2 - DUTIES AND POWERS OF COMMITTEE
It shall be the duty of the Committee to conduct the general
administration of the Plan in accordance with its provisions. The Committee
shall have the power to interpret the Plan and the Grants and to adopt such
rules for the administration, interpretation, and application of the Plan as are
consistent therewith and to interpret, amend or revoke any such rules. Any such
interpretations and rules shall be consistent with the basic purpose of
8
<PAGE> 9
the Plan to make Grants. In its absolute discretion, the Board may at any time
and from time to time exercise any and all rights and duties of the Committee
under the Plan. The Committee may act either by vote at a telephonic or other
meeting or by a memorandum or other written instrument signed by a majority of
the Committee.
SECTION 7.3 - COMPENSATION; PROFESSIONAL ASSISTANCE; GOOD FAITH ACTIONS
Members of the Committee shall not receive compensation for their
services as members but all expenses and liabilities they incur in connection
with the administration of the Plan shall be borne by Holdings. The Committee
may employ attorneys, consultants, accountants, appraisers, brokers or other
persons. The Committee, Holdings and the officers and Directors of Holdings
shall be entitled to rely upon the advice, opinions or valuations of any such
persons. All actions taken and all interpretations and determinations made by
the Committee in good faith shall be final and binding upon all Participants,
Holdings and all other interested persons. No member of the Committee shall be
personally liable for any action, determination or interpretation made in good
faith with respect to the Plan or the Grants, and all members of the Committee
shall be fully protected by Holdings with respect to any such action,
determination or interpretation.
ARTICLE VIII
MISCELLANEOUS PROVISIONS
SECTION 8.1 - AMENDMENT, SUSPENSION OR TERMINATION OF THE PLAN
The Plan may be wholly or partially amended or otherwise modified,
suspended or terminated at any time or from time to time by the Board. Except as
expressly permitted by the terms of the Plan, neither the amendment, suspension
nor termination of the Plan shall, without the consent of the Participant alter
or impair any rights or obligations under any Grant theretofore granted. No
Grant may be made during any period of suspension nor after termination of the
Plan.
SECTION 8.2 - EFFECT OF PLAN UPON OTHER OPTIONS AND COMPENSATION PLANS
Nothing in this Plan shall be construed to limit the right of Holdings
or any of its Subsidiaries (a) to establish any other forms of incentives or
compensation for Directors of Holdings or any of its Subsidiaries or (b) to
grant or assume options otherwise than under this Plan in connection with any
proper corporate purpose, including, but not by way of limitation, the grant or
assumption of options in connection with the acquisition by purchase, lease,
merger, consolidation or otherwise, of the business, stock or assets of any
corporation, firm or association.
9
<PAGE> 10
SECTION 8.3 - ADJUSTMENTS
(a) In the event of any change in the outstanding Common Stock by
reason of a stock split, spin-off, stock dividend, stock combination or
reclassification, recapitalization or merger, change of control, or similar
event, the Committee may adjust appropriately the number of Shares subject to
the Plan and available for or covered by Grants and Share prices related to
outstanding Grants and make such other revisions to outstanding Grants as it
deems are equitably required. Any such adjustment made by the Committee shall be
final and binding upon all Participants, Holdings and all other interested
persons.
(b) In the event of a Change of Control (as defined in paragraph
8.3(c) hereof):
(i) Stock options granted pursuant to Section 3 hereof
shall become fully vested and exercisable; provided; however, that the
Committee may elect to make a cash payment to Participants in
cancellation of such options in such amount as the Committee in its
sole discretion shall determine, which amount shall not be less than
the product of (x) and (y), where (x) is the excess of the Fair Market
Value of Common Stock on the date of exercise over the exercise price,
and (y) is the number of Shares subject to the stock options being
canceled.
(ii) The Committee shall have authority to revise the
terms of any such Grant or any other Grant as it, in its discretion,
deems appropriate; provided; however, that the Committee may not make
revisions that are adverse to the Participant without the Participant's
consent unless such revision is provided for or contemplated in the
terms of the Grant.
(c) For purposes of the Plan, a "Change of Control" shall mean the
first to occur of the following events:
(i) an individual, corporation, partnership, group,
associate or other entity or "person", as such term is defined inn
Section 14(d) of the Securities Exchange Act of 1934 (the "Exchange
Act"), other than Holdings or any employee benefit plans sponsored by
Holdings or the Company, is or becomes the "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly,
of 30% or more of the combined voting power of Holdings' outstanding
securities ordinarily having the right to vote at elections of
directors.
(ii) individuals who constitute the Holdings Board on June
15, 1999 (the "Incumbent Board") cease for any reason to constitute at
least a majority thereof, provided that any person becoming a director
subsequent to such date whose election, or nomination for election by
Holdings' shareholders, was approved by a vote of at least
three-quarters of the directors comprising the Incumbent Board (either
by a specific vote or by approval of the proxy statement of Holdings in
which such person is named as a nominee of Holdings for director), but
excluding for this purpose any such individual whose initial assumption
of office occurs as a result of either an actual or threatened election
contest (as such terms are used in Rule 14a-11
10
<PAGE> 11
of Regulation 14A promulgated under the Exchange Act) or other actual
or threatened solicitation of proxies or consents by or on behalf of an
individual, corporation, partnership, group, associate or other entity
or "person" other than the Holdings Board, shall be, for purposes of
this paragraph (ii), considered as though such person were a member of
the Incumbent Board;
(iii) the approval by the shareholders of Holdings of a
plan or agreement providing (1) for a merger or consolidation of
Holdings other than with a wholly-owned subsidiary and other than a
merger or consolidation that would result in the voting securities of
Holdings outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being converted into voting
securities of the surviving entity) more than 50% of the combined
voting power of the voting securities of Holdings or such surviving
entity outstanding immediately after such merger or consolidation, or
(2) for a sale, exchange or other disposition of all or substantially
all of the assets of Holdings. If any of the events enumerated in this
paragraph (iii) occur, the Holdings Board shall determine the effective
date of the Change of Control resulting therefrom for purposes of the
Program.
SECTION 8.4 - TITLES
Titles are provided herein for convenience only and are not to serve as
a basis for interpretation or construction of the Plan.
SECTION 8.5 - PRONOUNS
The masculine pronoun shall include the feminine and neuter and the
singular shall include the plural, where the context so indicates.
11
<PAGE> 1
EXHIBIT 12.1
R.J. REYNOLDS TOBACCO HOLDINGS, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS
ENDED MARCH 31, FOR THE YEARS ENDED DECEMBER 31,
--------------- -----------------------------------
2000 1999 1998 1997 1996 1995
--------------- ---- ----- ---- ------ ----
<S> <C> <C> <C> <C> <C> <C>
Earnings before fixed charges:
Income (loss) from continuing operations
before income taxes..................... $169 $510 $(679) $204 $ 563 $348
Interest and debt expense.................. 43 268 426 433 462 484
Interest portion of rental expense......... 4 15 16 16 14 14
---- ---- ----- ---- ------ ----
Earnings before fixed charges................ $216 $793 $(237) $653 $1,039 $846
==== ==== ===== ==== ====== ====
Fixed charges:
Interest and debt expense.................. $ 43 $268 $ 426 $433 $ 462 $484
Interest portion of rental expense......... 4 15 16 16 14 14
---- ---- ----- ---- ------ ----
Total fixed charges................ $ 47 $283 $ 442 $449 $ 476 $498
==== ==== ===== ==== ====== ====
Ratio of earnings to fixed charges........... 4.6 2.8 - 1.5 2.2 1.7
==== ==== ===== ==== ====== ====
Deficiency in the coverage of fixed charges
by earnings before fixed charges........... - - $(679) - - -
==== ==== ===== ==== ====== ====
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF R.J. REYNOLDS TOBACCO HOLDINGS, INC. FOR THE 3 MONTHS
ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 1,756
<SECURITIES> 0
<RECEIVABLES> 94
<ALLOWANCES> 11
<INVENTORY> 550
<CURRENT-ASSETS> 2,927
<PP&E> 2,332
<DEPRECIATION> 1,264
<TOTAL-ASSETS> 14,729
<CURRENT-LIABILITIES> 3,488
<BONDS> 1,653
0
0
<COMMON> 1
<OTHER-SE> 6,995
<TOTAL-LIABILITY-AND-EQUITY> 14,729
<SALES> 1,922
<TOTAL-REVENUES> 1,922
<CGS> 820
<TOTAL-COSTS> 820
<OTHER-EXPENSES> 92
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 43
<INCOME-PRETAX> 169
<INCOME-TAX> 89
<INCOME-CONTINUING> 80
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 80
<EPS-BASIC> .77
<EPS-DILUTED> .77
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF R.J. REYNOLDS TOBACCO HOLDINGS, INC. FOR THE THREE
MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 5
<SECURITIES> 0
<RECEIVABLES> 56
<ALLOWANCES> 10
<INVENTORY> 527
<CURRENT-ASSETS> 7,259
<PP&E> 2,349
<DEPRECIATION> 1,248
<TOTAL-ASSETS> 19,476
<CURRENT-LIABILITIES> 2,036
<BONDS> 4,743
0
0
<COMMON> 1
<OTHER-SE> 9,873
<TOTAL-LIABILITY-AND-EQUITY> 19,476
<SALES> 1,693
<TOTAL-REVENUES> 1,693
<CGS> 753
<TOTAL-COSTS> 753
<OTHER-EXPENSES> 92
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 105
<INCOME-PRETAX> 66
<INCOME-TAX> 36
<INCOME-CONTINUING> 30
<DISCONTINUED> 65
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 95
<EPS-BASIC> .88
<EPS-DILUTED> .88
</TABLE>
