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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-6388
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R.J. REYNOLDS TOBACCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-0950247
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
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)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH NAME OF EACH
EXCHANGE ON WHICH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED TITLE OF EACH CLASS REGISTERED
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Common Stock, par value $.01 per 8 3/4% Senior Notes due April 15,
share New York 2004 New York
8% Notes due July 15, 2001 New York 8 3/4% Notes due August 15, 2005 New York
8 5/8% Notes due December 1, 2002 New York 8 3/4% Notes due July 15, 2007 New York
9 1/4% Debentures due August 15,
7 5/8% Notes due September 15, 2003 New York 2013 New York
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of R.J.
Reynolds Tobacco Holdings, Inc. on February 23, 2000 was approximately $1.9
billion, based on 103,325,963 shares at the closing price of $18.75. Certain
directors of R.J. Reynolds Tobacco Holdings, Inc. are considered affiliates for
purposes of this calculation but should not necessarily be deemed affiliates for
any other purpose.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: February 23, 2000:
103,907,395 shares of common stock, par value $.01 per share.
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DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Definitive Proxy Statement of R.J. Reynolds Tobacco
Holdings, Inc. to be filed with the Securities and Exchange Commission pursuant
to Regulation 14A of the Securities Exchange Act of 1934 on or prior to March
30, 2000 are incorporated by reference into Part III of this report.
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INDEX
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15
Executive Officers of the Registrant........................ 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 18
Item 6. Selected Financial Data..................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 20
Item 7a. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 31
Item 8. Financial Statements and Supplementary Data................. 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 68
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 68
Item 11. Executive Compensation...................................... 68
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 68
Item 13. Certain Relationships and Related Transactions.............. 68
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 68
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PART I
ITEM 1. BUSINESS
R.J. Reynolds Tobacco Holdings, Inc., formerly known as RJR Nabisco, Inc.
was incorporated as a holding company in 1970, and is listed on the NYSE as RJR.
RJR owns 100% of the stock of its operating subsidiary, R. J. Reynolds Tobacco
Company. RJR Tobacco operates in one industry segment and is the second largest
cigarette manufacturer in the United States. RJR Tobacco's largest selling
cigarette brands, DORAL, CAMEL, WINSTON and SALEM were four of the top ten,
best-selling brands of cigarettes in the United States in 1999. Those brands,
and its other brands, including VANTAGE, MORE, NOW, MONARCH, BEST VALUE and
CENTURY, are manufactured in a variety of styles and marketed in the United
States to meet a range of smoker preferences.
During 1999, RJR and Nabisco Group Holdings Corp., referred to as NGH,
completed a series of transactions to reorganize their businesses and capital
structures. The principal transactions included:
- On March 9, 1999, RJR and RJR Tobacco entered into a definitive
agreement to sell the international tobacco business for approximately
$8 billion, net of the assumption of approximately $200 million of net
debt, to Japan Tobacco Inc.;
- On May 7, 1999, RJR entered into a $1.235 billion revolving credit
facility, effective May 18, 1999, with a syndicate of commercial banks.
RJR Tobacco has guaranteed RJR's obligations under that credit facility;
- On May 12, 1999, RJR and RJR Tobacco substantially completed the sale of
the international tobacco business. As a result of this sale, RJR
Tobacco's only cigarette market is the United States and its
territories, commonwealths, protectorates and possessions;
- On May 18, 1999, RJR used a portion of the net proceeds from the
international tobacco sale to repurchase approximately $4 billion of
public debt;
- On May 18, 1999, RJR transferred its 80.5% interest in Nabisco Holdings
Corp., referred to as Nabisco, together with approximately $1.6 billion
in cash proceeds from the international tobacco sale, to NGH through a
merger transaction that is intended to be tax-free;
- On May 18, 1999, RJR completed a private placement offering of $1.25
billion in debt securities. RJR Tobacco has guaranteed RJR's obligations
under the debt securities;
- On June 14, 1999, NGH distributed all of the outstanding RJR common
stock to NGH common stockholders in a spin-off transaction that is
intended to be tax-free for U.S. federal income tax purposes; and
- On July 16, 1999, RJR filed a registration statement, which became
effective October 8, 1999, for notes issued in exchange for the $1.25
billion of private placement notes. The exchange was substantially
completed in November 1999.
INDUSTRY OVERVIEW
U.S. cigarette shipments decreased at a compound annual rate of 1.6% from
1987 through 1997. In 1998, industry shipments declined 4.6% to 460.8 billion
units, and in 1999, declined 9.0% to 419.4 billion units, primarily as a result
of substantial settlement-related price increases and higher state sales and
excise taxes. From January 1998 to December 1999, wholesale cigarette prices
increased $.82 per pack primarily to satisfy payment obligations under the
Master Settlement Agreement with state attorneys general and other state
settlement costs. For more discussion of tobacco litigation and the MSA, see
"-- Tobacco Litigation Affecting the Cigarette Industry," "-- Environmental
Matters," "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Governmental Activity" in Item 7, note 12 to the
consolidated financial statements and Exhibit 99.1 to this report.
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COMPETITION
The U.S. market in which RJR Tobacco operates is highly competitive, with
several large participants. Based on data collected by an independent market
research firm during 1999, 1998 and 1997, Philip Morris, Inc. had an overall
share of retail consumer cigarette sales of 49.30%, 48.59% and 47.70%,
respectively. During these same periods, RJR Tobacco had an overall share of
24.12%, 25.17% and 25.41%, and the remaining participants held lesser shares.
Competition is primarily based on brand and packaging recognition, brand
loyalty, retail display and promotion, quality and price. Substantial
advertising, merchandising display and promotional expenditures, including
discounting, are necessary to maintain or improve a brand's market position or
to introduce a new brand.
Anti-smoking groups have undertaken activities designed to inhibit
cigarette sales, the form and content of cigarette advertising and the testing
and introduction of new cigarette products. In addition, the MSA contains
provisions restricting the marketing of cigarettes. See "-- Litigation Affecting
the Cigarette Industry" for more discussion of the MSA.
Because television and radio advertising for cigarettes is prohibited in
the United States and brand loyalty has tended to be higher in the cigarette
industry than in other consumer product industries, established cigarette brands
in the United States have a competitive advantage. RJR Tobacco has repositioned
or introduced brands designed to appeal to adult smokers of its competitive
cigarette brands in the United States, but there can be no assurance that such
efforts will be successful. See "-- Marketing" for more discussion of RJR
Tobacco's marketing efforts.
Increased selling prices and higher taxes on cigarettes have created
additional price sensitivity among consumers. This sensitivity has resulted in
increased competitive discounting and the proliferation of deep-discount brands
from manufacturers not yet subject to the MSA and other state settlement
payments.
STRATEGY
RJR's objectives are to:
- Stabilize, then grow, earnings and cash flow;
- Deliver an attractive return to its stockholders, including meaningful
and sustainable dividends; and
- Stabilize, then grow, share of market for RJR Tobacco's four key
investment brands: CAMEL, WINSTON, SALEM and DORAL.
MARKETING
RJR Tobacco is committed to providing unique products and increased value
to its adult smoking consumers. RJR Tobacco's marketing programs are designed to
strengthen its brands' image, build brand awareness and brand loyalty among
current adult smokers, attract adult smokers of competing brands and increase
market share. RJR Tobacco's focus is on its four investment brands, which
represent over 80% of its volume and its share of market.
Regarding these investment brands, CAMEL continued to be a strong
competitor, backed by its new "Pleasure to Burn" advertising campaign and
related promotional events launched in 1999. WINSTON continued to leverage its
"No Bull" positioning that was launched in mid-1997. In January 1999, RJR
Tobacco launched nationally the SALEM "It's not what you expect" repositioning
effort, after test marketing in 1998. SALEM's repositioning is concentrated in
markets where the full-price menthol category is strong. During 1999, DORAL, the
industry's leading savings brand, continued to build on its "Imagine Getting
More" campaign introduced in September 1998.
RJR Tobacco believes it is essential to compete in all categories of the
cigarette market, and in addition to its investment brands, offers other
full-price and savings brand alternatives. Additional full-price brands include
VANTAGE, MORE and NOW. Other savings brands include MONARCH, BEST VALUE,
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CENTURY and various private label brands that are intended to appeal to more
cost-conscious adult smokers.
RJR Tobacco is committed to new product development, product-line
extensions and brand repositioning as sources of growth. RJR Tobacco continues
to test market ECLIPSE, a cigarette that primarily heats rather than burns
tobacco, greatly reducing second-hand smoke, while leaving no ashes, stains or
lingering odor.
As a result of the MSA, RJR Tobacco has agreed, along with the other major
cigarette manufacturers, to discontinue the use of billboard advertising and
certain other marketing and promotional tools. RJR Tobacco has advertised, and
continues to advertise, in magazines that are read primarily by adults, through
direct mailings to age-verified adult smokers and through other means. In
addition, RJR Tobacco will continue to advertise and promote at retail cigarette
locations and in other adult venues where permitted by law.
MANUFACTURING AND DISTRIBUTION
RJR Tobacco manufactures cigarettes at its Tobaccoville and Whitaker Park
plants in the Winston-Salem, North Carolina area, both of which it owns.
Tobaccoville is a two-million-square-foot facility constructed in 1985. The
Whitaker Park complex includes a one and one-half-million-square-foot plant, RJR
Tobacco's Central Distribution Center and a pilot plant for trial manufacturing
of new products. RJR Tobacco has a production capacity of approximately 150
billion cigarettes per year, and believes its cigarette manufacturing facilities
are among the most technologically advanced in the United States.
RJR Tobacco sells cigarettes primarily to distributors and wholesalers and
to certain large retail stores. Most of RJR Tobacco's customers buy on a spot
basis rather than under long-term agreements. RJR Tobacco distributes its
cigarettes primarily to public warehouses located throughout the United States
that serve as local distribution centers for its customers. No significant
backlog of orders existed at December 31, 1999 or 1998.
During 1999, 1998 and 1997, sales made to McLane Company, Inc. and its
affiliate, Wal-Mart, comprised approximately 17.0%, 16.0%, and 16.5%,
respectively, of RJR's revenue. No other customer accounted for 10% or more of
RJR's revenue during those years.
RAW MATERIALS
In its production of cigarettes, RJR Tobacco primarily uses burley and
flue-cured leaf tobaccos that have been purchased at domestic auction. RJR
Tobacco has begun contracting directly with tobacco growers to obtain flue-cured
tobacco with reduced tobacco-specific nitrosamines. RJR Tobacco also purchases
oriental tobaccos, grown primarily in Turkey and Greece, and certain other
non-domestic tobaccos and believes there is a sufficient supply in the worldwide
tobacco market to satisfy its current production requirements.
Tobacco leaf is an agricultural commodity subject in the United States to
government production controls and price supports that can affect market prices
substantially. The tobacco leaf price-support program is subject to
Congressional review and may be changed at any time. In December 1994, Congress
enacted the Uruguay Round Agreements Act to replace a domestic content
requirement with a tariff rate quota system that keys tariffs to import volumes.
The tariff rate quotas have been established by the United States with overseas
tobacco producers and became effective on September 13, 1995.
RESEARCH AND DEVELOPMENT
RJR Tobacco's research and development activities are located in its
technologically-advanced Bowman Gray Technical Center in Whitaker Park.
Scientists and engineers continue to create more efficient methods of preparing
tobacco blends, new products and packaging, as well as product enhancements and
packaging that differentiate WINSTON, SALEM, CAMEL, DORAL and other RJR Tobacco
brands from the competition. RJR Tobacco has developed a simple, practical way
to reduce tobacco-specific nitrosamines, or TSNAs, by approximately 90% in
flue-cured tobacco, and expects to switch to low-TSNA flue-cured tobacco in its
cigarette blends as soon as reasonably possible. See note 19 to the consolidated
financial statements for additional information.
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INTELLECTUAL PROPERTY
RJR Tobacco owns numerous trademarks, including the brand names of its
cigarettes and their distinctive packaging and display. Also, RJR Tobacco
considers the blends of tobacco that make each of its brands distinctive to be
trade secrets. These trade secrets generally are not patented, although certain
of RJR Tobacco's manufacturing processes are patented.
In connection with the sale of the international tobacco business, RJR
Tobacco sold certain of its trademarks and patents outside the United States.
All of RJR Tobacco's material trademarks are registered with the U.S.
Patent and Trademark Office. Rights in these trademarks in the United States
will last as long as RJR Tobacco continues to use the trademarks.
LEGISLATION AND OTHER MATTERS AFFECTING THE CIGARETTE INDUSTRY
The tobacco business is subject to a wide range of laws and regulations
regarding the advertising, sale, taxation and use of tobacco products imposed by
local, state, federal and foreign governments. In addition, in 2000 the U.S.
Congress is likely to consider legislation regarding increases in the federal
excise tax and regulation of cigarette manufacturing and sale by the U.S. Food &
Drug Administration. In his budget submitted to Congress in February 2000,
President Clinton included a $.25 per pack increase in the federal excise tax
and an acceleration of the $.05 increase from January 2002 to October 2000.
Also, he included a provision requiring the tobacco industry to pay the federal
government an additional $3,000 for every underage smoker if the smoking rate
among teenagers fails to decline by at least 50% by 2004. For a discussion of
the regulatory and legislative environment applicable to the cigarette business,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Governmental Activity" in Item 7.
LITIGATION AFFECTING THE CIGARETTE INDUSTRY
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 1999, 147 new actions were served against RJR Tobacco and/or
its affiliates or indemnitees, and 273 actions were dismissed or otherwise
resolved in favor of RJR Tobacco and/or its affiliates or indemnitees without
trial. On December 31, 1999, there were 541 cases pending, as compared with 664
on December 31, 1998, 516 on December 31, 1997, and 234 on December 31, 1996. As
of February 23, 2000, 539 cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 538 in the United States and one in the Marshall
Islands. The U.S. case number does not include 501 Broin II cases, which are
discussed below.
The U.S. cases, exclusive of the 501 Broin II cases, are pending in 41 U.S.
states and the District of Columbia. The breakdown is as follows: 109 in West
Virginia; 103 in New York; 43 in Massachusetts; 40 in Florida; 38 in California;
28 in Louisiana; 18 in each of Texas and the District of Columbia; 10 in
Alabama; 9 in each of Iowa, New Mexico and Pennsylvania; 8 in each of Illinois,
Mississippi and New Jersey; 7 in each of Ohio and Tennessee; 6 in Minnesota; 5
in Nevada; 4 in each of Indiana, Michigan and Missouri; 3 in each of Arkansas,
Georgia, North Carolina, North Dakota, Oklahoma, South Dakota and Wisconsin; 2
in each of Arizona, Connecticut, Hawaii, Maryland, New Hampshire, Rhode Island,
South Carolina, Utah and Washington; and 1 in each of Colorado, Kansas, Kentucky
and Maine. Of the 538 active U.S. cases, 146 are pending in federal court, 387
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,
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are specifically pleaded in a number of cases, in addition to compensatory and
other damages. Six of the 538 active cases in the United States, plus the 501
Broin II cases, involve alleged non-smokers claiming injuries resulting from
exposure to environmental tobacco smoke. Forty-five 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 65 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, where applicable, include 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.
Most recently, on November 1, 1999, the Florida Supreme Court heard the
plaintiff's appeal in Carter v. Brown & Williamson Tobacco Corp., a case in
which a Florida Appeal Court had reversed a jury's 1996 verdict in favor of the
plaintiff in the amount of $750,000. In another Florida case, Widdick v. Brown &
Williamson Tobacco Corp., a Florida Court of Appeal on January 29, 1999,
reversed a jury verdict in favor of the plaintiff in the amount of approximately
$1 million in compensatory and punitive damages and ordered a new trial in a
different location. On February 9-10, 1999, in Henley v. Philip Morris, Inc., a
San Francisco state court jury awarded an individual smoker $1.5 million in
compensatory damages and $50 million in punitive damages. 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. On March
30, 1999, in Williams v. Philip Morris, Inc., an Oregon state court jury
returned a verdict against Philip Morris in the amount of $800,000 in actual
damages, $21,500 in medical expenses and $79 million in punitive damages.
Although the judge in this case reduced the punitive damages to $32 million,
Philip Morris is appealing this verdict as well. In the most recent verdict in a
non-RJR Tobacco individual case, Steele v. Brown & Williamson Tobacco Corp., a
jury in Missouri federal court found on May 13, 1999 that Brown & Williamson was
not liable for the death of the plaintiff.
RJR Tobacco ultimately has prevailed in every individual case that has gone
to trial. Most recently, on May 10, 1999, in Newcomb v. R. J. Reynolds Tobacco
Co., one of three individual cases consolidated for trial in Tennessee state
court, the jury refused to award damages against RJR Tobacco and Brown &
Williamson. The same jury found that the tobacco company defendants in the other
two cases were not liable. On June 2, 1999, in an environmental tobacco smoke
case, Butler v. Philip Morris Co., Inc., the jury returned a defense verdict. On
July 9, 1999, a Louisiana state court jury found in favor of RJR Tobacco and
Brown & Williamson, in an individual smoker case, Gilboy v. American Tobacco Co.
Broin II Cases. Numerous 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 (the "Broin II cases").
These lawsuits follow the resolution of the Broin class action, under which
settlement agreement the industry agreed to contribute to a fund to research
secondhand smoke issues, and further agreed 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 February 23, 2000, 502 such suits
have been served upon RJR Tobacco. One of these cases, however, was voluntarily
dismissed on February 8, 2000.
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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, in a
few instances, 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
"lights" 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 put 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 class-action complaints have been certified, or if certified, have
survived on appeal. On May 17, 1999, the U.S. Supreme Court declined to review a
circuit court decision upholding the denial of class certification in a
Pennsylvania medical monitoring case, Barnes v. American Tobacco Co. On April
12, 1999, in Chamberlain v. American Tobacco Co., a federal district court in
Ohio refused to certify a class of "nicotine-dependent" Ohio residents. On April
13, 1999, in Avallone v. American Tobacco Co., a state court judge in New Jersey
refused to certify a class of casino workers exposed to environmental tobacco
smoke. On June 21, 1999, in Geiger v. American Tobacco Co., a New York state
court refused to certify a class of New York state residents who were alleged to
have contracted lung and throat cancer as a result of cigarette smoking. On June
29, 1999, in Clay v. American Tobacco Co., a federal district court in Illinois
refused to certify a class of persons in 46 states who, "as children, purchased
and smoked cigarettes designed, manufactured, promoted or sold by the
defendants." On July 21, 1999, in Hansen v. American Tobacco Co., a federal
district court in Arkansas refused to certify an Arkansas state-wide class
consisting of smokers claiming to have tobacco-related disease. On July 23,
1999, in Reed v. Philip Morris, Inc., a District of Columbia superior court
judge entered an opinion and order refusing to certify as a class residents of
the District of Columbia claiming to have tobacco-related disease. On September
21, 1999, a federal district court judge in Pennsylvania dismissed the Brown v.
Philip Morris, Inc. complaint. This suit alleged, among other things, violations
of plaintiffs' civil rights in the marketing and sale of menthol cigarettes. On
October 26, 1999, the New York Court of Appeals affirmed a ruling by a lower
court decertifying five smoker class actions, including Hoskins v. R. J.
Reynolds Tobacco Co., and dismissing each case. 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. Finally, on January 10, 2000, in Taylor v. American
Tobacco Co., a state court judge in Michigan denied certification of another
smoker class action.
A Maryland state court in Richardson v. Philip Morris, Inc. granted class
certification in 1998. The Maryland Court of Appeals is reviewing that 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. Finally,
defendants, including RJR Tobacco, settled another class-action suit, Broin v.
Philip Morris, Inc., in October 1997. The Florida Court of Appeal denied
challenges to this settlement on March 24, 1999, and subsequently denied motions
to reconsider. On September 7, 1999, the Florida Supreme Court dismissed all
proceedings, and the settlement and judgment became final.
Trial continues 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
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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 currently consists of the claims of three
of the named class representatives, began on November 1, 1999. In addition, the
trial court has ordered that the jury shall determine punitive damages, if any,
on a class-wide basis if there is a finding of liability in any of the three
cases being tried in phase two. RJR Tobacco and certain other defendants
appealed this order to the Florida Third District Court of Appeal, which left
the order intact. On October 29, 1999, RJR Tobacco and certain other defendants
filed a petition asking the Florida Supreme Court to review the appropriateness
of determining punitive damages on a class-wide basis. On November 3, 1999, the
Florida Supreme Court agreed to address the issue and asked for further briefing
by the parties. On December 27, 1999, the Florida Supreme Court decided not to
review that issue at this time. 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.
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. Following the filing of the Moore case, most other states, through
their attorneys' general and/or other state agencies, sued RJR Tobacco and other
U.S. cigarette manufacturers based on similar theories. The cigarette
manufacturer defendants, including RJR Tobacco, settled the first four of these
cases scheduled to come to trial, those of Mississippi, Florida, Texas and
Minnesota, by separate agreements between each state and those manufacturers in
each case.
On November 23, 1998, the major U.S. cigarette manufacturers, including RJR
Tobacco, entered into the Master Settlement Agreement with attorneys general
representing the remaining 46 states, the District of Columbia, Puerto Rico,
Guam, the Virgin Islands, American Samoa and the Northern Marianas. The MSA
became effective on November 12, 1999, when final approval of the settlement was
achieved in 80% of the settling jurisdictions. As of February 23, 2000, final
approval was achieved in 46 settling jurisdictions. The MSA settled all the
health-care cost recovery actions brought by 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 and 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.
- Monetary Liabilities. In addition to payments made in 1998 and
1999, the MSA calls for four annual initial industry payments starting in
2000 of up to approximately $2.5 billion, $2.5 billion, $2.6 billion and
$2.7 billion, respectively. It also requires perpetual annual industry
payments, increasing from $4.5 billion in April 2000 to $8 billion in 2004
and further to $9 billion in 2018 and thereafter. Ten
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additional industry payments of $861 million are due annually beginning in
April 2008. All payments are to be allocated among the companies on the
basis of relative market share and most are subject to adjustments for
changes in sales volume units, inflation and other factors.
The tobacco companies also agreed to (a) make a one-time payment of
$50 million on March 31, 1999 to establish a fund for enforcement of the
MSA and laws relating to tobacco products and (b) fund activities of the
National Association of Attorneys General relating to the MSA at the cost
of $150,000 per year for ten years.
In addition, the MSA calls for the creation of a national foundation
that would establish public education and other programs, and conduct or
sponsor research to, reduce youth smoking; and to understand, and educate
the public about, diseases associated with tobacco-product use. The tobacco
companies agreed to fund the foundation with (1) 10 annual payments of $25
million, which began on March 31, 1999, (2) further payments of $250
million on March 31, 1999 and $300 million annually thereafter for four
years and (3) additional annual payments of $300 million beginning in 2004
if, during the year preceding the year when payment is due, participating
manufacturers collectively accounted for at least 99.05% of the cigarette
market. Each of these payments is to be allocated among the companies on
the basis of relative market share. Other than the $25 million annual
payments and the $250 million payment made on March 31, 1999, the payments
for the foundation are subject to adjustments for changes in sales volume
units, inflation and other factors.
The manufacturers also agreed to pay the litigation costs, including
government attorneys' fees, of the offices of the attorneys general
relating to the settled cases and, subject to certain quarterly and annual
payment caps, the costs and fees of outside counsel to the jurisdictions.
Outside counsel fees are to be determined either by arbitration or in
accordance with a negotiated fee procedure. Awards determined by
arbitration will be paid subject to an aggregate annual cap on arbitrated
attorneys' fees for all these and certain other settled cases of $500
million. Fees set by the negotiated fee procedure would be subject to an
annual cap of $250 million, and will not exceed a total of $1.25 billion.
As of February 23, 2000, awards determined by arbitration totaled $9.9
billion, and awards determined in accordance with a negotiated fee
procedure totaled approximately $598 million. Reimbursement of costs is
capped at $150 million for litigation costs, including government
attorneys' fees, of the attorneys' general offices and at $75 million
annually for outside counsels' costs. Payments for attorneys' fees and
costs are to be allocated on a market-share basis.
The payments made by RJR Tobacco pursuant to all existing tobacco
litigation settlement agreements, including the MSA and four individual
state settlements, aggregated approximately $1.6 billion in 1999 which were
primarily funded through price increases. RJR Tobacco estimates its
payments to exceed $2.2 billion in 2000 and to exceed $2.0 billion per year
in future years. 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.
- Growers' Trust. As part of the MSA, the tobacco companies agreed to
work with U.S. tobacco growers to address the possible adverse economic
impact of the MSA on growers. As a result, RJR Tobacco and the three other
major manufacturers agreed to participate in funding a $5.2 billion trust
fund to be administered by a trustee, in conjunction with a certification
entity from each of the tobacco-growing states. The trust agreement
provides for a schedule of aggregate annual payments, subject to various
adjustments, that are payable in quarterly installments each year for a
period of twelve years, beginning in 1999, and ending in 2010. The
aggregate annual payment by all participating manufacturers is adjusted
each year for inflation and any change in the total domestic cigarette
volume of all participating manufacturers. In general, the annual payment
by each participating manufacturer, including RJR Tobacco, is based on each
manufacturer's relative market share of total domestic cigarette shipments
during the preceding calendar year. Each manufacturer's annual payment is
also subject to a tax-offset adjustment, as well as additional adjustment
if a tobacco-growing state is unable to obtain final approval of the MSA.
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- Other Master Settlement Agreement Obligations. The MSA also
contains provisions restricting the marketing of cigarettes. Among these
are restrictions or prohibitions on the use of cartoon characters, brand
name sponsorships, brand name non-tobacco products, outdoor and transit
brand advertising, payments for product placement, free sampling and
lobbying. The MSA also required the dissolution of three industry-sponsored
research and advocacy organizations.
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 relies heavily upon
recently enacted legislation in British Columbia that is being separately
challenged by Canadian tobacco companies. An agreement was reached with the
government in British Columbia to litigate the separate constitutional
challenges prior to the health-care cost recovery action. On February 21, 2000,
the British Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action.
On September 22, 1999, the U.S. Department of Justice brought an action in
the United States District Court for the District of Columbia against various
industry members, including RJR Tobacco. The government seeks to recover federal
funds expended in providing health care to smokers who have developed diseases
and injuries alleged to be smoking-related, and, in addition, seeks, pursuant to
the federal RICO statute, disgorgement of profits the government contends were
earned as a consequence of a RICO racketeering "enterprise." On December 27,
1999, defendants filed a motion to dismiss challenging all counts included in
the action brought by the DOJ. Briefing on that motion is still underway, with
oral argument currently scheduled for May 15, 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 February 23, 2000, approximately 34
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 more than 30 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, the settled law
that one who pays an injured person's medical expenses is legally too remote to
maintain an action against the person allegedly responsible for the injury. In
addition, they argue that the traditional subrogation remedy cannot be
supplanted by a direct right of action for the trust fund that strips defendants
of the defenses they would ordinarily have against the allegedly injured
individual.
On March 29, 1999, in the first of these cases to be considered by a
federal court of appeals, Steamfitters Local Union 420 v. Philip Morris, Inc.,
the U.S. Court of Appeals for the Third Circuit affirmed a district court ruling
dismissing a case on remoteness grounds. Since then, the U.S. Courts of Appeals
for the Second Circuit (Laborers Local 17 v. Philip Morris, Inc.), the Fifth
Circuit (Texas Carpenters Health Benefit Fund v. Philip Morris, Inc.), the
Seventh Circuit (International Brotherhood of Teamsters Local 734 Health and
Welfare Trust Fund and Central States Joint Board Health and Welfare Trust Fund
v. Philip Morris, Inc.) and the Ninth Circuit (Oregon Laborers v. Philip Morris,
Inc.) all have 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 cases from the Second, Third and Ninth Circuits.
Numerous trial court judges also have dismissed union trust fund cases on
remoteness grounds, including, on July 22, 1999, a federal district court in
Washington in Northwest Laborers-Employees Health & Security Trust Fund v.
Philip Morris, Inc., and, on September 28, 1999, an Arkansas district court in
Arkansas Carpenters Health & Welfare Fund v. Philip Morris, Inc. 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. Most
recently, 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
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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 first and only union case to go to trial to date was Iron Workers Local
No. 17 v. Philip Morris, Inc. This case, in which a class of approximately 111
union trust funds was certified by a federal district court in Ohio, went to
trial on February 22, 1999, on the counts that survived motions to dismiss:
state and federal RICO claims and civil conspiracy claims. The federal RICO
claim was dismissed during the trial, and after the conclusion of plaintiffs'
case, the court directed a verdict dismissing RJR from the case. On March 18,
1999, the jury returned a unanimous verdict for the defendants, including RJR
Tobacco, on all remaining counts. On May 11, 1999, the trial court judge denied
plaintiffs' motion for a new trial. Plaintiffs appealed this ruling to the Sixth
Circuit Court of Appeals. On October 4, 1999, plaintiffs withdrew their appeal
and voluntarily dismissed their case.
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 claims in
two lawsuits: California v. Philip Morris, Inc., Superior Court, Los Angeles
County, California and California v. Brown & Williamson Tobacco Corp., Superior
Court, San Francisco County, California. These lawsuits were brought by the
cities of Los Angeles and San Jose, on behalf of the people of California, who
claim that the tobacco industry violated State Proposition 65 by failing to warn
nonsmokers about the State of California's conclusions concerning the dangers of
environmental tobacco smoke. The judge did not dismiss certain other California
state law claims.
Finally, 12 lawsuits, of which nine 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.
Wholesalers' Antitrust Cases. Twelve lawsuits have been filed by tobacco
wholesalers 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.
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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 January 24, 2000, 26 cases are
scheduled for trial before year-end 2000 against RJR Tobacco. In addition, the
Engle case in Florida and the Whiteley case in California (an individual smoking
and health lawsuit) are in progress, and multiple health-care cost recovery
trials are scheduled in 2000 before Judge Weinstein of the United States
District Court for the Eastern District of New York. 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.
Other Developments. RJR Tobacco is aware of a grand jury investigation
being conducted in North Carolina that relates to the cigarette business of RJR
Tobacco and some of its former affiliates that were sold to Japan Tobacco Inc.,
as well as a now-closed grand jury investigation in Pennsylvania. In connection
with the former, RJR Tobacco responded to a document subpoena dated July 7,
1999. In connection with the latter, RJR Tobacco received a document subpoena,
dated September 17, 1998, from a federal grand jury convened in the Eastern
District of Pennsylvania by the Antitrust Division of the Department of Justice.
RJR Tobacco understands that the grand jury was investigating possible
violations of the antitrust laws related to tobacco leaf buying practices. RJR
Tobacco responded to that subpoena. On February 4, 2000, RJR Tobacco received
formal notification from the Department of Justice that this investigation has
been closed.
By letter dated September 30, 1999, the U.S. Department of Justice informed
RJR Tobacco that its criminal investigation of RJR Tobacco, and a grand jury
investigation in the District of Columbia that involved allegations of perjury
and misrepresentation before Congress and other federal agencies and other
activities of the tobacco industry, have been completed.
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., now
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.
For a further discussion of litigation and legal proceedings pending
against RJR, its affiliates (including RJR Tobacco) or its indemnitees, see
"-- Environmental Matters" and "Management's Discussion and
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Analysis of Financial Condition and Results of Operations -- Governmental
Activity" in Item 7. For more detailed information about the class action and
other aggregated claims suits pending against RJR, its affiliates (including RJR
Tobacco) or its indemnitees, see Exhibit 99.1 to this report.
---------------------
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, including 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.
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
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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 forms, 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. RJR Tobacco cannot predict the amount of future
expenditures that may be required to comply with these regulations.
RJR and its subsidiaries have been engaged in a continuing program to
assure compliance with federal, state and local environmental laws and
regulations. Although it is difficult to identify precisely the portion of
capital expenditures or other costs attributable to compliance with
environmental laws and regulations and to estimate the cost of resolving these
CERCLA matters, RJR does not expect such expenditures or other costs to have a
material adverse effect on the business, results of operations or financial
condition of RJR or its subsidiaries.
EMPLOYEES
At December 31, 1999, RJR and its subsidiaries had approximately 7,900
employees, including 900 part-time employees. None of these employees are
unionized. RJR Tobacco believes that it maintains good relations with its
employees.
ITEM 2. PROPERTIES
RJR and its subsidiaries own executive offices, which are located in two
buildings in downtown Winston-Salem, and several other smaller properties, all
located in or near Winston-Salem. For information about RJR Tobacco's operating
facilities, see "Business -- Manufacturing" and "Business -- Research and
Development" in Item 1.
ITEM 3. LEGAL PROCEEDINGS
Various legal actions, proceedings and claims are pending or may be
instituted against RJR or its affiliates (including RJR Tobacco) or indemnitees,
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.
For information about litigation and legal proceedings pending against RJR or
its affiliates (including RJR Tobacco) or indemnitees, see
"Business -- Litigation Affecting the Cigarette Industry" and "Business --
Environmental Matters" in Item 1; "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Governmental Activity" in Item
7; note 12 to the consolidated financial statements; and Exhibit 99.1 to this
report. A copy of Exhibit 99.1 will be provided free of charge upon request by
writing to the Corporate Secretary, R.J. Reynolds Tobacco Holdings, Inc., P.O.
Box 2866, 401 N. Main Street, Winston-Salem, NC 27402-2866, or by phoning
336-741-5162.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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Executive Officers and Certain Significant Employees of the Registrant
The executive officers and certain significant employees of RJR and RJR
Tobacco are:
Andrew J. Schindler. Mr. Schindler, 55, has served as President and Chief
Executive Officer of RJR Tobacco since 1995 and of RJR since June 14, 1999. He
has served as Director of RJR since June 14, 1999 and of RJR Tobacco since 1989,
and as Chairman of the Board of RJR and RJR Tobacco since July 2, 1999. Mr.
Schindler joined RJR in 1974. He became Senior Vice President -- Operations of
RJR Tobacco in June 1989 and was elected Executive Vice President -- Operations
of RJR Tobacco in 1991. In May of 1994, Mr. Schindler became President and Chief
Operating Officer of RJR Tobacco. He is a member of the North Carolina Advisory
Board of Wachovia Bank, N.A., the North Carolina School of the Arts Foundation
Board, the Wake Forest University Baptist Medical Center Board of Visitors and
the Board of Directors of Winston-Salem Business, Inc. Mr. Schindler is Vice
Chairman of the North Carolina Emerging Technology Alliance.
Kenneth J. Lapiejko. Mr. Lapiejko, 51, has served as Executive Vice
President and Chief Financial Officer of RJR Tobacco since June 15, 1999 and of
RJR since June 14, 1999. He has been Director of RJR Tobacco since 1996. From
1995 until 1999, he served as Senior Vice President, Chief Financial Officer and
Treasurer of RJR Tobacco. Mr. Lapiejko joined R.J. Reynolds Tobacco
International as a Senior Financial Analyst in 1977. After holding a number of
positions with RJR Tobacco, in 1991 he was promoted to Vice President of Finance
and Accounting.
Charles A. Blixt. Mr. Blixt, 48, has been Executive Vice President,
General Counsel and Director of RJR Tobacco since 1995 and Executive Vice
President, General Counsel and Assistant Secretary of RJR since June 14, 1999.
He joined RJR Tobacco as Associate Counsel -- Litigation in 1985. Mr. Blixt
serves on the Board of Visitors of Salem College and Academy and the Board of
Visitors of Wake Forest University School of Law.
Lynn J. Beasley. Ms. Beasley, 42, has served as Executive Vice
President -- Marketing of RJR Tobacco since 1997. Ms. Beasley joined RJR Tobacco
in 1982 as a marketing assistant. After holding a number of positions at RJR
Tobacco, she became Senior Vice President of the Winston/Camel business unit in
1993. From 1995 until 1997, she was Senior Vice President of Brand Marketing for
WINSTON, CAMEL and SALEM. Ms. Beasley is a member of the Senior Services Board.
She is also a member of the Board of Directors of Tultex Corporation, a
manufacturer and distributor of activewear apparel.
Robert R. Gordon, Jr. Mr. Gordon, 55, has been Executive Vice
President -- Human Resources of RJR Tobacco since 1994 and of RJR since July 2,
1999, and Director of RJR Tobacco since 1991. He joined RJR Tobacco in 1967 and
became Vice President of Personnel in 1984. In 1989, he was promoted to Senior
Vice President of Personnel of RJR Tobacco.
Thomas R. Adams. Mr. Adams, 49, has been Senior Vice President and
Controller of RJR and RJR Tobacco since June 14, 1999. From 1985 until 1999, he
was a Partner at the accounting firm of Deloitte & Touche LLP.
Gary T. Burger. In July 1999, Dr. Burger, 51, was promoted to Executive
Vice President -- Research and Development after serving as Senior Vice
President -- Research and Development of RJR Tobacco since 1996. He joined RJR
Tobacco in 1984. From 1990 until 1996, he was Vice President of the Research and
Development Product Development & Assessment Group.
Lynn L. Lane. In June 1999, Ms. Lane, 48, rejoined RJR as Senior Vice
President and Treasurer and was named Senior Vice President and Treasurer of RJR
Tobacco. She joined RJR in 1973 and was promoted to Vice President and Assistant
Treasurer of RJR in 1991. In 1995, she was named Vice President and Treasurer of
R.J. Reynolds Tobacco Worldwide. From 1996 until 1999, Ms. Lane was Vice
President -- Treasury and Investor Relations of Burlington Industries, a
manufacturer and distributor of fabrics and other textile products.
James V. Maguire. In July 1999, Mr. Maguire, 48, was promoted to Executive
Vice President -- Sales after serving as Senior Vice President -- Sales of RJR
Tobacco since 1994. He joined RJR Tobacco in 1973
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as a sales representative and after holding a number of positions at RJR Tobacco
and RJR, he became Vice President of Sales Development in 1993.
Tommy J. Payne. Mr. Payne, 42, assumed his current positions as Executive
Vice President -- External Relations of RJR Tobacco and of RJR in July 1999,
after serving as Senior Vice President -- External Relations of RJR Tobacco
since 1998 and of RJR since June 1999. He joined RJR in 1988 and was promoted to
Director of Federal Government Affairs in 1995. From 1995 until 1998, he was
Vice President -- Federal Government Affairs of RJR Tobacco in Washington, D.C.
Mr. Payne serves on the board of trustees of Winston-Salem State University, the
North Carolina Community Colleges Foundation and the RJR Tobacco Company
Foundation.
James H. Wilson. In July 1999, Mr. Wilson, 57, was promoted to Executive
Vice President -- Operations after serving as Senior Vice
President -- Operations of RJR Tobacco since 1994 and Director of RJR Tobacco
since 1997. He joined RJR Tobacco in 1962 and was promoted to Vice President of
Manufacturing in 1991.
McDara P. Folan, III. Mr. Folan, 41, joined RJR Tobacco and RJR in June
1999 as Vice President, Deputy General Counsel and Secretary. From 1992 until
1999, Mr. Folan served as Vice President, Secretary and General Counsel for
Allen Telecom Inc., a manufacturer and distributor of wireless communications
equipment, in Cleveland, Ohio.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
RJR's common stock, par value $.01 per share, is listed on the New York
Stock Exchange as RJR and began trading on June 15, 1999. On February 23, 2000,
there were approximately 39,300 holders of record of RJR's common stock.
Stockholders whose shares are held of record by a broker or clearing agency are
not included in this amount; however, each of those brokers or clearing agencies
is included as one holder of record. The common stock closing price on February
23, 2000 was $18.75.
The high and low sales prices per share for the common stock on the NYSE
Composite Tape, as reported by the NYSE, was:
HIGH LOW
------ ------
1999:
Second Quarter (from June 15, 1999)....................... $32.94 $30.38
Third Quarter............................................. 32.88 24.81
Fourth Quarter............................................ 28.38 16.00
The board of directors of RJR declared a cash dividend of $.775 per common
share, or $3.10 on an annualized basis, in the third and fourth quarters of
1999.
RJR conducts its business through its subsidiaries and is dependent on the
earnings and cash flow of its subsidiaries to satisfy its obligations and other
cash needs. Certain RJR credit facilities limit the amount of dividends,
distributions and advances by subsidiaries to RJR. RJR's credit facilities and
the distribution agreement between RJR and NGH limit the payment by RJR of
dividends on the common stock in excess of specific amounts. For more
information see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Financial Condition" in Item 7 and note 8
and note 11 to the consolidated financial statements. RJR believes that the
provisions of its credit facilities and its distribution agreement will not
impair its payment of quarterly dividends.
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ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial data as of December 31, 1999
and 1998 and for each of the three years in the period ended December 31, 1999
are derived from the consolidated financial statements and accompanying notes,
which have been audited by Deloitte & Touche LLP, independent auditors. The
selected historical consolidated financial data as of December 31,1997 and for
the year ended December 31, 1996 are derived from audited consolidated financial
statements not presented or incorporated by reference. The selected historical
consolidated financial data as of December 31, 1996 and 1995 and for the year
ended December 31, 1995 are derived from unaudited consolidated financial
statements, which are not presented or incorporated by reference, that reflect
all adjustments, consisting only of adjustments of a normal and recurring
nature, necessary for a fair presentation. These financial statements segregate
the account balances and activities of the international tobacco business and
Nabisco and report those account balances and activities as discontinued
operations. This table should be read in connection with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7 and the consolidated financial statements.
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
RESULTS OF OPERATIONS:
Net sales (1).................................... $ 7,567 $ 5,716 $ 5,044 $ 4,702 $ 4,612
Income (loss) from continuing operations......... 195 (519) 19 226 65
Net income (loss)................................ 2,343 (516) 433 666 622
PER SHARE DATA:
Basic income (loss) from continuing operations... 1.80 (4.77) .17 2.08 .60
Diluted income (loss) from continuing
operations..................................... 1.80 (4.77) .17 2.08 .60
Basic net income (loss).......................... 21.60 (4.74) 3.98 6.13 5.72
Diluted net income (loss)........................ 21.58 (4.74) 3.98 6.13 5.72
Weighted average number of common and dilutive
potential common shares used in EPS (in
thousands):
Basic.......................................... 108,495 108,691 108,691 108,691 108,691
Diluted........................................ 108,570 108,691 108,691 108,691 108,691
Cash dividends declared per share of common stock
(2)............................................ $ 1.55 $ -- $ -- $ -- $ --
BALANCE SHEET DATA (AT END OF PERIODS):
Total assets..................................... 14,377 19,310 20,251 20,747 21,391
Long-term debt................................... 1,653 4,861 4,944 4,928 4,944
Stockholders' equity............................. 7,064 9,886 11,079 11,669 12,153
OTHER DATA:
Ratio of earnings to fixed charges (3)........... 2.8 -- 1.5 2.2 1.7
Deficiency in the coverage of fixed charges by
earnings before fixed charges (3).............. $ -- $ (679) $ -- $ -- $ --
- ---------------
(1) Net sales exclude excise taxes of $1.173 billion, $1.292 billion, $1.369
billion, $1.401 billion and $1.447 billion for the years ended December 31,
1999, 1998, 1997, 1996 and 1995, respectively.
(2) RJR began trading as a separate company on June 15, 1999. A dividend of
$.775 was declared in each of the last two quarters of 1999. The annualized
dividend is $3.10.
(3) Earnings consist of income before income taxes and fixed charges. Fixed
charges consist of interest on indebtedness, amortization of debt issuance
costs, and one-third of operating rental expense, representative of the
interest factor.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis of the consolidated financial condition and
results of operations of RJR should be read in connection with the consolidated
financial statements and the related notes of RJR as of December 31, 1999 and
1998 and for each of the years in the three-year period ended December 31, 1999.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED
DECEMBER 31,
------------------------
1999 1998 1997
------ ------ ------
Net sales................................................... $7,567 $5,716 $5,044
Cost of products sold (1)................................... 3,292 1,353 1,209
Selling, general and administrative expenses................ 3,023 2,780 2,361
------ ------ ------
1,252 1,583 1,474
Tobacco settlement and related expenses (1)................. 23 1,442 359
------ ------ ------
Operating company contribution.............................. $1,229 $ 141 $1,115
====== ====== ======
- ---------------
(1) $2.178 billion and $148 million of ongoing settlement expense was recorded
in cost of products sold for the years ended 1999 and 1998, respectively.
Tobacco settlement and related expenses include only initial, up-front
tobacco settlement and related expenses.
1999 COMPARED TO 1998
Net sales of $7.6 billion for the year ended December 31, 1999 increased
32.4% over 1998. This increase was primarily due to favorable pricing of $2.5
billion, partly offset by $692 million in lower volumes. Collective price
increases since November 1998, in response to litigation settlements, have
adversely impacted the shipment volume of RJR Tobacco and the industry in
general. RJR Tobacco's total shipment volume during 1999 of 96.4 billion units,
excluding Puerto Rico and certain other territories' volume of approximately 1.4
billion units, declined 12.7% from the prior year, while industry volume
declined 9.0%. RJR Tobacco's full-price shipments represented 62.6% of total
shipments for each of the years ended December 31, 1999 and 1998, whereas
industry-wide, full-price shipments represented 73.4% and 73.0% of total
shipments for the years ended December 31, 1999 and 1998, respectively.
Compared to 1998, the 1999 shipment volume for CAMEL, excluding the
non-filter style, was down 7.4%, but outperformed the industry full-price
decline of 8.5%. Shipments of the WINSTON styles, supported by the "No Bull"
repositioning, declined 13.9% compared to 1998. WINSTON's performance has been
negatively impacted by the unprecedented settlement-related price increases and
the price sensitivity among its franchise smokers. Consequently, new WINSTON "No
Bull" programs, such as "Winston Racing Nation," are being introduced to enhance
loyalty among WINSTON's adult smokers. SALEM shipments were down 12.7% compared
to 1998, also negatively impacted by settlement-related price increases. Volume
for DORAL, the industry's leading savings brand, was down 13.5% from 1998.
DORAL's performance reflected the industry savings category decline of 10.3%
during 1999, and also was impacted negatively by increased activity from
competitive deep-discount brands.
RJR Tobacco's total retail share of market declined by 1.05 share points to
24.12% in 1999 compared to 25.17% in 1998. Most of this share loss occurred by
the end of the second quarter. In line with RJR Tobacco's strategy to stabilize,
then grow, market share on the four investment brands, the second half 1999
trend improved due to the combined performance of CAMEL, WINSTON, SALEM and
DORAL.
CAMEL's market share, excluding the non-filter style, grew almost .20 share
points on average in the last half of the year compared to the second quarter of
1999. CAMEL finished the year at 4.78% share of market, up slightly versus 4.71%
in 1998.
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WINSTON and SALEM experienced retail market share declines in the first
half of 1999, most of which occurred in the first quarter largely as a result of
the impact of increased prices and competitive activity. However, SALEM's retail
share of market has been stable since March 1999, reflecting the positive impact
of the January 1999 "It's not what you expect" national repositioning. WINSTON
styles supported by the "No Bull" repositioning were level since June 1999.
Due to gains made by deep-discount brands, DORAL, the nation's leading
savings brand, experienced slight market share declines for the full year down
from 6.38% in 1998 to 6.27% in 1999. Additional marketing programs have been put
into place to stabilize, then strengthen DORAL's share of market. DORAL's 1999
share performance, although a decline, exceeded the performance of the industry
branded-savings category, which declined to 21.89% from 22.66% in 1998.
Cost of products sold of $3.3 billion for the year ended December 31, 1999
increased $1.9 billion from 1998, primarily due to an increase of $2 billion in
ongoing settlement costs.
Selling, general and administrative expenses of $3 billion for 1999
increased $243 million, or 8.7%, from the comparable prior-year period. This
increase over 1998 was primarily due to increased promotional expenses, composed
mainly of competitive discounts provided directly to retailers and passed
through to the consumer, partly offset by lower corporate expenses.
Tobacco settlement and related expenses for initial, up-front charges,
totaling $1.442 billion during 1998, included:
"MOST
FAVORED
NATION" RATIONALIZATION EMPLOYEE
MASTER MINNESOTA ADJUSTMENTS OF SEVERANCE
SETTLEMENT SETTLEMENT FOR PREVIOUSLY MANUFACTURING AND RELATED
AGREEMENT AGREEMENT SETTLED STATES OPERATIONS BENEFITS TOTAL
---------- ---------- -------------- --------------- ----------- ------
Original charge................ $620 $312 $145 $214 $151 $1,442
Utilized in 1998............... (620) (312) (145) (214) (54) (1,345)
---- ---- ---- ---- ---- ------
Balance, December 31, 1998..... -- -- -- -- 97 97
Utilized in 1999............... -- -- -- -- (42) (42)
Adjustments in 1999............ -- -- -- -- (17) (17)
---- ---- ---- ---- ---- ------
Balance, December 31, 1999..... $ -- $ -- $ -- $ -- $ 38 $ 38
==== ==== ==== ==== ==== ======
For more information about the MSA, the Minnesota settlement and the "most
favored nation" adjustments see "Business -- Litigation Affecting the Cigarette
Industry" in Item 1 and note 12 to the consolidated financial statements. The
rationalization of manufacturing operations primarily represents a charge to
write-down the book value of one of RJR Tobacco's production facilities and
certain equipment in Winston-Salem, North Carolina to fair value. The employee
severance and related benefits expense was a charge for workforce reductions
totaling approximately 1,300 employees. These charges were in response to the
changing business conditions expected to result from the MSA agreement signed in
November 1998. Management believes that the recent price increases, which were
necessary to satisfy RJR Tobacco's ongoing annual payment obligations under the
MSA, have adversely affected, and are likely to adversely affect RJR Tobacco's
volume.
During the fourth quarter of 1999, a $17 million reversal of the liability
for employee severance and related benefits to tobacco settlement and related
expenses reflected a less-than-expected volume decline and a corresponding
less-than-expected related workforce reduction. During the third quarter of
1999, RJR Tobacco recorded $40 million, $24 million after-tax, for initial,
up-front costs related to RJR Tobacco's tobacco growers' settlement.
Cash expenditures related to the termination of employees is expected to be
approximately $80 million, of which $42 million was paid as of December 31,
1999. The remaining reserve is expected to be paid from operations in 2000.
Pre-tax savings in 1999 were approximately $57 million, and are expected to be
$86 million in 2000.
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Ongoing tobacco settlement costs of $2.2 billion and $148 million during
1999 and 1998, respectively, were included in cost of products sold.
Operating company contribution of $1.2 billion in 1999, increased $1.1
billion, primarily due to favorable pricing, partly offset by lower volumes,
higher settlement costs and higher selling, general and administrative expenses.
Excluding the impact of recorded initial, up-front tobacco settlement and
related expenses of $23 million in 1999 and $1.4 billion in 1998, operating
company contribution of $1.3 billion in 1999 decreased 20.9% from $1.6 billion
in 1998.
Restructuring expense of $80 million, $52 million after-tax, was recorded
by RJR in 1997 related to the reorganization of RJR Tobacco's operations. This
restructuring program was implemented to enhance its competitive position and
improve its long-term earnings growth prospects.
The components of the charges recorded in 1997 and utilized through
December 31, 1999 were:
EMPLOYEE RATIONALIZATION CONTRACT
SEVERANCE AND OF MANUFACTURING TERMINATION AND
RELATED BENEFITS OPERATIONS OTHER COSTS TOTAL
---------------- ---------------- --------------- -----
Original charge.............................. $ 30 $ 30 $ 20 $ 80
Utilized in 1997............................. (5) (2) -- (7)
---- ---- ---- ----
Balance, December 31, 1997................... 25 28 20 73
Utilized in 1998............................. (15) (28) (20) (63)
---- ---- ---- ----
Balance, December 31, 1998................... 10 -- -- 10
Utilized in 1999............................. (7) -- -- (7)
Adjustments in 1999.......................... (2) -- -- (2)
---- ---- ---- ----
Balance, December 31, 1999................... $ 1 $ -- $ -- $ 1
==== ==== ==== ====
The Brook Cove, North Carolina Stemmery was closed in February 1998 after
the tobacco leaf from the 1997 burley crop was processed. Beginning with the
1998 flue-cured crop, RJR Tobacco processed its leaf through a third party. The
employee severance and related benefits charge reflected the reductions of 192
full-time positions and 217 seasonal positions in manufacturing and staff,
primarily at Brook Cove. The rationalization of manufacturing operations also
related to Brook Cove. The expenses to exit this activity included the write-off
of equipment to be abandoned.
The contract termination and other costs related to management's commitment
in 1997 to a plan of termination of a leaf supply contract at a price below RJR
Tobacco's contract price. The loss represents the shortfall between the contract
cost and the amount that was recovered upon the sale of the leaf inventory. RJR
Tobacco, acting as a broker, exercised all of its remaining obligations under a
leaf supply contract and immediately transferred title to a third party without
taking possession of the tobacco.
Of the $80 million total restructuring charge, cash outlays will total
approximately $42 million. During 1999 and 1998, approximately $7 million and
$35 million, respectively, were cash outlays. During the third quarter of 1999,
RJR reduced the accrued restructuring charge by $2 million reflecting
lower-than-expected expenses. Pre-tax savings were $18 million and $33 million
in 1999 and 1998, respectively, and are expected to be $18 million in 2000.
Headquarters close-down and related charges recorded by RJR in the second
quarter of 1999 of $143 million, $93 million after-tax, reflected the
elimination of its New York corporate headquarters. Total cash expenditures
related to this charge were $122 million. The elimination of its headquarters
resulted from reorganization transactions, described in note 2 to the
consolidated financial statements, that fundamentally changed its business and
capital structure. Approximately $127 million of the charge was for severance
and related benefits for approximately 100 employees in the elimination of all
functions at the New York headquarters. The employment of these individuals was
terminated on June 14, 1999, at which time RJR satisfied its obligation in full.
The remainder of the charge was primarily related to contractual lease
termination payments and the write-off of leasehold improvements and abandoned
equipment. During 1999, pre-tax savings were approximately $30 million.
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23
Interest and debt expense of $268 million in 1999 decreased $158 million
from the prior-year period. The 1999 decrease resulted from the repurchase of
approximately $4 billion of debt, partly offset by the issuance of $1.25 billion
of debt. See note 11 to the consolidated financial statements.
Interest income increased to $114 million in 1999 from $7 million in 1998,
mainly due to the temporary investment of net proceeds from the sale of the
international tobacco business in the second quarter of 1999. See note 2 to the
consolidated financial statements.
Other expense, net increased $23 million in 1999 from the prior year,
primarily due to various expenses related to the reorganization.
Provision for (benefit from) income taxes included a 1999 tax provision of
$315 million, or an effective rate of 61.8%, compared to a $160 million tax
benefit, or an effective rate of 23.6%, in 1998. The variances of the effective
rates from the statutory rate of 35% were primarily due to the adverse impact of
nondeductible goodwill amortization on income (loss) before income taxes. This
impact increased the 1999 provision, and decreased the 1998 benefit.
Discontinued operations increased approximately $2.4 billion, after-tax,
compared to 1998. This increase was primarily due to the gain on the sale of the
international tobacco business in May of 1999, partially offset by the loss on
the recognition of Nabisco's cumulative translation adjustment account. See note
2 to the consolidated financial statements.
Extraordinary loss of approximately $384 million, $250 million after-tax,
was incurred during 1999 in connection with the repurchase of approximately $4
billion of debt securities. See note 2 to the consolidated financial statements.
1998 COMPARED TO 1997
Net sales of $5.7 billion in 1998 increased 13.3% from $5.0 billion in
1997. The increase was driven by higher prices partly offset by lower volumes.
RJR Tobacco's manufacturer's list prices increased in 1998 by approximately $.64
per pack.
RJR Tobacco's overall retail share of market decreased to 25.17% from
25.41% in 1997 reflecting its full-price share decrease to 16.27% from 16.65% in
1997, while its savings share increased to 8.90% from 8.76% in 1997. CAMEL's
retail share increased to 5.31% from 5.18% in 1997. This strength was primarily
attributed to two new 1998 promotions for CAMEL, the "Mighty Tasty Lifestyles"
sweepstakes and the new CAMEL Cash catalog. WINSTON's retail share was flat for
the year. SALEM's market share declined to 3.44% in 1998 from 3.71%. In
response, RJR Tobacco expanded the "It's not what you expect" repositioning
nationally in early 1999, with special emphasis on markets where the full-price
menthol segment is strong. DORAL's retail share increased to 6.38% in 1998 from
5.90% in the prior year, solidifying its position as the nation's leading
savings brand. During September 1998, the brand introduced a new advertising
campaign, "Imagine Getting More."
The mix between RJR Tobacco's full-price and savings brands changed
slightly, as full-price shipments represented 62.6% of total shipments in 1998
compared to 63.4% in 1997. The trend away from full-price towards savings brands
reflects the impact of price increases on full-price volumes to a greater extent
than savings volumes.
Cost of products sold of $1.4 billion in 1998 increased 11.9% from $1.2
billion in 1997. The increase was due primarily to the inclusion of $148 million
in ongoing settlement costs in 1998 with no corresponding charge in 1997.
Selling, general and administrative expenses of $2.8 billion in 1998
increased 17.7% from $2.4 billion in 1997. The increase was due primarily to a
26.8% increase in competitive discounts provided directly to retailers and
passed through to consumers.
Tobacco settlement and related expenses were $1.4 billion for initial,
up-front tobacco settlement costs in 1998 compared to $359 million in 1997. The
1997 charges related to settlement agreements reached with the
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Florida, Mississippi and Texas state attorneys general and in certain class
action cases. See note 3 to the consolidated financial statements.
Restructuring expense of $80 million was recorded in 1997, with no
corresponding expense in 1998. See note 4 to the consolidated financial
statements.
Provision for (benefit from) income taxes included a tax benefit of $160
million, or a 23.6% effective rate, in 1998 compared to a tax provision of $185
million, or a 90.7% effective rate, in 1997. The rate decrease is primarily due
to the relative impact of nondeductible goodwill amortization on income (loss)
before income taxes.
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 enable it
to meet its obligations under the MSA with attorneys general for most U.S.
states, territories and possessions and other existing settlement agreements, to
fund its budgeted capital expenditures and to make payments to RJR that will
enable 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 its cash requirements related to any future settlement and
judgements, including cash required to bond any appeals, if necessary, and make
no assurance that it will be able to meet all of those requirements.
CASH FLOWS
Net cash flows from operating activities were $819 million in 1999 in
comparison to $367 million in 1998. The increase in cash flow primarily results
from 1999 price increases, partly offset by lower volume, in addition to the
fourth quarter of 1998 payment of tobacco settlements. Net cash flows from
operating activities in 1998 declined from $628 million in 1997, primarily due
to increased 1998 tobacco settlement payments.
Net cash flows from investing activities for 1999 were $7.7 billion,
compared to a use of $43 million in 1998. The increase is primarily due to the
proceeds received from the sale of the international tobacco business. Net cash
flows used in investing activities in 1998 were slightly lower than the $46
million in 1997, due to lower capital expenditures in 1998, offset by lower
proceeds from the sale of various assets during 1998.
Net cash flows used in financing activities were $5.4 billion in 1999,
compared to $611 million in 1998. The increase in funds used was primarily due
to payments of approximately $4.5 billion for the early extinguishment of debt
and related costs, as well as transfers and payments of approximately $2 billion
made to RJR's former parent company. These increases were partially offset by
proceeds from the issuance of $1.25 billion of private placement debt. During
1998, net cash flows used in financing activities declined from $848 million in
1997, primarily due to decreased payments on short-term borrowings in 1998
partly offset by the 1997 issuance of long-term debt.
Net cash flows related to discontinued operations were adversely impacted
during 1999, primarily by income taxes paid on the gain on the sale of the
international tobacco business.
In connection with the spin-off from NGH, RJR has assumed, subject to
specified exceptions, all U.S. pension liabilities and related assets for
current and former tobacco employees. The additional cash required, compared to
1998, to fund these liabilities was $58 million in 1999 and is expected to be
approximately $58 million in each of the years 2000, 2001, 2002 and 2003.
In November 1999, RJR's board of directors authorized the repurchase of
shares of its common stock from time to time on the open market, with a maximum
cost of $125 million. Effective February 2, 2000, RJR's board of directors
expanded its share repurchase authorization by an additional $100 million. The
purpose of the stock repurchase program is to enhance stockholder value. The
stock repurchases will be
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25
funded by cash flows from operations. The timing of repurchases and the number
of shares ultimately repurchased will depend upon market conditions. As of
December 31, 1999, RJR had repurchased 2,727,400 shares of its common stock,
with a total cost of approximately $55 million. As of February 23, 2000, RJR had
repurchased a total of 6,370,656 shares, at a total cost of $125 million.
DEBT
On April 13, 1999, RJR offered to purchase substantially all of its
outstanding debt securities and sought consents from the holders of those
securities to waive covenants that might have prevented some of the
reorganization transactions described in note 2 to the consolidated financial
statements. These consents were received as of April 26, 1999. The tender offers
were completed on May 18, 1999. RJR repurchased approximately $4 billion of its
debt with a portion of the proceeds from the sale of the international tobacco
business and recognized an extraordinary loss from the early extinguishment of
debt of approximately $384 million, $250 million after-tax.
Effective May 18, 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 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
December 31, 1999, RJR had $417 million in letters of credit and no borrowings
outstanding, with the remaining $818 million of the facility available for
borrowing. RJR was in compliance with the covenants of the facility at December
31, 1999. RJR had additional letters of credit outstanding of approximately $3
million as of December 31, 1999.
On May 18, 1999, RJR completed an aggregate $1.25 billion private placement
offering 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 December 31, 1999.
On July 16, 1999, RJR filed a registration statement, which became
effective October 8, 1999, in order to issue publicly registered notes in
exchange for the $1.25 billion private placement notes originally issued on May
18, 1999. The terms of the exchange notes are identical to the terms of the
private placement notes, except the transfer restrictions and registration
rights relating to the private placement notes do not apply to the exchange
notes. The exchange was substantially completed in November 1999.
As of December 31, 1999, RJR also had $345 million of foreign currency
debt, with fixed interest rates between 5.375% and 6.875%, due in 2000, and $451
million of public notes, at fixed interest rates of 6.8% through 10%, due in
2000 through 2013. See note 11 and note 13 to the consolidated financial
statements.
On December 10, 1999, RJR filed a shelf registration statement, which
became effective December 22, 1999, for $1.876 billion of debt securities.
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DIVIDENDS
The board of directors of RJR declared a cash dividend of $.775 per common
share, $3.10 on an annualized basis, in the third and fourth quarters of 1999.
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.
CAPITAL EXPENDITURES
Capital expenditures were $55 million in 1999, $47 million in 1998 and $57
million in 1997. Management expects that its capital expenditure program will
continue at a level sufficient to support the strategic and operating needs of
RJR Tobacco. RJR Tobacco plans to spend $50 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 December 31, 1999.
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
"Business -- Litigation Affecting the Cigarette Industry" and
"Business -- Environmental Matters" in Item 1; "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Governmental
Activity" in Item 7; note 12 to the consolidated financial statements; and
Exhibit 99.1 to this report. 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 under "Business -- Litigation
Affecting the Cigarette Industry" in Item 1, the MSA imposes a stream of future
payment obligations on RJR Tobacco and the other major U.S. cigarette
manufacturers and places significant restrictions on their ability to market and
sell cigarettes in the future. The cash payments made by RJR Tobacco under the
MSA and other existing settlement agreements were approximately $1.6 billion in
1999 and $786 million in 1998. RJR Tobacco estimates its payments in 2000 to
exceed $2.2 billion and in future years to 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.
Cigarettes are subject to substantial excise taxes in the United States.
The federal excise tax per pack of 20 cigarettes was $.34 as of January 1, 2000.
The federal cigarette excise tax will increase by $.05 per pack in 2002. In his
budget submitted to Congress in February 2000, President Clinton included a $.25
additional increase in the federal excise tax and an acceleration of the $.05
increase from January 2002 to October 2000. Also, he included a provision
requiring the tobacco industry to pay the federal government an additional
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$3,000 for every underage smoker if the smoking rate among teenagers fails to
decline by at least 50% by 2004. In addition, all states and the District of
Columbia impose excise taxes at levels ranging from $.025 per pack in Virginia
to $1.11 per pack in New York.
In 1964, the Report of the Advisory Committee to the Surgeon General of the
U.S. Public Health Service concluded that cigarette smoking was a health hazard
of sufficient importance to warrant appropriate remedial action. Since 1966,
federal law has required a warning statement on cigarette packaging. Since 1971,
television and radio advertising of cigarettes has been prohibited in the United
States. Cigarette advertising in other media in the United States is required to
include information with respect to the "tar" and nicotine yield of cigarettes,
as well as a warning statement.
During the past three decades, various laws affecting the cigarette
industry have been enacted. In 1984, Congress enacted the Comprehensive Smoking
Education Act. Among other things, the Smoking Education Act:
- establishes an interagency committee on smoking and health that is
charged with carrying out a program to inform the public of any dangers
to human health presented by cigarette smoking;
- requires a series of four health warnings to be printed on cigarette
packages and advertising on a rotating basis;
- increases type size and area of the warning required in cigarette
advertisements; and
- requires that cigarette manufacturers provide annually, on a
confidential basis, a list of ingredients added to tobacco in the
manufacture of cigarettes to the Secretary of Health and Human Services.
The warnings currently required on cigarette packages and advertisements
are:
- "SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease,
Emphysema, And May Complicate Pregnancy";
- "SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious
Risks To Your Health";
- "SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in
Fetal Injury, Premature Birth, and Low Birth Weight"; and
- "SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide".
Since the initial report in 1964, the Secretary of Health, Education and
Welfare (now the Secretary of Health and Human Services) and the Surgeon General
have issued a number of other reports which purport to find the nicotine in
cigarettes addictive and to link cigarette smoking and exposure to cigarette
smoke with certain health hazards, including various types of cancer, coronary
heart disease and chronic obstructive lung disease. These reports have
recommended various governmental measures to reduce the incidence of smoking. In
1992, the federal Alcohol, Drug Abuse and Mental Health Act was signed into law.
This act requires states to adopt a minimum age of 18 for purchases of tobacco
products and to establish a system to monitor, report and reduce the illegal
sale of tobacco products to minors in order to continue receiving federal
funding for mental health and drug abuse programs. In January 1996, the U.S.
Department of Health and Human Services announced regulations implementing this
legislation.
The U.S. Food and Drug Administration has promulgated regulations asserting
jurisdiction over cigarettes as "medical devices" under the provisions of the
Food, Drug and Cosmetic Act. These regulations include severe restrictions on
the distribution, marketing and advertising of cigarettes, and would require the
industry to comply with a wide range of labeling, reporting, recordkeeping,
manufacturing and other requirements. The FDA's exercise of jurisdiction, if not
reversed by judicial or legislative action, could lead to more expansive
FDA-imposed restrictions on cigarette operations than those set forth in the
regulations, and could materially adversely affect RJR Tobacco's business,
volume, results of operations, cash flows and financial position. 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 December 1,
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1999, the U.S. Supreme Court heard the FDA's appeal of the Fourth Circuit's
ruling. RJR is awaiting the Court's decision.
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.
Legislation imposing various restrictions on public smoking has also been
enacted in 48 states and many local jurisdictions, and many employers have
initiated programs restricting or eliminating smoking in the workplace. A number
of states have enacted legislation designating a portion of increased cigarette
excise taxes to fund either anti-smoking programs, health-care programs or
cancer research. In addition, educational and research programs addressing
health-care issues related to smoking are being funded from industry payments
made or to be made under settlements with state attorneys general. Federal law
prohibits smoking on all domestic airline flights of six hours duration or less,
and the U.S. Interstate Commerce Commission has banned smoking on buses
transporting passengers inter-state. Certain common carriers have imposed
additional restrictions on passenger