UNITED STATES
FORM 10-K/A
(Mark One)
For the fiscal year ended December 31, 2002
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
Commission file number: 1-6388
Delaware | 56-0950247 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
401 North Main Street
(336) 741-5500
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 | |||||||
Common stock, par value $.01 per share | New York | 8 3/4 Notes due August 15, 2005 | New York | |||||||
7 5/8 Notes due September 15, 2003 | New York | 8 3/4 Notes due July 15, 2007 | New York | |||||||
8 3/4 Senior Notes due April 15, 2004 | New York | 9 1/4 Debentures due August 15, 2013 | New York |
Securities registered pursuant to Section 12(b) 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. YESx NOo
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.x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
YESx NOo
The aggregate market value of common stock held by non-affiliates of R.J. Reynolds Tobacco Holdings, Inc. on June 28, 2002 was approximately $4.8 billion, based on the closing price of $53.75. 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 4, 2003: 84,849,600 shares of common stock, par value $.01 per share.
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 19, 2003 are incorporated by reference into Part III of this report.
INDEX
Part II | ||||||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 3 | ||||
Part IV | ||||||
Item 15. | Exhibits, Financial Statement Schedules, and Reports on Form 8-K | 26 | ||||
Signatures | 27 |
EXPLANATORY NOTE
This Form 10-K/A, Amendment No. 2 amends the annual report of R. J. Reynolds Tobacco Holdings, Inc. referred to as RJR, on Form 10-K for the year ended December 31, 2002, referred to as the 2002 Form 10-K, filed with the SEC on March 3, 2003, and Form 10-K/A to the 2002 Form 10-K, filed with the SEC on January 15, 2004. The purpose of this amendment is to include additional disclosure regarding tobacco-related litigation under “Results of Operations” in Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This amendment is limited in scope to the portions of the 2002 Form 10-K set forth above and does not amend, update or change any other items or disclosures contained in the original 2002 Form 10-K.
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PART II
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
You should read this discussion and analysis of RJR’s consolidated financial condition and results of operations in conjunction with the consolidated financial statements and the related notes as of December 31, 2002 and 2001 and for each of the years in the three-year period ended December 31, 2002.
Business Trends and Initiatives
RJR’s operating subsidiaries primarily conduct business in the highly competitive U.S. cigarette market with a few large manufacturers and many smaller participants. The U.S. cigarette market is believed to be a mature market, and overall consumer demand is expected to decline over time. Trade inventory adjustments may result in short-term changes in demand for RJR Tobacco’s products if, and when, wholesale and retail tobacco distributors adjust the timing of their purchases of product to manage their inventory level. However, RJR Tobacco believes it is not appropriate for it to speculate on external factors that may impact the purchasing decision of the wholesale and retail tobacco distributors.
Competition is primarily based on a brand’s products, positioning, consumer loyalty, retail display, promotion, price and advertising. Substantial marketing support, merchandising display, competitive pricing and other financial incentives generally are required to maintain or improve a brand’s market position or to introduce a new brand. Established cigarette brands historically have had a competitive advantage in the United States because significant cigarette marketing restrictions have made gaining consumer awareness and trial of new brands difficult.
RJR’s operating subsidiaries are committed to building strong brands. RJR Tobacco’s marketing programs are designed to strengthen each brand’s image, build brand awareness and loyalty, and attract adult smokers of competing brands, primarily in an effort to grow share of market on RJR Tobacco’s four key brands. RJR Tobacco has repositioned or introduced brand styles and line extensions designed to build each brand’s equity and attract adult smokers of competitive brands, but there can be no assurance that such efforts will be successful.
In addition to building strong brand equity, RJR Tobacco’s marketing approach utilizes a retail pricing strategy, including discounting at retail, to defend its brands’ shares of market against competitive pricing pressure. Competitive discounting has increased significantly as a result of higher state excise taxes and the growth of deep-discount brands. Deep-discount brands are brands manufactured by manufacturers that are not original participants in the MSA, and accordingly, which do not have cost structures burdened with MSA payments to the same extent as the original participating manufacturers.
Starting in mid-July 2002, RJR Tobacco’s largest competitor significantly increased promotional spending. These increases, together with the continued growth of the deep-discount price-tier of the market and the impact of substantially higher state excise taxes, have resulted in an adverse business environment. During 2002, excise taxes were significantly increased in 20 states and New York City. To maintain competitive prices RJR Tobacco increased its promotional spending in the second half of 2002. The increased promotional costs may continue into the foreseeable future. Management cannot predict the adverse impact, if any, that these circumstances may have on RJR’s results of operations or financial condition, including the fair value of RJR’s goodwill or RJR Tobacco’s trademarks.
Although the level and rate of change of retail sales to consumers, referred to as consumption, are not independently available, consumption trend estimates are generated. These estimates are based on shipment volume, retail share of market, trade inventory levels and pricing in the marketplace. In recent years, the consumption decline for the industry has been estimated to be approximately 2% to 3% annually. RJR Tobacco believes its consumption decline has been somewhat greater than that of the industry, due to the higher price sensitivity of its consumers on some of its brands. This acceleration in the decline is believed to be due to the substantial increase in state excise taxes and continued pricing pressure from the deep-discount price-tier, potential acceleration in industry consumption decline, as well as general economic conditions.
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During the fourth quarter of 2002, RJR implemented a restructuring plan in an effort to streamline its cost structure and improve long-term earnings. The restructuring plan included a workforce reduction, expected to be primarily completed in the first half of 2003, and the reclassification of certain non-tobacco businesses as held-for-sale.
Critical Accounting Policies
Accounting principles generally accepted in the United States of America require estimates and assumptions to be made that affect the reported amounts in RJR’s consolidated financial statements and accompanying notes. Some of these estimates require difficult, subjective and/or complex judgments about matters that are inherently uncertain, and as a result, actual results could differ from those estimates. Due to the estimation processes involved, the following summarized accounting policies and their application are considered to be critical to understanding the business operations, financial condition and results of operations of RJR and its subsidiaries.
Tobacco–Related Litigation
RJR and RJR Tobacco disclose information concerning tobacco-related litigation for which an unfavorable outcome is other than remote. RJR Tobacco and its affiliates record their legal expenses and other litigation costs and related administrative costs as selling, general and administrative expenses as these costs are incurred.
As discussed in “Business — Litigation Affecting the Cigarette Industry” in Item 1 and note 14 to the consolidated financial statements, RJR Tobacco and its affiliates have been named in a number of tobacco-related legal actions, proceedings or claims seeking damages in amounts ranging into the hundreds of millions or even billions of dollars. Unfavorable judgments awarding compensatory damages, punitive damages and/or fines have been returned against RJR Tobacco in theEngleclass action case, a small number of individual smoking and health cases, aBroin IIflight attendant ETS case, a healthcare cost recovery case, an MSA enforcement action and a California state law enforcement action. However, RJR Tobacco believes that it has numerous bases for successful appeals in these cases, and both RJR Tobacco and RJR believe they have a number of valid defenses to all actions and intend to defend all actions vigorously. RJR’s management continues to conclude that the loss of any particular smoking and health tobacco litigation claim against RJR Tobacco or its affiliates, when viewed on an individual basis, is not probable. Accordingly, no liability for tobacco-related litigation currently is recorded in RJR’s consolidated financial statements. RJR and RJR Tobacco will record any loss related to tobacco litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated. When the reasonable estimate is a range, the recorded loss will be the best estimate within the range. If no amount in the range is a better estimate than any other amount, the minimum amount of the range will be recorded.
Litigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could ultimately be decided against RJR Tobacco, or its affiliates, including RJR. Any unfavorable outcome of such actions could have a material adverse effect on the results of operations, cash flows or financial condition of RJR or its subsidiaries.
Settlement Agreements
As discussed in “Business — Litigation Affecting the Cigarette Industry” in Item 1 and note 14 to the consolidated financial statements, RJR’s operating subsidiaries are participants in the MSA and other state settlement agreements related to governmental health–care cost recovery actions. Their obligations and the related expense charges under the MSA and other settlement agreements are subject to adjustments based upon, among other things, the volume of cigarettes sold by the operating subsidiaries, their relative market share and inflation. Since relative market share is based on cigarette shipments, the best estimate of the allocation of charges under these agreements is recorded in costs of products sold as the products are shipped. Settlement expenses under these MSA and other settlement agreements recorded in the accompanying consolidated statements of income were $2.5 billion in 2002, $2.6 billion in 2001 and $2.3 billion in 2000.
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RJR Tobacco estimates that its settlement charges will approximate $2.2 billion in each of 2003 and 2004, and exceed $2.3 billion in 2005, subject to adjustments, including those discussed above.
Goodwill and Trademarks
As of December 31, 2001, the carrying values of RJR Tobacco’s goodwill and trademarks were $6.9 billion and $2.8 billion, respectively. RJR Tobacco recorded goodwill and trademark amortization expense of $362 million during 2001 and $366 million during 2000.
On January 1, 2002, RJR adopted the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” which provides that trademarks and goodwill are no longer amortized and requires the testing of impairment based on fair value. For initial application of SFAS No. 142, an independent appraisal firm was engaged to value RJR’s goodwill and trademarks as of January 1, 2002. RJR’s goodwill as of January 1, 2002 was attributable to one reporting unit, RJR Tobacco, which comprises substantially all of RJR’s consolidated results of operations and financial condition. No goodwill impairment was indicated, since the fair value of RJR was determined to be greater than its carrying value using several valuation techniques, including discounted cash flow analysis.
Other intangible assets as of January 1, 2002 consisted of RJR Tobacco’s trademarks acquired through business combinations, which have indefinite useful lives. However, the trademarks of WINSTON, VANTAGE, SALEM, NOW and MORE each had a fair value less than its carrying value, using the present value of estimated future cash flows assuming a discount rate of 11%, which yielded results consistent with available market-approach data. Accordingly, a cumulative effect of an accounting change of $830 million, or $502 million after tax, was recorded during the quarter ended March 31, 2002.
In the fourth quarter of 2002, impairment occurred on two of RJR Tobacco’s non-key brands, VANTAGE and CENTURY. The annual valuation, in accordance with SFAS No. 142, indicated that the carrying values of these brands were in excess of their fair values. Accordingly, RJR Tobacco recorded an impairment charge of $13 million, $8 million after tax. Factors that may impact the fair value of goodwill and trademarks include, among other things, the level of brand support, consumer demand, governmental regulations, the ability to raise prices and changes in the competitive environment. As discussed under “— Business Trends and Initiatives,” RJR Tobacco cannot predict the impact of current market circumstances on the fair value of goodwill or trademarks.
Pension and Post Retirement Benefits
Pension expense is determined in accordance with the provisions of SFAS Nos. 87 and 88. Gains or losses are annual changes in the amount of either the benefit obligation or the market-related value of plan assets resulting from experience different from that assumed or from changes in assumptions. The minimum amortization of unrecognized gains or losses, as described in SFAS No. 87, is included in pension expense. Prior service costs, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the average remaining service period for active employees. The market-related value of plan assets recognizes changes in fair value in a systematic and rational manner over five years.
During 2002, actual asset returns for RJR’s pension assets were adversely impacted by the continued deterioration of the equity markets and declining interest rates. For the year ended December 31, 2002, the asset return on RJR’s pension plan was approximately negative 11%. Additionally, corporate bond yields, which are used in determining the discount rate for future pension obligations, continued to decline. The negative asset returns and declining discount rates unfavorably affected RJR’s 2002 year-end SFAS No. 87, “Employers’ Accounting for Pensions,” funded status. Pension expense in 2003 will be adversely impacted due to these events and by RJR lowering the expected return on asset assumption from 9.5% per annum for 2002 to 9.0% per annum for 2003. RJR voluntarily contributed $100 million to its pension plan in January 2003.
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At December 31, 2002, the pension benefit obligation of RJR’s pension plans exceeded the fair value of plan assets by $933 million. As a result of the unfavorable equity market performance and benefit payments made during 2002, there has been a reduction in the plan assets of $245 million during 2002. As a result of the decline in the fair value of plan assets, and changes in actuarial assumptions, including the discount rate used to calculate the pension benefit obligation, pension expense is expected to increase. In 2002, pension expense totaled $39 million, including $37 million curtailment and special benefit changes related to the 2002 restructuring plan. RJR expects pension expense in 2003 to approximate $90 million. Additional cash funding may be made in the future.
Management assumptions were made concerning future events that determine the amount and timing of benefit payments, the present value of those benefit payments and the return on plan assets.
The weighted average actuarial assumptions used to determine the funded status of the pension and postretirement benefit plans as of December 31 were:
2002 | 2001 | |||||||
Discount rate | 6.4 | % | 7.4 | % | ||||
Expected return on pension plan assets | 9.0 | % | 9.5 | % | ||||
Rate of compensation increase | 5.0 | % | 5.0 | % |
The weighted average actuarial assumptions used to determine the total benefit cost of these plans during the years ended December 31 were:
2002 | 2001 | 2000 | ||||||||||
Discount rate | 7.4 | % | 7.5 | % | 8.0 | % | ||||||
Expected return on pension plan assets | 9.5 | % | 9.5 | % | 9.5 | % | ||||||
Rate of compensation increase | 5.0 | % | 5.0 | % | 5.0 | % |
The discount rate was based on the average yield of a hypothetical bond portfolio. The portfolio used was determined by selecting a portfolio of high-quality corporate bonds to match the estimated future cash flows from the benefit plans.
The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation. RJR’s third-party investment consultant calculates an expected return with regard to realistic and projectable asset return assumptions reflective of current economic conditions. The assumptions relied upon reflect a combination of historical performance analysis and forward-looking views of the financial markets based upon the yield on long-term bonds and the price-earnings ratios of the major stock market indices.
Assumed asset return and discount rates have a significant effect on the amounts reported for the benefit plans. A one-percentage-point change in the assumed discount rate for the pension plans would have the following effects:
1-Percentage | 1-Percentage | |||||||
Point | Point | |||||||
Increase | Decrease | |||||||
Effect on Net Periodic Benefit Cost | $ | (3 | ) | $ | 13 | |||
Effect on Benefit Obligation | (246 | ) | 270 |
A one-percentage-point change in the assumed asset return for the pension plans would have the following effects:
1-Percentage | 1-Percentage | |||||||
Point | Point | |||||||
Increase | Decrease | |||||||
Effect on Net Periodic Benefit Cost | $ | (23 | ) | $ | 23 |
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A one-percentage-point change in the assumed discount rate for the post retirement benefits would have the following effects:
1-Percentage | 1-Percentage | |||||||
Point | Point | |||||||
Increase | Decrease | |||||||
Effect on Net Periodic Benefit Cost | $ | (6 | ) | $ | 6 | |||
Effect on Benefit Obligation | (87 | ) | 96 |
Merchandising Fixtures
In response to changes in industry retail displays, RJR Tobacco accelerated its replacement of certain merchandising fixtures beginning in the fourth quarter of 2002. As a result, accelerated amortization of $43 million, or $27 million after tax, was recorded during the fourth quarter of 2002. Additionally, the service life of merchandising fixtures has been reduced from five years to three years for fixtures acquired after September 30, 2002, reflecting usage of more technologically dependent components that are subject to accelerated obsolescence. Amortization expense of fixtures during 2003 is expected to approximate that of 2002.
RJR Tobacco believes that the assumptions used to calculate the accelerated amortization charge are reasonable given current information, and if actual experience differs materially from current assumptions, the effects on the accelerated amortization charge will be reflected in the period it becomes known.
Recent Accounting Developments
Reductions of Net Sales
Effective January 1, 2002, EITF No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” requires that consideration paid to a distributor or retailer to promote the vendor’s products, such as slotting fees or buydowns, generally be characterized as a reduction of revenue when recognized in the vendor’s income statement. EITF No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products),” became effective in November 2001, codifying and reconciling certain issues in EITF No. 00-25. With respect to estimated amounts of consideration that will be claimed by customers, costs are recognized at the latter of the date at which the related revenue is recognized or the date at which the sales incentive is offered. As of January 1, 2002, RJR’s operating subsidiaries have characterized the applicable costs as reductions of net sales rather than as selling, general and administrative expenses. For the years ended December 31, 2001 and 2000, $2.3 billion and $2.0 billion, respectively, were reclassified from selling, general and administrative expenses to a reduction of net sales. The adoption of EITF No. 00-25, as codified by EITF No. 01-9, did not impact RJR’s consolidated financial position, operating income or net income.
Effective January 1, 2001, RJR and its subsidiaries adopted the EITF No. 00-14, “Accounting for Certain Sales Incentives,” which addresses the recognition, measurement and income statement classification for certain sales incentives, including rebates, coupons and free products or services. EITF No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products),” became effective in November 2001, codifying and reconciling certain issues in EITF No. 00-14. EITF No. 00-14 requires that in the accompanying consolidated income statements, certain costs that historically were included in selling, general and administrative expenses now be classified in cost of products sold or as reductions of net sales. With respect to estimated amounts of redemptions or free products that will be claimed by customers, costs are recognized at the latter of the date at which the related revenue is recognized or the date at which the sales incentive is offered. For the year ended December 31, 2000, $220 million was reclassified from selling, general and administrative expense, with an increase to cost of products sold of $111 million and a reduction to net sales of $109 million. The adoption of EITF No. 00-14 did not impact RJR’s consolidated annual net income or cumulative earnings.
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Long-Lived Assets
On January 1, 2002, RJR adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and certain portions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 provides updated guidance concerning the recognition and measurement of an impairment loss for certain types of long-lived assets, and requires that long-lived assets to be disposed of by sale be measured at the lower of the carrying amount or fair value less cost to sell, and reported separately in the asset and liabilities sections of the consolidated balance sheet. SFAS No. 144 also expands the reporting of discontinued operations to include components of an entity that have been or will be disposed of. The scope of SFAS No. 144 excludes long-lived assets, goodwill and other intangibles that are accounted for in accordance with SFAS No. 142. The adoption of SFAS No. 144 did not have a material impact on the consolidated results of operations, financial position or cash flows.
Guarantees
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 requires the disclosure of certain guarantees existing at December 31, 2002. In addition, FIN No. 45 requires the recognition of a liability for the fair value of the obligation of qualifying guarantee activities that are initiated or modified after December 31, 2002. Accordingly, RJR will apply the recognition provisions of FIN No. 45 prospectively to guarantee activities initiated after December 31, 2002. See note 14 to the consolidated financial statements for further information regarding guarantees, including indemnities related to the 1999 sale of the international business to Japan Tobacco Inc., Nabisco Group Holdings Corp.’s sale of Nabisco Holdings Corp. to Philip Morris Companies, Inc., environmental matters and intercompany debt and related instruments. RJR is not able to estimate the maximum potential amount of future payments, if any, related to these guarantees. RJR has recorded liabilities totaling approximately $130 million at December 31, 2002 relating to these guarantees.
Stock Compensation
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of SFAS No. 123.” SFAS No. 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to that statement’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provision of SFAS No. 123 and APB No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies about the method of accounting for stock-based compensation and the effects of the method on reported net income and earnings per share in annual and interim financial statements. The transition and disclosure provisions of this statement are effective for financial statements for fiscal years ending after December 15, 2002. RJR has not elected the fair value-based method of accounting for stock-based compensation under SFAS No. 123, as amended by SFAS No. 148.
Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 nullifies EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized when it is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Under SFAS No. 146, an entity may not restate its previously issued financial statements. RJR does not expect the adoption of SFAS No. 146 to have a material impact on its financial position, results of operations or cash flows.
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In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” This interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 is effective February 1, 2003 for variable interest entities created after January 31, 2003, and July 1, 2003 for variable interest entities created prior to February 1, 2003. RJR does not expect the adoption of FIN No. 46 to have a material impact on its financial position, results of operations or cash flows.
Results of Operations
�� | |||||||||||||
2002 | 2001 | 2000 | |||||||||||
Net sales | $ | 6,211 | $ | 6,269 | $ | 6,085 | |||||||
Cost of products sold (1) | 3,732 | 3,560 | 3,436 | ||||||||||
Selling, general and administrative expenses | 1,463 | 1,429 | 1,369 | ||||||||||
Restructuring and asset impairment charges | 224 | — | — | ||||||||||
Trademark impairment charge | 13 | — | 89 | ||||||||||
Amortization of trademarks & goodwill | — | 362 | 366 | ||||||||||
Other operating expense | — | — | (3 | ) | |||||||||
Operating income | $ | 779 | $ | 918 | $ | 828 | |||||||
(1) | Includes settlement expense of $2,514 million, $2,584 million and $2,329 million for the years ended 2002, 2001 and 2000, respectively. |
2002 Compared with 2001
Net salesof $6.2 billion for the year ended December 31, 2002 decreased 0.9% from 2001. Of this decrease, $111 million was due to a less favorable, full-price/savings-brand mix and lower overall volume partially offset by $53 million of favorable pricing, net of higher promotional spending.
Domestic shipment volume for RJR’s operating subsidiaries, in billions of units, included:
For the Twelve Months | |||||||||||||
Ended December 31, | |||||||||||||
% | |||||||||||||
2002 | 2001 | Change | |||||||||||
RJR Tobacco key brands: | |||||||||||||
Camel ex. Regular | 22.1 | 20.9 | 5.7 | % | |||||||||
Winston Base | 17.9 | 19.0 | (5.5 | )% | |||||||||
Salem | 9.5 | 10.6 | (11.1 | )% | |||||||||
Doral | 24.6 | 23.5 | 4.4 | % | |||||||||
RJR Tobacco total full-price | 55.5 | 57.4 | (3.4 | )% | |||||||||
RJR Tobacco total savings | 35.1 | 33.3 | 5.4 | % | |||||||||
RJR Tobacco total domestic (1) | 90.6 | 90.7 | (0.2 | )% | |||||||||
RJR total domestic (1) | 91.6 | 90.7 | 1.0 | % | |||||||||
Industry: (2) | |||||||||||||
Full-price | 284.8 | 300.1 | (5.1 | )% | |||||||||
Savings | 106.6 | 106.3 | 0.4 | % | |||||||||
Industry total domestic | 391.4 | 406.4 | (3.7 | )% | |||||||||
(1) | Excludes Puerto Rico and certain other U.S. territories’ volume. |
(2) | The source of industry data is Management Science Associates. This data may not include all shipments of some manufacturers that Management Science Associates is presently unable to monitor effectively. RJR Tobacco believes that the industry total domestic shipment volume may not fully include deep-discount volume. |
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The 0.2% decline from the prior-year period in RJR Tobacco’s total domestic shipment volume reflected an overall decline in retail sales to consumers, partially offset by the estimated slight building of inventories by wholesale and retail distributors.
Shipments in the full-priced tier were 61.2% and 63.3% of RJR Tobacco’s total domestic shipments for the years ended December 31, 2002 and 2001, respectively. Industry full-price shipments were 72.8% and 73.9% of total domestic shipments for the years ended December 31, 2002 and 2001, respectively.
RJR Tobacco’s retail share of market, according to data from Information Resources Inc./Capstone, averaged 22.93% for the year ended December 31, 2002, a decrease of .49 share points when compared with the prior year.
CAMEL, RJR Tobacco’s largest full-price brand, continued its growth trend. CAMEL’s share of market, excluding the non-filtered style, was 5.69% in 2002, compared with 5.52% in 2001. CAMEL’s growth was based on the strength of the brand’s equity, its “Pleasure to Burn” positioning and initiatives to market CAMEL’s three distinct product families — the Classic, Turkish and Exotic families, which contributed to the brand’s strong performance in 2002.
Base WINSTON’s retail share averaged 4.57% in 2002, compared with 4.84% in 2001. Despite intense competitive price pressures, its market share has remained relatively stable since March 2002. In 2003, the brand is strengthening its positioning with a new “Leave the Bull Behind” marketing campaign highlighting WINSTON’s additive-free, naturally smooth tobacco blends. During 2002, WINSTON’s S2 line extension, launched in 2001, was stable, but did not meet anticipated sales volumes.
SALEM’s share declined to 2.41% in 2002 compared with 2.73% in 2001, reflecting reduced levels of in-market support while the brand evaluated opportunities to strengthen its positioning. In the second quarter of 2003 the brand will launch a new “Stir the Senses” campaign and expansion of the Slide Box styles into additional markets. The brand’s new packaging communicates that SALEM offers adult smokers a range of choices in menthol styles: SALEM Green Label, with a lighter menthol taste, and SALEM Black Label, with a richer menthol-and-tobacco taste.
The retail market share of DORAL, the nation’s best-selling brand in the savings-brand tier, averaged 5.86% in 2002, down slightly from 5.92% in 2001. DORAL grew market share during the course of 2002, reversing its prior-year trend primarily due to a comprehensive brand upgrade. DORAL’s improved trend reflects increased promotional support, new tobacco blends on key styles, modernized packaging and the imaginative “Splendidly Blended” advertising campaign.
In 2003, RJR Tobacco will begin a phased expansion of ECLIPSE, a cigarette that primarily heats rather than burns tobacco, into a select number of retail chain outlets. Based on learning garnered from the ECLIPSE test market in Dallas/Fort Worth since April 2000, where the brand built a small — but loyal — franchise of adult smokers, RJR Tobacco believes the brand has business potential if it is selectively distributed and supported by cost-efficient communications targeted to specific prospective adult smokers. This move further underscores RJR Tobacco’s commitment to finding ways to develop and market consumer-acceptable cigarettes that may present less smoking-related health risk. RJR Tobacco has concluded that ECLIPSE may present less risk for certain, but not all, smoking related diseases, when compared with tobacco-burning cigarettes. This conclusion is based on the weight of evidence from several scientific studies conducted internally by RJR Tobacco and externally by several universities, funded by RJR Tobacco, and reviewed by an outside expert scientific panel.
Cost of products sold of $3.7 billion increased 4.8% or $172 million from 2001, primarily due to increased promotional product costs, raw material costs and the inclusion of Santa Fe’s operations. These increases were partially offset by $70 million lower settlement costs.
Selling, general and administrative expenses increased $34 million to $1.5 billion in 2002 from the prior year. This change over the prior year was primarily due to accelerated amortization of $43 million related to the replacement of merchandising fixtures. The increase was also impacted by higher legal expenses and the
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Selling, general and administrative expenses include the costs of litigating and administering product liability claims, as well as other legal expenses. For the years ended December 31, 2002 and 2001, RJR Tobacco’s product liability defense costs were $192 million and $165 million, respectively.
“Product liability” cases generally include smoking and health related cases. In particular, these cases include the following categories of cases listed in the table of cases set forth in “Business — Litigation Affecting the Cigarette Industry — Overview” in Item 1 and note 14 to the consolidated financial statements:
• | Individual Smoking and Health; | |
• | Flight Attendant — ETS (Broin II); | |
• | Class Actions; | |
• | Governmental Health-Care Cost Recovery; | |
• | Other Health-Care Cost Recovery and Aggregated Claims; and | |
• | Asbestos Contribution. | |
“Product liability defense costs” include the following items:
• | direct and indirect compensation, fees and related costs and expenses for internal legal and related administrative staff administering product liability claims; | |
• | fees and cost reimbursements paid to outside attorneys; | |
• | direct and indirect payments to third party vendors for litigation support activities; | |
• | expert witness costs and fees; and | |
• | payments to the Council for Tobacco Research — U.S.A., Inc. which funds are used primarily by the CTR to fund its legal defense costs. | |
Numerous factors affect the amount of product liability defense costs. The most important factors are the number of cases pending and the number of cases in trial or in preparation for trial (i.e., with active discovery and motions practice). See “Business — Litigation Affecting the Cigarette Industry — Overview” in Item 1 and note 14 to the consolidated financial statements for detailed information regarding the number and type of cases pending, and “Business — Litigation Affecting the Cigarette Industry — Scheduled Trials” in Item 1 and note 14 to the consolidated financial statements for detailed information regarding the number and nature of cases in trial and scheduled for trial through the end of 2003. The increase in product liability defense costs in 2002 compared with 2001 was primarily due to an increase in the level of activity in cases in preparation for trial, in trial and on appeal in 2002 compared with 2001.
RJR Tobacco expects that the factors described above will continue to have the primary impact on its product liability defense costs in the future. Given the level of activity in cases in preparation for trial, in trial and on appeal and the amount of product liability defense costs incurred by RJR Tobacco over the past three years, RJR Tobacco’s recent experiences in defending its product liability cases and the reasonably anticipated level of activity in RJR Tobacco’s pending cases and possible new cases, RJR Tobacco does not expect that the variances in its product liability defense costs will be significantly different than they have been historically. However, it is possible that adverse developments in the factors discussed above, as well as other circumstances beyond the control of RJR Tobacco, could have a material adverse effect on the financial condition, results of operation or cash flows of RJR or its subsidiaries. Those other circumstances beyond the control of RJR Tobacco include the results of present and future trials and appeals, and the development of possible new theories of liability by plaintiffs and their counsel.
Restructuring and asset impairment charges of $224 million, $135 million after tax, were recorded in the fourth quarter 2002, related to the 2002 restructuring plan including the sale of certain non-tobacco
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The non-tobacco businesses included in the restructuring plan were remeasured at the lower of their carrying value or fair value less cost to sell, and classified as assets held for sale and liabilities related to assets held for sale in the consolidated balance sheet at December 31, 2002, in accordance with SFAS No. 144. This remeasurement resulted in a $115 million charge in the fourth quarter of 2002.
Contract termination and other exit costs consisted of $7 million related to contract and lease termination payments, and exit costs related to the segregation of the non-tobacco businesses held for sale.
The cash portion of the restructuring charge primarily relates to employee severance costs and is expected to be $68 million. No significant amount was expended as of December 31, 2002. Annual savings are expected to be approximately $50 million in 2003 and $75 million in 2004.
Atrademark impairment chargeof $13 million, $8 million after tax, was incurred in the fourth quarter of 2002, on two non-key brands, VANTAGE and CENTURY. The impairment was indicated during the annual valuation in accordance with SFAS No. 142, based on their estimated undiscounted net future cash flows. The impairment charge was measured as the excess of the brands’ carrying values over fair values, determined using the present value of estimated future cash flows assuming a discount rate of 10.5%. This impairment charge is reflected as a decrease in the carrying value of the trademarks in the consolidated balance sheets, as a trademark impairment charge in the 2002 consolidated income statement and had no impact on cash flows.
Amortization expensewas eliminated in 2002, reflecting the adoption of SFAS No. 142 on January 1, 2002. Amortization expense in 2001 was $362 million.
Interest and debt expensewas $147 million and $150 million in 2002 and 2001, respectively. This reduction was due to interest rate swaps acquired in the first and second quarters, mostly offset by the increased average debt balance resulting from the May 2002 issuance of the $750 million of notes.
Interest incomeduring 2002 was $62 million, a decline of $75 million when compared with 2001, primarily due to lower interest rates in 2002.
Other expense, netdecreased $2 million for the year ended December 31, 2002 from the prior year, reflecting lower financing-related fees mostly offset by earnings on investments accounted for under the equity method.
Provision for income taxeswas $265 million, or an effective rate of 38.8%, in 2002 compared with $448 million, or an effective rate of 50.2%, in 2001. The effective tax rate in 2002 exceeded the federal statutory rate of 35% primarily due to the impact of state taxes and, to a lesser extent, certain non-deductible items. The effective tax rate in 2001 exceeds the federal statutory rate of 35% primarily due to the impact of certain nondeductible items, including goodwill amortization, and to a lesser extent, state taxes.
Discontinued operationsin 2002 included a $40 million after-tax reversal of an indemnification accrual, reflecting a favorable settlement, and in 2001, included a $9 million after-tax, purchase-price adjustment. Both transactions relate to the 1999 sale of the international tobacco business to Japan Tobacco Inc. Including these adjustments, the net after-tax gain on the sale of the international tobacco business was $2.4 billion.
2001 Compared with 2000
Net salesof $6.3 billion for the year ended December 31, 2001 increased 3.0% over 2000. This increase was primarily driven by favorable pricing of $0.7 billion, net of discounting, as a result of price increases in 2001 and the last half of 2000, partially offset by volume declines of $0.5 billion.
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Domestic shipment volume for RJR’s operating subsidiaries, in billions of units, included:
For the Twelve Months Ended | |||||||||||||
December 31, | |||||||||||||
% | |||||||||||||
2001 | 2000 | Change | |||||||||||
RJR Tobacco key brands: | |||||||||||||
Camel ex. Regular | 20.9 | 20.6 | 1.6 | % | |||||||||
Winston Base | 19.0 | 19.7 | (3.7 | )% | |||||||||
Salem | 10.6 | 12.3 | (13.7 | )% | |||||||||
Doral | 23.5 | 26.2 | (10.1 | )% | |||||||||
RJR Tobacco total full-price | 57.4 | 60.9 | (5.7 | )% | |||||||||
RJR Tobacco total savings | 33.3 | 35.5 | (6.2 | )% | |||||||||
RJR Tobacco total domestic (1) | 90.7 | 96.4 | (5.9 | )% | |||||||||
Industry: (2) | |||||||||||||
Full-price | 300.1 | 308.5 | (2.7 | )% | |||||||||
Savings | 106.3 | 111.3 | (4.4 | )% | |||||||||
Industry total domestic | 406.4 | 419.8 | (3.2 | )% | |||||||||
(1) | Excludes Puerto Rico and certain other U.S. territories’ volume. |
(2) | The source of industry data is Management Science Associates. This data may not include all shipments of some manufacturers that Management Science Associates is presently unable to monitor effectively. RJR Tobacco believes that the industry total domestic shipment volume may not fully include deep-discount volume. |
The 5.9% decline from the prior-year period in RJR Tobacco’s total domestic shipment volume was due to estimated declines in the inventory levels of wholesale and retail distributors and decreased consumption. Consumption of RJR Tobacco’s products, representing retail sales to consumers, declined approximately 2.8% during 2001 compared with 2000.
Shipments in the full-priced tier were 63.3% and 63.2% of RJR Tobacco’s total domestic shipments for the years ended December 31, 2001 and 2000, respectively. Industry full-price shipments were 73.9% and 73.5% of total domestic shipments for the years ended December 31, 2001 and 2000, respectively.
RJR Tobacco’s retail share of market, according to data from Information Resources Inc./Capstone, averaged 23.42% for the year ended December 31, 2001, a decrease of .16 share points when compared with the prior year.
CAMEL continued its growth trend in 2001. CAMEL’s share of market, excluding the non-filtered style, was 5.52% in 2001, compared with 5.14% in 2000. CAMEL’s growth was attributed to its strong “Pleasure to Burn” positioning, which was enhanced by unique programs such as the “Seven Pleasures of the Exotic” consumer events, and the strength of its Turkish line extensions. Following the successful launch of CAMEL Turkish Gold in 2000, the brand launched CAMEL Turkish Jade, a menthol line extension, during the third quarter of 2001.
Base WINSTON’s retail share averaged 4.84% in 2001, up from 4.76% in 2000. During 2001, WINSTON modernized its “No Boundaries, No Bull” positioning by launching WINSTON S2, a line extension that features a new blend and high-impact silver embossed packaging. Additionally, the base WINSTON family was enhanced to incorporate the same silver highlights.
SALEM’s share averaged 2.73% in 2001 compared with 3.01% in 2000. SALEM’s decline was due to increased competitive activity in the menthol category coupled with reduced marketing support in SALEM’s ten emphasis markets in the latter portion of 2001. While the trend in the ten emphasis markets had been better than in the balance of the country, the brand continued evaluating opportunities to strengthen its performance.
Through the last three quarters of 2001, DORAL’s share of market declined after holding relatively steady at 6.1 to 6.2 share points for several quarters. The retail share of market of DORAL, the nation’s best-
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Cost of products soldof $3.6 billion increased $124 million from 2000, primarily due to an increase of $255 million in ongoing settlement costs partially offset by decreased volume and lower raw material costs.
Selling, general and administrative expensesof $1.4 billion in 2001 increased $60 million from the prior year. This change over the prior year was primarily due to increased retail discounting, partially offset by lower legal expenses.
Selling, general and administrative expenses include the costs of litigation and administering product liability claims, as well as other legal expenses. For the years ended December 31, 2001 and 2000, RJR Tobacco’s product liability defense costs were $165 million and $179 million, respectively.
Amortization expensedecreased $4 million to $362 million during 2001, reflecting the impact of trademark impairment during 2000.
Animpairment chargeof $89 million, $54 million after tax, was recorded on two of RJR Tobacco’s non-key brands, MAGNA and CENTURY. The impairment was the result of a decision, in the fourth quarter of 2000, to reduce market support of these brands. The related impairment testing indicated that the carrying amount of these brands would not be recoverable through future undiscounted cash flows. The impairment was based on the excess of the brands’ carrying value over fair value, determined using the present value of estimated future cash flows assuming a discount rate of 12.0%. This impairment charge is reflected as a decrease in trademarks in the consolidated balance sheets, as an impairment charge in the 2000 consolidated income statement and had no impact on cash flows. As a result of this charge, amortization expense related to trademarks was $4 million lower in 2001 than in 2000.
Tobacco settlement and related expensesincluded a $3 million reversal for the completion of a $1.4 billion pre-tax tobacco settlement and related charge recorded in 1998 by RJR Tobacco. This tobacco settlement and related expense charge was in response to the MSA and other state settlement agreements. At December 31, 1998, $1.3 billion had been utilized. Since December 31, 1998, the remaining liability for employee severance and related benefits for workforce reductions totaling approximately 1,300 employees was utilized through cash expenditures of $76 million and the reversal of $21 million, due to a less-than-expected workforce reduction.
Interest and debt expensewas $150 million and $168 million in 2001 and 2000, respectively. This decrease primarily resulted from lower debt balances.
Interest incomeduring 2001 increased $18 million when compared with the prior year, primarily reflecting a higher average cash balance during 2001 when compared with 2000, partially offset by declining interest rates.
Other expense, netdecreased $18 million for the year ended December 31, 2001 from the prior year. This decrease was primarily due to foreign exchange losses realized during 2000 on debt denominated in foreign currencies. All debt denominated in foreign currencies was retired in 2000.
Provision for income taxeswas $448 million, or an effective rate of 50.2%, in 2001 compared with $449 million, or an effective rate of 60.0%, in 2000. The effective tax rates exceed the federal statutory rate of 35% primarily due to the impact of certain nondeductible items, including goodwill amortization, and to a lesser extent, state taxes.
Discontinued operationsin 2001 included a $14 million, $9 million after-tax, purchase-price adjustment of the 1999 gain on the sale of the international tobacco business to Japan Tobacco Inc. Discontinued operations in 2000 included a $53 million after-tax gain resulting from a re-evaluation of tax reserves related to
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Extraordinary itemincluded a gain of $1.5 billion realized during the fourth quarter of 2000 in connection with RJR’s acquisition of NGH. See note 2 to the consolidated financial statements for further discussion.
Liquidity and Financial Condition
Liquidity
At present, the principal sources of liquidity for RJR’s operating subsidiaries’ businesses and operating needs are internally generated funds from their operations and borrowings through RJR. Cash flows from operating activities are believed to be sufficient for the foreseeable future to enable the operating subsidiaries to meet their obligations under the MSA, to fund their capital expenditures and to make payments to RJR that will enable RJR to make its required debt-service payments and to pay dividends to RJR’s stockholders. Additionally, the acquisition of NGH in December 2000 provided $1.5 billion cash proceeds to RJR Acquisition Corp., which has funded RJR’s share repurchase programs, the acquisition of Santa Fe and dividends to its stockholders. The negative impact, if any, on the sources of liquidity that could result from a decrease in demand for products due to short-term inventory adjustments by wholesale and retail distributors cannot be predicted. RJR cannot predict its cash requirements or those of its subsidiaries related to any future settlements or judgments, including cash required to be held in escrow or to bond any appeals, if necessary, and RJR makes no assurance that it or its subsidiaries will be able to meet all of those requirements.
Contractual obligations as of December 31, 2002 were:
Payments Due by Period | |||||||||||||||||||||
Less than | 1-3 | 4-5 | |||||||||||||||||||
Total | 1 Year | Years | Years | Thereafter | |||||||||||||||||
Long-term debt (1) | $ | 2,496 | $ | 741 | $ | 644 | $ | 353 | $ | 758 | |||||||||||
Operating leases (2) | 38 | 19 | 16 | 2 | 1 | ||||||||||||||||
Non-qualified pension obligations (3) | * | 5 | 11 | 11 | * | ||||||||||||||||
Joint venture funding (4) | 29 | 29 | — | — | — | ||||||||||||||||
Service agreement (5) | 26 | 12 | 12 | 2 | — | ||||||||||||||||
Equipment purchase commitment (6) | 3 | 3 | — | — | — | ||||||||||||||||
Total Cash Obligations | $ | 2,592 | $ | 809 | $ | 683 | $ | 368 | $ | 759 | |||||||||||
* | Obligations beyond five years are not estimatable. For more information about RJR’s pension plan, see note 18 to the consolidated financial statements. |
(1) | For more information about RJR’s long-term debt, see “— Debt” below and note 13 to the consolidated financial statements. |
(2) | Operating lease obligations represent estimated lease payments primarily related to computer equipment, and to a lesser extent, aviation services and field sales offices. |
(3) | For more information about RJR’s pension plan, see note 18 to the consolidated financial statements. |
(4) | Joint venture funding is provided each budget year, denominated in euros. For more information about the joint venture, see note 2 to the consolidated financial statements. |
(5) | A service agreement related to the joint venture with Gallaher Group Plc. provides for annual payments denominated in pounds Sterling. For more information about the related joint venture, see note 2 to the consolidated financial statements. |
(6) | Equipment purchase commitments are related to firm commitments denominated in euros, to purchase manufacturing equipment. For more information, see note 15 to the consolidated financial statements. |
RJR Tobacco estimates that its settlement charges will approximate $2.2 billion in 2003 and range from $2.0 billion to $2.3 billion each year thereafter. For more information about RJR Tobacco’s settlement payments, see “Business — Litigation Affecting the Cigarette Industry” in Item 1 and note 14 to the consolidated financial statements.
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Commitments as of December 31, 2002 were:
Commitment | |||||||||
Expiration Period | |||||||||
Less than | |||||||||
Total | 1 Year | ||||||||
Standby letters of credit backed by revolving credit facility | $ | 17 | $ | 17 | |||||
Total commitments | $ | 17 | $ | 17 | |||||
Cash Flows
Net cash flows from operating activities decreased $137 million to $489 million when compared with 2001. This decrease is primarily due to the decreased operating income as a result of increased promotional expenses in response to competitive promotions in the second half of 2002. Net cash flows from operating activities of $626 million in 2001 increased $36 million from 2000. This change primarily reflects increased revenues from higher pricing and increased interest income, partially offset by increased tobacco settlement expenses, raw material purchases and promotional expenses.
Net cash flows used in investing activities increased $513 million to $820 million compared with 2001. This change is primarily due to investments in short-term securities, utilizing the proceeds from the May 2002 issuance of notes; the cash payment for the acquisition of Santa Fe, net of cash acquired; and to a lesser extent, an increase in capital expenditures. These investments were partially offset by proceeds from the maturity of short-term securities in the fourth quarter, which were used to make required debt-service payments and to pay dividends to stockholders. Net cash flows used in investing activities were $307 million in 2001 compared with net cash inflows of $1.6 billion in 2000. This change is primarily due to investments in short-term securities in 2001, compared with $1.5 billion net proceeds from the NGH acquisition in 2000. Net cash flows used in investing activities during 2001 included a $14 million, $9 million after-tax, purchase-price adjustment of the 1999 gain on the sale of the international tobacco business.
Net cash flows used in financing activities were $105 million in 2002 compared with a use of $842 million in 2001. This reduction is primarily due to the funds received from the May 2002 issuance of $750 million of public notes, partially offset by an increase in repurchases of common stock. Net cash flows used in financing activities of $842 million in 2001, compared with $881 million in 2000, included $314 million reduction of long-term debt maturities during 2001 mostly offset by a $263 million increase in the repurchase of common stock.
Net cash flows related to discontinued operations in 2000 included an $84 million refund of taxes paid on the gain on the 1999 sale of the international tobacco business.
In connection with the spin-off from NGH in 1999, 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 with 1998, to fund these liabilities was $58 million in each of 2001, 2000 and 1999. In January 2002, RJR contributed the expected additional cash requirement of $58 million for each of 2002 and 2003. As a result, the Pension Benefit Guaranty Corporation cancelled the related $116 million letter of credit. RJR contributed $100 million to its pension plan in January 2003.
Stock Repurchases
The following tables summarize stock repurchases from November 1999 through February 4, 2003. These repurchases have been made under programs authorized by RJR’s board of directors and funded through cash provided by operating activities and from RJR Acquisition Corp., utilizing the cash proceeds of the NGH acquisition. The objective of the current program, authorized February 6, 2002 to enhance stockholder value, is to repurchase shares of RJR’s common stock over time in the open market, with a maximum aggregate cost of $1.0 billion. The timing of repurchases and the number of shares repurchased under this authorization amount will depend upon internal operating cash requirements and market conditions. RJR also purchases stock through a program designed to repurchase shares related to tax liability concerning
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Repurchases — 2002 and 2003 | Shares | Cost | |||||||
(In Millions) | |||||||||
$300 million authorization | 1,600,000 | $ | 95 | ||||||
$1 billion authorization | 7,745,700 | 410 | |||||||
1999 LTIP tax withholding | 119,074 | 6 | |||||||
Total during 2002. | 9,464,774 | 511 | |||||||
$1 billion authorization | 926,360 | 42 | |||||||
1999 LTIP tax withholding | 237,756 | 10 | |||||||
Total during 2003. | 1,164,116 | 52 | |||||||
Total through February 4, 2003. | 10,628,890 | $ | 563 | ||||||
Cumulative | Period Completed | Shares | Cost | |||||||
Programs completed | November 1999 to February 2002 | 21,570,739 | $ | 875 | ||||||
$1 billion approved February 6, 2002 | Ongoing — $548 million remaining | 8,672,060 | 452 | |||||||
1999 LTIP tax withholding | Ongoing | 356,830 | 16 | |||||||
Total as of February 4, 2003 | 30,599,629 | $ | 1,343 | |||||||
Dividends
On February 5, 2003, RJR’s board of directors declared a quarterly cash dividend of $0.95 per common share. The dividend will be paid on April 1, 2003 to stockholders of record as of March 11, 2003. On an annualized basis, the dividend rate is $3.80 per common share.
Capital Expenditures
RJR Tobacco’s capital expenditures were $111 million, $74 million and $60 million in 2002, 2001 and 2000, respectively. RJR Tobacco’s capital expenditure program is expected to continue at a level sufficient to support its strategic and operating needs. RJR Tobacco plans to spend $105 million to $115 million for capital expenditures during 2003, funded primarily by cash flows from operations. This increase in 2002 and 2003 over recent years is primarily due to increased equipment replacements. There were no material long-term commitments for capital expenditures as of December 31, 2002.
Debt
RJR’s revolving credit facility with a syndicate of banks was amended and restated on May 10, 2002. Under the amendment and restatement, the committed amount will remain at $622 million until May 2003, at which time the committed amount will be reduced to $531 million through November 2004. The amendment and restatement was further amended on January 17, 2003, to modify among other things, certain financial covenants and definitions to take into account the effect of the restructuring charges incurred by RJR in the fourth quarter of 2002. RJR can use the full facility to obtain loans or letters of credit, at its option. RJR Tobacco and RJR Acquisition Corp. have guaranteed RJR’s obligations under the revolving credit facility. If RJR’s guaranteed unsecured notes are rated below BBB- by Standard & Poor’s or Baa3 by Moody’s, RJR’s other material subsidiaries will be required to guarantee the facility. If RJR’s guaranteed unsecured notes, including the notes issued in May 2002, are rated below BBB- by Standard & Poor’s and below Baa3 by Moody’s, or two levels below these thresholds for either of these rating agencies, RJR and the guarantors will be required to pledge all of their assets to secure their obligations under RJR’s revolving credit facility.
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RJR is not required to maintain compensating balances; however, RJR pays commitment fees of 1% per annum of the committed amount. The credit 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. Under the credit facility, cumulative dividends and share repurchases generally may not exceed the sum of $500 million plus 50% of cumulative adjusted cash net income. Despite this general restriction, however, the credit facility further provides that (1) the remaining amount from the $1.5 billion proceeds from the NGH acquisition, and any further proceeds thereon, may be used to pay dividends and repurchase shares, and (2) up to an additional $500 million in dividends and share repurchases may be made. Most of the proceeds from the NGH acquisition and the earnings thereon, however, have been used for these purposes. Stock repurchases also are limited to the extent that a stated minimum level of net worth must be maintained. Borrowings under the revolving credit facility bear interest at rates that vary with the prime rate or LIBOR. At December 31, 2002, RJR and RJR Tobacco had $17 million in letters of credit outstanding under the facility. No borrowings were outstanding, and the remaining $605 million of the facility was available for borrowing.
Since the spin-off in 1999, RJR’s unsecured, unsubordinated debt notes have maintained the ratings of BBB-by Standard & Poor’s and Baa2 by Moody’s. In December 2002, Moody’s revised its outlook to negative but maintained its rating, reflecting its concern over the impact of industry trends including heavy promotional activity in the premium price-tier and the growth of the deep-discount price-tier despite the reduction in payments under the MSA.
RJR also has a $30 million uncommitted, unsecured line of credit with one bank. No borrowings were outstanding on this line of credit at December 31, 2002.
RJR filed a registration statement, effective in October 1999, in order to issue publicly registered notes of $550 million in principal amount at 7.375% due in May 2003, $500 million in principal amount at 7.75% due in May 2006 and $200 million in principal amount at 7.875% due in May 2009 in exchange for an aggregate $1.25 billion of private placement debt securities. The net proceeds received from the private placement were used for general corporate purposes.
RJR filed a shelf registration statement, effective December 1999, for the issuance of up to $1.876 billion of debt securities, guaranteed by RJR Tobacco. RJR filed a second shelf registration statement, effective in April 2001, superseding the initial registration and adding RJR Acquisition Corp. as a guarantor of these debt securities. Under this registration statement, in May 2002, RJR completed the sale of $300 million of 6.5% notes due in June 2007, and $450 million of 7.25% notes due in June 2012. The proceeds from the sale of these notes are intended to be used to repay RJR’s 7.375% notes due in May 2003, in the principal amount of $550 million. The remainder of the proceeds is intended to be used for the repayment of other public notes due through 2004.
The $2.0 billion guaranteed unsecured notes described above are unsecured obligations and, unlike RJR’s other non-bank debt, are guaranteed by RJR Tobacco and RJR Acquisition Corp. In addition, any other subsidiaries of RJR that in the future guarantee the $622 million revolving credit facility, as amended and restated, will also be required to guarantee these notes. If RJR and the guarantors are required to pledge their assets to secure their obligations under the revolving credit facility, as amended and restated, they also will be required to pledge certain of their assets to secure these notes. Excluded from the pledge to secure these notes are intellectual property, inventory, accounts receivable and certain other assets. Generally, the terms of these 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.
As long as RJR’s unsecured, unsubordinated debt rating remains investment grade, RJR may be required to post collateral under its interest rate swap agreements if the fair value of the interest rate swaps results in a liability position that exceeds specified threshold amounts. If RJR’s unsecured, unsubordinated debt rating is either one level below BBB- by Standard & Poor’s or Baa3 by Moody’s, any fair value that results in a liability position of the interest rate swaps will require full collateralization. In addition, as long as RJR’s existing revolving credit facility is in place, if RJR and the guarantors are required to pledge their assets to secure their
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RJR was in compliance with all covenants and restrictions imposed by its indebtedness at December 31, 2002.
On December 11, 2000, related to the acquisition of NGH, RJR acquired $98 million of 9.5% junior subordinated debentures, due in 2047, with a mandatory redemption date of September 30, 2003. Interest on these debentures is paid quarterly in arrears. These debentures are effectively defeased by an irrevocable trust, which is included in other current assets in the accompanying consolidated balance sheet as of December 31, 2002 and in other assets and deferred charges as of December 31, 2001. The trust holds certain U.S. government obligations maturing at such times and in such amounts sufficient to pay interest and principal.
On December 1, 2002, RJR repaid $43 million of public notes with a fixed interest rate of 8.625% on their due date. As of December 31, 2002, RJR had $288 million of public notes outstanding, at fixed interest rates of 7.625% through 9.25%, due in 2003 through 2013.
Litigation and Settlements
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’s operating subsidiaries’ products, are pending or may be instituted against RJR Tobacco or its affiliates, including RJR, or indemnitees. In July 2000, a jury in the Florida state court caseEngle v. R. J. Reynolds Tobacco Co.rendered a punitive damages verdict in favor of the “Florida class” of plaintiffs of approximately $145 billion, with approximately $36.3 billion being assigned to RJR Tobacco. RJR Tobacco and other defendants have appealed this verdict. RJR Tobacco believes it has numerous bases for a successful appeal, although it cannot predict the outcome of the appellate process. For further discussion of theEnglecase and other litigation and legal proceedings pending against RJR or its affiliates or indemnitees, see “Business — Litigation Affecting the Cigarette Industry,” “Business — ERISA Litigation” and “Business — Environmental Matters” in Item 1; “— Governmental Activity”; note 14 to the consolidated financial statements; and Exhibit 99.1 to this report. Even though RJR’s management continues to conclude that the loss of any particular smoking and health tobacco litigation claim against RJR Tobacco or its affiliates, when viewed on an individual basis, is not probable, the possibility of material losses related to tobacco litigation is more than remote. However, RJR’s management is unable to predict the outcome of such litigation or to reasonably estimate the amount or range of any possible loss. Moreover, notwithstanding the quality of defenses available to it and its affiliates in tobacco-related litigation matters, it is possible that RJR’s results of operations, cash flows or financial condition could be materially adversely affected by the ultimate outcome of certain pending or future litigation matters.
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 and note 14 to the consolidated financial statements, the MSA imposes a stream of future payment obligations on RJR Tobacco and the other major U.S. cigarette manufacturers and places significant restrictions on their ability to market and sell cigarettes in the future. The cash payments made by RJR Tobacco under the MSA and other existing state settlement agreements were $2.5 billion, $2.4 billion and $2.2 billion in 2002, 2001 and 2000, respectively. RJR Tobacco estimates these payments will be $1.9 billion in 2003 and will exceed $2 billion per year thereafter. However, these payments will be subject to adjustments for, 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 or results of operations of the MSA and the other existing state 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.
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Governmental Activity
The marketing, sale, taxation and use of cigarettes have been subject to substantial regulation by government and health officials for many years. Various state governments have adopted or are considering, among other things, legislation and regulations increasing their excise taxes on cigarettes; restricting displays and advertising of tobacco products; establishing fire safety standards for cigarettes; raising the minimum age to possess or purchase tobacco products; requiring the disclosure of ingredients used in the manufacture of tobacco products; imposing restrictions on smoking in public and private areas and restricting the sale of tobacco products directly to consumers or other unlicensed recipients, including over the Internet. In addition, in 2003, the U.S. Congress may consider legislation regarding further increases in the federal excise tax, regulation of cigarette manufacturing and sale by the U.S. Food and Drug Administration, amendments to the Federal Cigarette Labeling and Advertising Act to require additional warnings, reduction or elimination of the tax deductibility of advertising expenses, implementation of a national standard for “fire-safe” cigarettes, regulation of the retail sale of cigarettes over the Internet and changes to the tobacco price support program. 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 is $0.39. All states and the District of Columbia currently impose excise taxes at levels ranging from $.025 per pack in Virginia to $1.51 per pack in Massachusetts. During 2002, 20 states and New York City approved an increase in their excise taxes, raising the weighted average state cigarette excise tax per pack from $0.42 in 2001 to $0.62. RJR Tobacco expects state excise taxes to increase even further in 2003 due to many states having budget shortfalls. Since January 1, 2003, the District of Columbia has increased its excise tax on cigarettes to $1.00 per pack and numerous states have pending legislation proposing further state excise tax increases.
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 four 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 |
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• | “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.
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 judgment of the district court was in turn vacated by the U. S. Court of Appeals for the Fourth Circuit on December 11, 2002, on the ground that the district court lacked jurisdiction to review the EPA’s report. RJR Tobacco has not decided whether to seek review of the appellate court’s decision. The appellate decision raises important legal issues, but, ten years after the appearance of the original EPA report, the practical issues are not compelling because other agencies have reached similar conclusions and smoking restrictions have increasingly proliferated.
Legislation imposing various restrictions on public smoking also has 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 in scheduled passenger aircraft, 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 smoking.
Several states have enacted or proposed legislation or regulations that would require cigarette manufacturers to disclose the ingredients used in the manufacture of cigarettes. In July 1996, Massachusetts enacted legislation requiring manufacturers of tobacco products sold in Massachusetts to report yearly, beginning December 15, 1997, the ingredients of each brand sold. The statute also requires the reporting of nicotine yield ratings in accordance with procedures established by the state. The legislation contemplates public disclosure of all ingredients in descending quantitative order, a trade-secret disclosure that RJR Tobacco believes could damage the competitive position of its brands. RJR Tobacco, together with other cigarette manufacturers, filed suit in the U.S. District Court for the District of Massachusetts seeking to have the statute declared invalid. In September 2000, the district court permanently enjoined enforcement of provisions of the law relating to ingredient reporting and issued a judgment in favor of the cigarette manufacturers. The United States Court of Appeals for the First Circuit upheld the district court’s judgment on December 2, 2002. The Massachusetts attorney general has not announced whether the Commonwealth will seek review by the Supreme Court.
In August 1998, the Massachusetts Department of Public Health issued proposed regulations for public comment that would require annual reporting, beginning July 1, 2000, on a brand-by-brand basis of 43 smoke constituents in both mainstream smoke and sidestream smoke. RJR Tobacco, together with other cigarette manufacturers, filed comments with the MDPH on October 9, 1998. RJR Tobacco and the other manufacturers believe that the MDPH lacks legal authority to promulgate these regulations. Nevertheless, RJR Tobacco and the other manufacturers have conducted a cooperative benchmarking study to address certain MDPH concerns. The benchmarking study obtained smoke constituent information on a representative number of
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On May 21, 1999, RJR Tobacco, Lorillard Tobacco Company, Brown & Williamson Tobacco Corporation and Philip Morris, Inc. filed lawsuits in the U.S. District Court for the District of Massachusetts to enjoin implementation of certain Massachusetts attorney general regulations concerning the advertisement and display of tobacco products. The regulations went beyond those required by the MSA, and banned outdoor advertising of tobacco products within 1,000 feet of any school or playground, as well as any indoor tobacco advertising placed lower than five feet in stores within the 1,000-foot zone. The district court ruled against the industry on January 25, 2000, and the U. S. Court of Appeals for the First Circuit affirmed. The U.S. Supreme Court granted the industry’s petition for writ of certiorari on January 8, 2001, and ruled in favor of RJR Tobacco and the rest of the industry on June 28, 2001. The Supreme Court found that the regulations were preempted by the Federal Cigarette Labeling and Advertising Act, which precludes states from imposing any requirement or prohibition based on smoking and health with respect to the advertising or promotion of cigarettes labeled in conformity with federal law.
In June 2000, the New York State legislature passed legislation charging the state’s Office of Fire Prevention and Control with developing standards for “fire-safe” or self-extinguishing cigarettes. On December 31, 2002, OFPC issued a proposed standard with accompanying regulations for public comment. The agency will decide whether to make amendments and when final regulations should be issued after review of the information submitted in response to its notice. Current law requires that all cigarettes offered for sale in New York will be required to meet the standard not later than six months after the regulations become final. If the standard is finalized as proposed on December 31, 2002, there may be an adverse impact on the sale of cigarettes in New York due to reduced consumer acceptance of the changes in the cigarette made necessary to meet the standard. RJR Tobacco is unable to predict the outcome of this regulatory process. Similar legislation is being considered in other states.
On September 11, 2001, RJR Tobacco, together with several retailers who sell RJR Tobacco’s products, filed a Petition for Declaratory Judgment and Injunctive Relief in the District Court of Lancaster County, Nebraska, challenging the validity of the Nebraska Department of Revenue’s interpretation of 316 N.A.C. §§ 57-012, 57-015 and 57-016. The Department of Revenue maintains that this regulation prohibits the advertisement of RJR Tobacco’s manufacturer’s promotion known as a “buydown” to consumers. The plaintiffs have challenged the Department of Revenue’s interpretation of this regulation on the grounds that such action exceeded the Department’s statutory authority, constituted an unlawful rulemaking, violated the United States and Nebraska constitutions and is preempted by federal law. On October 15, 2001, the defendants filed a Demurrer to the plaintiffs’ Petition for Declaratory Judgment and Injunctive Relief. The Court has not yet ruled on the parties’ motions.
A price differential exists between cigarettes manufactured for sale abroad and cigarettes manufactured for U.S. sale; consequently, a domestic “gray market” has developed in cigarettes manufactured for sale abroad. These cigarettes compete with the cigarettes RJR Tobacco manufactures for domestic sale. The U.S. federal government and all 50 states have enacted legislation prohibiting the sale and distribution of gray market cigarettes. In addition, RJR Tobacco has taken legal action against certain distributors and retailers who engage in such practices.
Eighteen states have passed, and various states are considering, legislation to ensure “nonparticipating manufacturers” under the MSA are making required escrow payments. The National Association of Attorneys General has endorsed adoption of such legislation. Under this legislation, a state would only permit distribution of brands by manufacturers who are deemed by the state to be MSA compliant. Failure to make escrow payments could result in the loss of a nonparticipating manufacturer’s ability to sell tobacco products in a respective state.
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Tobacco leaf is an agricultural product subject to U.S. 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 bases tariffs on import volumes. The tariff rate quotas have been established by the United States with overseas tobacco producers and became effective on September 13, 1995. Because of the importance of tobacco leaf as a raw material for RJR Tobacco’s products, substantial changes in the legislative or regulatory environment applicable to tobacco leaf could have a material effect on RJR Tobacco’s results of operations and cash flows.
It is not possible to determine what additional federal, state or local legislation or regulations relating to smoking or cigarettes will be enacted or to predict the effect of new legislation or regulations on RJR Tobacco or the cigarette industry in general, but any new legislation or regulations could have an adverse effect on RJR Tobacco or the cigarette industry in general.
For further discussion of litigation and legal proceedings pending against RJR, its affiliates, including RJR Tobacco, or indemnitees, see “Business — Litigation Affecting the Cigarette Industry,” “Business — ERISA Litigation” and “Business — Environmental Matters” in Item 1; note 14 to the consolidated financial statements; and Exhibit 99.1 to this report.
Environmental Matters
RJR and its subsidiaries are subject to federal, state and local environmental laws and regulations concerning the discharge, storage, handling and disposal of hazardous or toxic substances. RJR and its subsidiaries have been engaged in a continuing program to assure compliance with these environmental laws and regulations. Although it is difficult to identify precisely the portion of capital expenditures or other costs attributable to compliance with environmental laws and regulations, RJR does not expect such expenditures or other costs to have a material adverse effect on the business or financial condition of RJR or its subsidiaries.
For further discussion of environmental matters, see “Business — Environmental Matters” in Item 1 and note 14 to the consolidated financial statements.
Other Contingencies
Until the acquisition by merger by Philip Morris Companies, Inc. of Nabisco from NGH on December 11, 2000, NGH and Nabisco were members of the consolidated group of NGH for U.S. federal income tax purposes. Each member of a consolidated group is jointly and severally liable for the U.S. federal income tax liability of other members of the group, as well as for pension and funding liabilities of the other group members. NGH, now known as RJR Acquisition Corp., continues to be jointly and severally liable for these Nabisco liabilities prior to December 11, 2000.
In connection with Philip Morris’ acquisition by merger of Nabisco and RJR’s subsequent acquisition by merger of NGH, Philip Morris, Nabisco and NGH entered into a voting and indemnity agreement that generally seeks to allocate tax liabilities ratably based upon NGH’s taxable income and that of Nabisco, had the parties been separate taxpayers. If Philip Morris and Nabisco are unable to satisfy their obligations under this agreement, NGH, now known as RJR Acquisition Corp., would be responsible for satisfying them.
In connection with the sale of the international tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR and RJR Tobacco agreed to indemnify Japan Tobacco against (1) any liabilities, costs and expenses arising out of the imposition or assessment of any tax with respect to the international tobacco business arising prior to the sale, other than as reflected on the closing balance sheet, (2) any liabilities, costs and expenses that Japan Tobacco or any of its affiliates, including the acquired entities, may incur after the sale in respect of any of RJR’s or RJR Tobacco Tobacco’s employee benefit and welfare plans and (3) any liabilities, costs and expenses incurred by Japan Tobacco or any of its affiliates arising out of certain activities of Northern Brands. See “Business — Litigation Affecting the Cigarette Industry” in Item 1 and note 14 to the consolidated financial statements for a description of the Northern Brands litigation. Although it is impossible to predict the outcome of the Northern Brands litigation or the amount of liabilities, costs and expenses, a significant adverse
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RJR and the guarantors will be required to pledge all of their assets to secure their obligations under RJR’s revolving credit facility if RJR’s guaranteed unsecured notes are rated below BBB- by Standard & Poor’s and below Baa3 by Moody’s, or two levels below these thresholds for either of these rating agencies. If RJR and the guarantors are required to pledge their assets to secure their obligations under the revolving credit facility, as amended and restated, they also will be required to pledge certain of their assets to secure RJR’s guaranteed unsecured notes. For a further discussion of RJR’s revolving credit facility and other debt, see “— Liquidity and Financial Condition — Debt” above.
As long as RJR’s unsecured, unsubordinated debt rating remains investment grade, RJR may be required to post collateral under its interest rate swap agreements if the fair value of the interest rate swaps results in a liability position that exceeds specified threshold amounts. If RJR’s unsecured, unsubordinated debt is rated either one level below BBB- by Standard & Poor’s or Baa3 by Moody’s, any fair value that results in a liability position of the interest rate swaps will require full collateralization. In addition, as long as RJR’s existing revolving credit facility is in place, if RJR and the guarantors are required to pledge their assets to secure their obligations under RJR’s revolving credit facility, as amended and restated, such pledge also will secure their obligations under these interest rate swap agreements.
Acquisition and Joint Venture
On January 16, 2002, RJR acquired, with cash, 100% of the voting stock of privately held Santa Fe. Fiesta Acquisition Corp., a wholly owned subsidiary of RJR, merged with and into Santa Fe, and Santa Fe, being the surviving corporation, became a wholly owned subsidiary of RJR. The acquisition was accounted for as a purchase, with its cost of $354 million allocated on the basis of the estimated fair market value of the assets acquired and liabilities assumed. The results of operations of Santa Fe have been included in the accompanying consolidated statements of income since January 16, 2002. Although Santa Fe is an operating segment of RJR, its financial condition and results of operations do not meet the criteria to be reportable. As a result, information related to Santa Fe is not generally disclosed separately in this document.
Santa Fe manufactures and markets cigarettes and other tobacco products, under the NATURAL AMERICAN SPIRIT brand, primarily in the United States. RJR believes that Santa Fe will enhance RJR’s consolidated earnings, and that its approach to building brand equity is consistent with RJR Tobacco Tobacco’s strategy for its key brands. Santa Fe has posted solid increases in volume, revenue, earnings and share of market over the past three years, based on the success of cigarettes and pouch tobaccos sold under the NATURAL AMERICAN SPIRIT brand name. NATURAL AMERICAN SPIRIT cigarettes are made with no-additive tobacco blends and are marketed in distinctive packages bearing the silhouette of an American Indian in a feathered headdress. The NATURAL AMERICAN SPIRIT retail share of market during 2002 was 0.26% in the United States. Santa Fe also has a small, but growing international tobacco business.
On July 16, 2002, RJR, through its wholly owned subsidiary, R. J. Reynolds Tobacco C.V., acquired a 50% interest in R.J. Reynolds-Gallaher International Sarl, a joint venture created with Gallaher Group Plc., to manufacture and market a limited portfolio of American-blend cigarette brands. The joint venture, headquartered in Switzerland, will initially market its products in France, Spain, the Canary Islands and Italy. RJR’s financial contribution over the next five years is expected to be $75 million to $100 million. As a part of the transaction, RJR Tobacco is licensing REYNOLDS, a new American-blend brand in a unique Slide Box pack, to the joint venture. This investment is accounted for using the equity method.
Statements included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are not historical in nature are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements regarding RJR’s future performance and financial results inherently are subject to a variety of risks and uncertainties, many of which are beyond the control of RJR, that could cause actual results to differ materially from those described
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PART IV
Item 15. | Exhibits, Financial Statement Schedules, and Reports on Form 8-K |
(a) | The following documents are filed as a part of this report: |
(1) | Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000. Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000. Consolidated Balance Sheets as of December 31, 2002 and 2001. Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2002, 2001 and 2000. | |
(2) | Financial Statement Schedules have been omitted because the information required has been separately disclosed in the consolidated financial statements or notes. | |
(3) | See (c) below |
(b) | RJR filed a Current Report on Form 8-K, dated December 20, 2002, disclosing Amendment No. 2, dated as of December 18, 2002, to the Rights Agreement, dated as of May 17, 1999, between R.J. Reynolds Tobacco Holdings, Inc. and The Bank of New York, as rights agent. |
(c) | The following exhibits are filed as part of this report: |
Exhibit | ||||
Number | ||||
23.1 | Consent of Independent Auditors. | |||
31.1 | Certification of Chief Executive Officer relating to RJR’s Annual Report on Form 10-K/A, Amendment No. 2 for the period ended December 31, 2002. | |||
31.2 | Certification of Chief Financial Officer relating to RJR’s Annual Report on Form 10-K/A, Amendment No. 2 for the period ended December 31, 2002. | |||
32.1 | Certification of Chief Executive Officer and Chief Financial Officer relating to RJR’s Annual Report on Form 10-K/A, Amendment No. 2 for the period ended December 31, 2002, pursuant to Section 18 U.S.C. § 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
R.J. REYNOLDS TOBACCO HOLDINGS, INC. |
Dated: March 5, 2004
By: | /s/ ANDREW J. SCHINDLER |
Andrew J. Schindler | |
Chairman of the Board, President, | |
Chief Executive Officer and Director | |
/s/ DIANNE M. NEAL | |
Dianne M. Neal | |
Executive Vice President and Chief Financial Officer | |
(principal financial officer) |
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