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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
------------------------
RJR NABISCO HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 1-10215 13-3490602
(State or other jurisdiction (Commission file number) (I.R.S. Employer
of Identification No.)
incorporation or
organization)
RJR NABISCO, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 1-6388 56-0950247
(State or other jurisdiction (Commission file number) (I.R.S. Employer
of Identification No.)
incorporation or
organization)
1301 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019-6013
(212) 258-5600
(Address, including zip code, and telephone number, including area code,
of the principal executive offices of RJR Nabisco Holdings Corp. and RJR
Nabisco, Inc.)
--------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANTS (1) HAVE 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
REGISTRANTS WERE REQUIRED TO FILE SUCH REPORTS), AND (2) HAVE BEEN SUBJECT TO
SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES_X_. NO ____.
--------------------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANTS'
CLASSES OF COMMON STOCK AS OF THE LATEST PRACTICABLE DATE: JUNE 30, 1997:
RJR NABISCO HOLDINGS CORP.: 323,717,664 SHARES OF COMMON STOCK, PAR VALUE $.01
PER SHARE
RJR NABISCO, INC.: 3,021.86513 SHARES OF COMMON STOCK, PAR VALUE $1,000 PER
SHARE
--------------------------
RJR NABISCO, INC. MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(A)
AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT.
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INDEX
PAGE
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PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Income--Three Months Ended 1
June 30, 1997 and 1996...................................................................
Consolidated Condensed Statements of Income--Six Months Ended 2
June 30, 1997 and 1996...................................................................
Consolidated Condensed Statements of Cash Flows--Six Months 3
Ended June 30, 1997 and 1996.............................................................
Consolidated Condensed Balance Sheets--June 30, 1997 4
and December 31, 1996....................................................................
Notes to Consolidated Condensed Financial Statements....................................... 5-13
Item 2. Management's Discussion and Analysis of Financial Condition and 14-20
Results of Operations....................................................................
PART II--OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 21-22
Item 6. Exhibits and Reports on Form 8-K........................................................... 23
Signatures............................................................................................. 24
PART I
ITEM 1. FINANCIAL STATEMENTS
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
-------------------- ---------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- --------- ---------- ---------
NET SALES*............................................................ $ 4,286 $ 4,286 $ 4,203 $ 4,203
--------- --------- ---------- ---------
Costs and expenses:
Cost of products sold*.............................................. 1,954 1,954 1,941 1,941
Selling, advertising, administrative and general expenses........... 1,456 1,455 1,437 1,441
Amortization of trademarks and goodwill............................. 160 160 160 160
Restructuring expense............................................... -- -- 428 428
--------- --------- ---------- ---------
OPERATING INCOME.................................................. 716 717 237 233
Interest and debt expense............................................. (231) (206) (230) (207)
Other income (expense), net........................................... (47) (47) (23) (23)
--------- --------- ---------- ---------
Income (loss) before income taxes................................. 438 464 (16) 3
Provision for income taxes............................................ 175 184 53 63
--------- --------- ---------- ---------
INCOME (LOSS) BEFORE MINORITY INTEREST IN INCOME (LOSS) OF NABISCO
HOLDINGS.......................................................... 263 280 (69) (60)
Less minority interest in income (loss) of Nabisco Holdings........... 20 20 (42) (42)
--------- --------- ---------- ---------
NET INCOME (LOSS)................................................. 243 260 (27) (18)
Less preferred stock dividends........................................ 11 -- 10 --
--------- --------- ---------- ---------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK...................... $ 232 $ 260 $ (37) $ (18)
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Net income (loss) per common and common equivalent share.............. $ 0.71 $ (0.11)
--------- ----------
--------- ----------
Dividends per share of Series C preferred stock....................... $ 0.751 $ 1.503
--------- ----------
--------- ----------
Dividends per share of common stock................................... $ 0.5125 $ 0.4625
--------- ----------
--------- ----------
Weighted average number of common and common equivalent shares
outstanding (in thousands).......................................... 325,607 325,879
--------- ----------
--------- ----------
- ------------------------
* Excludes excise taxes of $879 million and $960 million for the three months
ended June 30, 1997 and 1996, respectively.
See Notes to Consolidated Condensed Financial Statements
1
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
-------------------- --------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- --------- --------- ---------
NET SALES*............................................................. $ 8,065 $ 8,065 $ 8,089 $ 8,089
--------- --------- --------- ---------
Costs and expenses:
Cost of products sold*............................................... 3,674 3,674 3,742 3,742
Selling, advertising, administrative and general expenses............ 2,704 2,704 2,724 2,728
Amortization of trademarks and goodwill.............................. 318 318 318 318
Restructuring expense................................................ -- -- 428 428
--------- --------- --------- ---------
OPERATING INCOME................................................... 1,369 1,369 877 873
Interest and debt expense.............................................. (463) (415) (464) (417)
Other income (expense), net............................................ (76) (76) (58) (58)
--------- --------- --------- ---------
Income before income taxes......................................... 830 878 355 398
Provision for income taxes............................................. 341 360 216 234
--------- --------- --------- ---------
INCOME BEFORE MINORITY INTEREST IN INCOME (LOSS) OF NABISCO
HOLDINGS....................................................... 489 518 139 164
Less minority interest in income (loss) of Nabisco Holdings............ 33 33 (32) (32)
--------- --------- --------- ---------
NET INCOME......................................................... 456 485 171 196
Less preferred stock dividends......................................... 22 -- 21 --
--------- --------- --------- ---------
NET INCOME APPLICABLE TO COMMON STOCK.............................. $ 434 $ 485 $ 150 $ 196
--------- --------- --------- ---------
--------- --------- --------- ---------
Net income per common and common equivalent share...................... $ 1.33 $ 0.46
--------- ---------
--------- ---------
Dividends per share of Series C preferred stock........................ $ 2.254 $ 3.006
--------- ---------
--------- ---------
Dividends per share of common stock.................................... $ 1.025 $ 0.925
--------- ---------
--------- ---------
Weighted average number of common and common equivalent shares
outstanding (in thousands)........................................... 325,998 328,224
--------- ---------
--------- ---------
- ------------------------
* Excludes excise taxes of $1.731 billion and $1.855 billion for the six
months ended June 30, 1997 and 1996, respectively.
See Notes to Consolidated Condense Financial Statements
2
NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
------------------------ ------------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
----------- ----------- ----------- -----------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income................................................................ $ 456 $ 485 $ 171 $ 196
----- ----- ----- -----
Adjustments to reconcile net income to net cash flows from (used in)
operating activities:
Depreciation and amortization........................................... 579 579 577 577
Deferred income tax benefit............................................. (1) (1) (163) (162)
Changes in working capital items, net................................... (608) (452) (321) (238)
Restructuring and restructuring related expense, net of cash payments... (146) (146) 361 361
Other, net.............................................................. (7) (14) (40) (42)
----- ----- ----- -----
Total adjustments..................................................... (183) (34) 414 496
----- ----- ----- -----
Net cash flows from operating activities.................................. 273 451 585 692
----- ----- ----- -----
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Capital expenditures...................................................... (308) (308) (332) (332)
Acquisition of businesses................................................. -- -- (129) (129)
Disposition of businesses and certain assets.............................. 100 100 126 126
----- ----- ----- -----
Net cash flows used in investing activities............................. (208) (208) (335) (335)
----- ----- ----- -----
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net borrowings (repayments) of long-term debt............................. 68 68 (139) (139)
Increase in short-term borrowings......................................... 239 239 374 374
Dividends paid on common stock and preferred stock, including dividends
paid to Nabisco Holdings' minority common shareholders.................. (383) (16) (347) (14)
Other, net -- including intercompany transfers and payments............... 20 (524) (4) (442)
----- ----- ----- -----
Net cash flows used in financing activities............................. (56) (233) (116) (221)
----- ----- ----- -----
Effect of exchange rate changes on cash and cash equivalents................ (10) (10) (7) (7)
----- ----- ----- -----
Net change in cash and cash equivalents................................. (1) -- 127 129
Cash and cash equivalents at beginning of period............................ 252 251 234 232
----- ----- ----- -----
Cash and cash equivalents at end of period.................................. $ 251 $ 251 $ 361 $ 361
----- ----- ----- -----
----- ----- ----- -----
See Notes to Consolidated Condensed Financial Statements
3
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(DOLLARS IN MILLIONS)
JUNE 30, 1997 DECEMBER 31, 1996
-------------------- --------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- --------- --------- ---------
ASSETS
Current assets:
Cash and cash equivalents........................................... $ 251 $ 251 $ 252 $ 251
Accounts and notes receivable, net.................................. 1,489 1,485 1,418 1,413
Inventories......................................................... 2,847 2,847 2,636 2,636
Prepaid expenses and excise taxes................................... 593 593 445 445
--------- --------- --------- ---------
TOTAL CURRENT ASSETS............................................ 5,180 5,176 4,751 4,745
--------- --------- --------- ---------
Property, plant and equipment, net.................................. 5,771 5,771 5,835 5,835
Trademarks, net..................................................... 7,890 7,890 8,030 8,030
Goodwill, net....................................................... 12,080 12,080 12,268 12,268
Other assets and deferred charges................................... 380 359 405 382
--------- --------- --------- ---------
$ 31,301 $ 31,276 $ 31,289 $ 31,260
--------- --------- --------- ---------
--------- --------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings............................................... $ 741 $ 741 $ 609 $ 609
Accounts payable and accrued liabilities............................ 3,124 2,947 3,375 3,217
Current maturities of long-term debt................................ 39 39 63 63
Income taxes accrued................................................ 282 407 259 235
--------- --------- --------- ---------
TOTAL CURRENT LIABILITIES......................................... 4,186 4,134 4,306 4,124
--------- --------- --------- ---------
Long-term debt (less current maturities).............................. 9,409 9,409 9,256 9,256
Minority interest in Nabisco Holdings................................. 806 806 797 797
Other noncurrent liabilities.......................................... 2,202 1,623 2,223 1,872
Deferred income taxes................................................. 3,577 3,514 3,605 3,542
Contingencies (Note 3)
RJRN Holdings' obligated mandatorily redeemable preferred securities
of subsidiary trust holding solely junior subordinated
debentures*......................................................... 954 -- 954 --
Stockholders' equity:
Series C convertible preferred stock................................ -- -- 3 --
Other preferred stock............................................... 528 -- 534 --
Common stock (327,094,964 shares issued at June 30, 1997)........... 3 -- 3 --
Paid-in capital..................................................... 10,042 11,886 10,038 11,890
Retained earnings................................................... 68 190 -- --
Cumulative translation adjustments.................................. (286) (286) (221) (221)
Other stockholders' equity.......................................... (188) -- (209) --
--------- --------- --------- ---------
TOTAL STOCKHOLDERS' EQUITY........................................ 10,167 11,790 10,148 11,669
--------- --------- --------- ---------
$ 31,301 $ 31,276 $ 31,289 $ 31,260
--------- --------- --------- ---------
--------- --------- --------- ---------
- ------------------------
* The sole asset of the subsidiary trust is the junior subordinated debentures
of RJRN Holdings. Upon redemption of the junior subordinated debentures,
which have a final maturity of December 31, 2044, the preferred securities
will be mandatorily redeemed. The outstanding junior subordinated debentures
have an aggregate principal amount of approximately $978 million and an
annual interest rate of 10%.
See Notes to Consolidated Condensed Financial Statements
4
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1--INTERIM REPORTING
GENERAL
For interim reporting purposes, certain costs and expenses are charged to
operations in proportion to the estimated total annual amount expected to be
incurred.
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
In management's opinion, the accompanying unaudited consolidated condensed
financial statements (the "Consolidated Condensed Financial Statements") of RJR
Nabisco Holdings Corp. ("RJRN Holdings") and RJR Nabisco, Inc. ("RJRN" and
together with RJRN Holdings, the "Registrants") contain all adjustments,
consisting only of normal recurring adjustments, necessary for a fair statement
of the results for the interim periods presented. The Consolidated Condensed
Financial Statements should be read in conjunction with the consolidated
financial statements and footnotes included in the Annual Report on Form 10-K of
RJRN Holdings and RJRN for the year ended December 31, 1996.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, Earnings per Share, which establishes
new standards for computing and presenting net income per share. As a result,
RJRN Holdings will begin reporting in the fourth quarter of 1997 both a basic
and diluted net income per share amount for each period presented. It is
anticipated that basic net income per share, which excludes any dilution, and
diluted net income per share will not be significantly different than net income
per share calculated under current accounting standards.
RESTRUCTURING EXPENSE
In the second quarter of 1996, Nabisco Holdings Corp. ("Nabisco Holdings")
recorded a $428 million ($241 million after-tax, net of minority interest)
restructuring expense related to a program undertaken to streamline operations
and improve profitability.
As of June 30, 1997, approximately $260 million of the restructuring
accruals were utilized as follows: $146 million for severance and related
benefits, $82 million for product line rationalizations, $26 million for
contract terminations and $6 million for plant closures.
NOTE 2--INVENTORIES
The major classes of inventory are shown in the table below:
JUNE 30, DECEMBER 31,
1997 1996
----------- -------------
Finished products.................................................... $ 876 $ 830
Leaf tobacco......................................................... 1,290 1,161
Raw materials........................................................ 248 234
Other................................................................ 433 411
----------- ------
$ 2,847 $ 2,636
----------- ------
----------- ------
5
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES
TOBACCO-RELATED LITIGATION
OVERVIEW. Various legal actions, proceedings and claims are pending or may
be instituted against R.J. Reynolds Tobacco Company ("RJRT") or its affiliates
(including, with increasing frequency, RJRN) or indemnitees, including those
claiming that lung cancer and other diseases as well as addiction have resulted
from the use of or exposure to RJRT's tobacco products. During the second
quarter of 1997, 124 new actions were filed or served against RJRT and/or its
affiliates or indemnitees (as against only 44 in the second quarter of 1996) and
57 such actions were dismissed or otherwise resolved in favor of RJRT and/or its
affiliates or indemnitees without trial. Since the close of the second quarter,
through August 7, 1997, an additional 117 suits have been filed or served, and
14 dismissed. There have also been noteworthy increases in the number of these
cases pending. On August 7, 1997, there were 448 active cases pending against
RJRT and/or its affiliates or indemnitees, as compared with 203 cases in July
1996 and 68 in July 1995. Of these cases, 443 are in the United States, one in
Canada, three in Puerto Rico, and one in Guam.
The United States cases are in 44 states and are distributed as follows: 179
in Florida, 61 in New York, 36 in Texas, 18 in Louisiana, 11 in each of New
Jersey and Pennsylvania, ten in each of Alabama, California, and Ohio, eight in
each of Tennessee and Mississippi, six in West Virginia, five in each of Indiana
and Massachusetts, four in each of Kansas, Michigan, and Oklahoma, three in each
of Arizona, Colorado, District of Columbia, Hawaii, Minnesota, New Mexico,
Oregon, and Washington, two in each of Connecticut, Georgia, Illinois, Iowa,
Maryland, Missouri, Montana, New Hampshire, South Dakota, and Wisconsin, and one
in each of Alaska, Arkansas, Idaho, Kentucky, Nevada, North Carolina, South
Carolina, Utah, and Vermont. Of the 443 active cases in the United States, 331
are pending in state court and 112 in federal court.
THEORIES OF RECOVERY. The plaintiffs in these actions seek recovery on a
variety of legal theories, including, among others, strict liability in tort,
design defect, negligence, special duty, voluntary undertaking, breach of
warranty, failure to warn, fraud, misrepresentation, unfair trade practices,
conspiracy, aiding and abetting, unjust enrichment, anti-trust, Racketeer
Influenced and Corrupt Organization Act ("RICO"), indemnity and common law
public nuisance. Punitive damages, often in amounts ranging into the hundreds of
millions or even billions of dollars, are specifically pleaded in a number of
cases in addition to compensatory and other damages. Eight of the 443 active
cases in the United States involve alleged non-smokers claiming injuries
resulting from exposure to environmental tobacco smoke. Thirty-six cases purport
to be class actions on behalf of thousands of individuals. Purported classes
include individuals claiming to be addicted to cigarettes, individuals and their
estates claiming illness and death from cigarette smoking, flight attendants
alleging personal injury from exposure to environmental tobacco smoke in their
workplace and Blue Cross/Blue Shield subscribers claiming reimbursement for
premiums paid. Sixty-six of the active cases seek, INTER ALIA, recovery of the
cost of Medicaid funds or other health related costs paid for treatment of
individuals suffering from diseases or conditions allegedly related to tobacco.
DEFENSES. The defenses raised by RJRT and/or its affiliates, where
applicable, include preemption by the Federal Cigarette Labeling and Advertising
Act ("the Cigarette Act") of some or all such claims arising after 1969; the
lack of any defect in the product; assumption of the risk; contributory or
comparative fault; lack of proximate cause; and statutes of limitations or
repose; and, in the attorneys general cases (discussed below), additional
equitable and constitutional defenses. RJRN has asserted additional defenses,
including
6
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
jurisdictional defenses, in many of the cases in which it is named. Juries have
found for plaintiffs in three smoking and health cases in which RJRT was not a
defendant, but in one such case, no damages were awarded and the judgment was
affirmed on appeal. The jury awarded plaintiffs $400,000 in another such case,
CIPOLLONE V. LIGGETT GROUP, INC., but the award was overturned on appeal and the
case was subsequently dismissed. In the third such case, on August 9, 1996, a
Florida jury awarded damages of $750,000 to an individual plaintiff. The
defendant in that case, CARTER V. BROWN & WILLIAMSON, is seeking to reverse the
judgment on appeal. On May 5, 1997, in an individual case filed against RJRT,
brought by the same attorney who represented plaintiffs in the CARTER case, a
Florida state court jury found no RJRT liability.
On June 24, 1992, the United States Supreme Court in CIPOLLONE held INTER
ALIA that claims that tobacco companies failed adequately to warn of the risks
of smoking after 1969 and claims that their advertising and promotional
practices undermined the effect of warnings after that date were preempted by
the Cigarette Act. The Supreme Court also held that certain claims sounding in
breach of express warranty, fraud, misrepresentation and conspiracy were not
preempted.
CERTAIN CLASS ACTION SUITS. In May 1996, there was an important ruling in
one of the purported class action cases, CASTANO V. THE AMERICAN TOBACCO
COMPANY, originally filed in March 1994 in the United States District Court for
the Eastern District of Louisiana against tobacco industry defendants, including
RJRT and RJRN. Plaintiffs sought to obtain certification of a class action on
behalf of all United States residents who allegedly are or claim to be addicted,
or are the legal survivors of persons who allegedly were addicted, to tobacco
products manufactured by defendants. The complaint alleged that cigarette
manufacturers manipulated the levels of nicotine in their tobacco products to
induce addiction in smokers. Plaintiffs' motion for certification of the class
was granted in part on February 17, 1995 but, on May 23, 1996, the Fifth Circuit
Court of Appeals overturned the certification and ordered the case remanded to
the district court for decertification of the class on the grounds that a class
consisting of all "addicted" smokers failed to meet the standards and
requirements of Federal Rule 23 governing class actions. The class has been
decertified and the case is proceeding as an individual suit. Another purported
class action, filed shortly after CASTANO, remains stayed in federal district
court in Louisiana.
Since the federal appeals court decision in CASTANO, class action suits
based on similar claims have been brought in state courts in Alabama, Arkansas,
the District of Columbia (D.C. court), Georgia, Hawaii, Iowa, Kansas, Louisiana,
Maryland, Michigan, Minnesota, New Mexico, Ohio, Oklahoma, New Jersey, New York,
Pennsylvania, South Dakota, Tennessee, Texas, West Virginia and Wisconsin. A
similar suit had previously been filed in Indiana. Similar suits are also
expected to be filed in additional jurisdictions and there are additional class
action suits pending in Canada and Puerto Rico. Each such suit asserts claims on
behalf of residents of the particular jurisdiction who allegedly are or claim to
be addicted, injured, or at greater risk of injury by the use of tobacco, or are
the legal survivors of such persons. In addition, two earlier class action suits
are still pending in Florida. In one case, BROIN V. PHILIP MORRIS COMPANY, a
class consisting of all non-smoking flight attendants who work or have worked
for U.S. airlines has been certified, and the first phase of the case is
currently being tried. In a second case, ENGLE V. R.J. REYNOLDS TOBACCO COMPANY,
a class consisting of Florida residents or their survivors who claim to have
diseases or medical conditions caused by their "addiction" to cigarettes has
been certified, and the case, previously scheduled for trial in September 1997,
will be rescheduled based on when the BROIN trial is completed. A class was
certified in another purported class action suit, SCOTT V. AMERICAN TOBACCO
7
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
COMPANY, on April 11, 1997. Defendants have removed the case to federal court
and are seeking reconsideration of the certification. Another suit, GEIGER V.
AMERICAN TOBACCO COMPANY, was certified as a class action by a New York State
court on July 24, 1997 and defendants have filed a notice of appeal. A class
action filed in Tennessee seeks reimbursement of Blue Cross/Blue Shield premiums
paid by subscribers throughout the United States. During the second quarter of
1997, class certification was denied in two other cases: one, ARCH V. AMERICAN
TOBACCO COMPANY, pending in the United States District Court for the Eastern
District of Pennsylvania, on June 3, 1997 and another, SMITH V. BROWN &
WILLIAMSON, pending in the United States District court for the Western District
of Missouri, in which RJRT is not a defendant, on May 22, 1997.
THE ATTORNEYS GENERAL AND RELATED CASES. In June 1994, the Mississippi
attorney general brought an action, MOORE V. THE AMERICAN TOBACCO COMPANY,
against various industry members including RJRT. This case was brought on behalf
of the state to recover state funds paid for health care and medical and other
assistance to state citizens suffering from diseases and conditions allegedly
related to tobacco use. This suit, which was brought in Chancery (non-jury)
Court, Jackson County, Mississippi, also sought an injunction against
"promoting" or "aiding and abetting" the sale of cigarettes to minors. Both
actual and punitive damages were sought in unspecified amounts. The case was
scheduled for trial on July 7, 1997, but on July 2, 1997, the parties arrived at
an agreement in principle settling the claims relating to the subject matter of
the litigation, subject to the drafting and execution of a comprehensive
settlement agreement. See "Proposed Resolutions" below.
Following the filing of the MOORE case referred to above, other states,
through their attorneys general and/or other state agencies, have sued RJRT and
other U.S. cigarette manufacturers as well as, in some instances, their parent
companies, in actions to recover the costs of medical expenses incurred by the
state or its agencies in the treatment of diseases allegedly caused by cigarette
smoking. Some of these cases also seek injunctive relief and treble damages for
state and/or federal antitrust law and RICO violations. Certain of the actions
also seek statutory penalties and other forms of relief under state consumer
protection statutes. On August 7, 1997, there were 36 such cases pending in the
following states or territories: Alaska, Arizona, California, Colorado,
Connecticut, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana,
Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana,
New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon,
Pennsylvania, Puerto Rico, South Carolina, Texas, Utah, Vermont, Washington,
West Virginia and Wisconsin. Jury selection has begun in the Florida attorney
general's case and the Texas case is scheduled for September 29, 1997.
The suit by the State of Florida raises special issues because it was
brought under a July 1994 amendment to a Florida statute which allows the state
to bring an action in its own name against the tobacco industry to recover the
state's Medicaid payments for the treatment of illnesses statistically
associated with cigarette smoking. The amendment did not require the state to
identify the individuals who received medical care, permitted claims to be filed
in the aggregate and eliminated the comparative negligence and assumption of
risk defenses. The amendment was challenged on state and federal constitutional
grounds in a lawsuit brought by Philip Morris Companies Inc., Associated
Industries of Florida and others in June 1994. The trial court ruling in this
case was appealed to the Florida Supreme Court which, on June 27, 1996, issued
its opinion limiting the amendment in several respects. Among other things, the
court ruled: that provisions abrogating affirmative defenses available to
tobacco companies if sued by individuals could only be applied to claims brought
by the state arising out of payments made after
8
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
July 1, 1994, the effective date of the amendment; that the state must identify
individual recipients of Medicaid payments; and that claims previously barred by
the statute of repose could not be revived. The Florida Supreme Court, in a 4-3
decision, expressly stated that although it found provisions of the statute to
be "facially" constitutional, it was specifically leaving open the right to
challenge those provisions as applied in any specific lawsuit. The plaintiffs in
that lawsuit were unsuccessful in their request to obtain United States Supreme
Court review of the Florida Supreme Court's decision.
In an order dated September 16, 1996, the Florida trial court hearing the
attorney general's case applied the Florida Supreme Court decision to that case.
The order dismissed fifteen of plaintiff's eighteen causes of action, but left
standing the claims of negligence and/or products liability and one count of the
complaint which seeks to enjoin certain acts, including the sale of cigarettes
to minors. It also required the attorney general to identify the individual
Medicaid recipients for whom the state is seeking recovery within 30 days and
precluded recovery by the state on payments made prior to July 1994, except by
subrogation and assignment. Following this ruling, the State of Florida filed an
amended complaint that restated the counts of the prior complaint left standing
by the September order and added five additional counts. One of these counts
alleged various statutory and criminal violations arising under the Florida Drug
and Cosmetic Act, based on alleged wrongful and illegal targeting of minors,
fraudulent practices, public nuisance and deceptive and unfair trade practices.
The other four new counts alleged violations of various sections of the Florida
RICO Act. Defendants' motion to dismiss the RICO counts was denied.
In response to certain pretrial motions filed by the defendants, the Court
has ruled INTER ALIA that: (1) all claims for punitive damages under Counts One
(negligence) and Two (strict liability) of the complaint are dismissed; and (2)
the state's cause of action does not accrue until such time as it has paid
Medicaid benefits and that the state's action must be limited to its past
damages and may not include a claim for future damages. In addition, in ruling
on certain procedural motions, the judge in this case has severely limited the
affirmative evidence that defendants may present at trial, which could have a
significant adverse impact on the course and outcome of this trial.
In addition to the 36 actions brought by the various state attorneys
general, 30 actions advancing similar theories have been brought by private
attorneys and/or local officials purportedly on behalf of the citizens of
certain states, counties and/or cities, union health and welfare funds, a
university and four native American tribes.
Although RJRT and most other cigarette manufacturers have agreed to the
Memorandum described below, the uncertainty of its enactment into law requires
that they continue to defend these attorneys general and related cases
vigorously and they continue to do so (as does RJRN in the cases where it is a
named defendant). In addition, these tobacco company defendants filed for
declaratory judgment in several of the states in which attorneys general cases
are now pending including Massachusetts (federal court), Texas (state court),
Maryland (state court), Connecticut (federal court), Utah (state court), New
Jersey (state court), Alaska (federal court) and Hawaii (federal court). Motions
to dismiss on behalf of the state government defendants in three of the
declaratory judgment actions (Maryland, New Jersey and Connecticut) have been
granted. RJRT and the other cigarette manufacturers involved in those cases have
noticed appeals seeking to overturn these rulings.
PROPOSED RESOLUTIONS. Following several months of negotiations among
tobacco companies, state attorneys general, representatives of the public health
community and plaintiffs' lawyers, on June 20, 1997,
9
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
counsel representing RJRT and certain other parties signed a Memorandum of
Understanding and Resolution (the "Memorandum") that sets forth concepts for
federal legislation and a contractual protocol to resolve a variety of
litigation and regulatory issues concerning tobacco. The Memorandum is subject
to any necessary approvals by the various states and the Boards of Directors of
RJRT and the other participating tobacco companies. For the complete terms of
the Memorandum, see the Companies' Report on Form 8-K, filed with the Securities
and Exchange Commission on June 20, 1997, which includes the Memorandum as an
exhibit.
There can be no assurance that legislation to implement the Memorandum will
be enacted or that it will be enacted without modification that is materially
adverse to the tobacco industry, particularly in light of the complex legal and
factual issues involved and the need to reconcile the views of many competing
interests. It is not certain that any proposed legislation that emerges from
this process will be acceptable to RJRT. If enacted, the legislation could face
challenges on the grounds, among others, that the federal government lacks the
authority to regulate the tobacco industry or limit its liability in the manner
contemplated by the Memorandum. Regardless of the legislative outcome, the
negotiation and signing of the Memorandum could adversely affect other federal,
state and local regulation of the tobacco industry, alter the climate for
pending litigation against RJRN, RJRT and other tobacco companies and affect the
number of new smoking and health claims filed against the industry.
The Memorandum requires the tobacco companies to make an initial $10 billion
payment and subsequent annual multi-billion dollar payments. Discussions with
other manufacturers who were participants in the negotiations which led to the
Memorandum are still in progress, but, RJRT believes that its share of the
initial payment will be in the range of $600 to $700 million and that subsequent
payments will be allocated within the industry based on market share. However,
the financial effects of this legislation and the related contractual protocol
are difficult to predict. They depend, among other things, on (i) the amount and
timing of the payments actually required of RJRT by the legislation; (ii) the
means used to finance these payments; (iii) the impact of increased cigarette
prices and other aspects of the legislation and the contractual protocol on
domestic cigarette consumption; (iv) the effect of the legislation and the
contractual protocol on the consumption of tobacco products and the regulatory
and litigation environment outside the United States; (v) their effect, if any,
on public attitudes toward smoking and the tobacco industry; and (vi) their
impact on RJRT's competitive position in the tobacco industry.
Despite these uncertainties, RJRN believes that implementation of the
Memorandum would increase the costs and reduce the consumption of RJRT's tobacco
products in the United States and that it could have a significant negative
effect on the business of RJRT and the stated financial position of RJRN and
RJRT. Any significant negative effect on the financial position of RJRN could
ultimately impact the share repurchase and dividend policies of RJRN Holdings.
On the other hand, the proposals contemplated by the Memorandum offer a measure
of relief from certain litigation that could otherwise materially affect the
results of operations or cash flows of RJRN in particular quarterly or annual
periods or its financial condition. In evaluating any legislation to resolve
tobacco issues, RJRN and RJRT will continue to weigh carefully the potential
benefits, principally greater regulatory and litigation certainty and a
reduction in aggregate contingency risk, against the resulting monetary,
regulatory and other costs.
THE MISSISSIPPI AGREEMENT. Because the Memorandum, unless and until it is
enacted into law, will not resolve any pending litigation scheduled for trial in
advance of such enactment, the parties in each of these cases must decide, on a
case-by-case basis, whether to proceed to trial or seek some other resolution.
The
10
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
first attorney general case scheduled for trial after adoption of the Memorandum
was MOORE V. AMERICAN TOBACCO COMPANY. In that case, a settlement was agreed to
on July 2, 1997, based on a Memorandum of Understanding and subject to a number
of conditions, including the negotiation and execution of a full settlement
agreement.
The agreement calls for the defendants to pay an aggregate of $170 million
to the State of Mississippi, as well as additional amounts to the Attorney
General and plaintiffs' private counsel for their litigation costs and expenses.
It also provides for continuing payments commencing December 31, 1998, and
annually thereafter, based on Mississippi's 1.7% share of $4 billion in the
first year, escalating to 1.7% of $8 billion in year eight and thereafter,
adjusted upward by no less than 3% per year and further adjusted upward or
downward to reflect increases or decreases in volume of domestic tobacco product
sales. If the U.S. Congress enacts federal legislation in keeping with the
Memorandum discussed above, the terms of that legislation would supersede the
terms of the Mississippi agreement and defendants would receive credit for these
payments against the obligations arising under the federal legislation for
payments already made to Mississippi. If, instead, the defendants enter into a
number of separate settlement agreements with the other individual states that
have brought cost recovery suits against tobacco companies, Mississippi would be
entitled to payment adjustments to assure that it receives at least as favorable
a settlement as any other separately settling non-federal governmental
plaintiff.
On July 15, 1997, the settling defendants made their first payment under the
Mississippi agreement into an escrow account to be released to the State when
certain conditions, including the execution of a definitive agreement, have been
satisfied. RJRT's payment into that escrow account was $12,410,000. An
additional aggregate payment of $15 million relating to plaintiffs' legal
expenses (subject to later adjustment) was paid on July 30, 1997. RJRT's share
of that payment was $3,765,000.
RJRT has participated and may continue to participate in discussions with
certain other states with health care cost recovery actions scheduled to be
tried in the coming months in order to postpone or settle those actions while
awaiting passage of the legislation contemplated by the Memorandum. There can be
no assurance that any such postponement or settlement can be achieved, or, if
achieved, as to the terms ultimately agreed to. In the absence of postponement
or settlement, these actions would be tried as scheduled and any final judgment
reached prior to enactment of the contemplated legislation would not be affected
by the passage of the legislation.
RECENT AND SCHEDULED TRIALS. As of August 7, 1997, there were 12 cases
scheduled for trial in 1997 against RJRT and/or RJRN alleging injuries relating
to tobacco. Among these are three class action suits (one of which is currently
in trial) and two attorneys general suits. Cases against other tobacco company
defendants are also scheduled for trial in 1997 and thereafter. Although trial
schedules are subject to change and many cases are dismissed before trial, it is
likely that there will be an increased number of tobacco cases, involving claims
for possibly billions of dollars, against RJRT and RJRN coming to trial over the
next year as compared to prior years when trials in these cases were infrequent.
OTHER DEVELOPMENTS. On May 28, 1997, a suit was filed against RJRT in the
U.S. District Court for the Northern District of Georgia, Atlanta Division, FARR
V. R.J. REYNOLDS TOBACCO COMPANY, alleging claims under Title VII and the Equal
Pay Act on behalf of female RJRT employees and applicants for employment in the
"southeast sales region", seeking equitable relief, back pay and lost benefits,
as well as
11
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
punitive damages, based on allegations that plaintiffs had been denied
employment, desirable job assignments, training, promotion and equal pay. RJRT
has filed an answer in the case and intends to defend it vigorously. Other
lawsuits filed by RJRT against various government agencies are described below.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Tobacco-- Governmental Activity."
RJRT, R.J. Reynolds Tobacco International ("RJRTI") and Northern Brands
International, another subsidiary of RJRN, each received document subpoenas
dated July 24, 1997, from a federal grand jury sitting in the Northern District
of New York. RJRT understands that the grand jury is investigating possible
smuggling activities. RJRT, RJRTI and Northern Brands International will respond
to these subpoenas, but are unable to predict the outcome of the grand jury's
investigation.
------------------------
Litigation is subject to many uncertainties and it is possible that some of
the tobacco-related legal actions, proceedings or claims could be decided
against RJRT or its affiliates (including RJRN Holdings and RJRN) or
indemnitees. Determinations of liability or adverse rulings against other
cigarette manufacturers that are defendants in similar actions, even if such
rulings are not final, could adversely affect the litigation against RJRT or its
affiliates or indemnitees and could encourage an increase in the number of such
claims. There have been a number of political, legislative, regulatory and other
developments relating to the tobacco industry and cigarette smoking that have
received wide media attention, including the recent Liggett settlements of
certain health care cost recovery actions and a purported nationwide smoking and
health class action, and a decision by a federal district court on a motion for
summary judgment to uphold the FDA's regulation of cigarettes as "drugs" or
"medical devices." These developments, as well as the widespread media attention
given to the Memorandum referred to above, may negatively affect the outcomes of
tobacco-related legal actions and encourage the commencement of additional
similar litigation.
Although it is impossible to predict the outcome of such events on pending
litigation and the rate at which new lawsuits are filed against RJRT and RJRN, a
significant increase in litigation and/or in adverse outcomes for tobacco
defendants could have an adverse effect on RJRT and RJRN. RJRT and RJRN each
believe that they have a number of valid defenses to any such actions and intend
to defend vigorously all such actions in which they are named defendants.
RJRN Holdings and RJRN believe that notwithstanding the quality of defenses
available to them and RJRT in litigation matters, it is possible that the
results of operations or cash flows of RJRN Holdings or RJRN in particular
quarterly or annual periods or the financial condition of RJRN Holdings and RJRN
could be materially affected by the ultimate outcome of certain pending
litigation matters (including litigation costs). Management is unable to predict
the outcome of the litigation or to derive a meaningful estimate of the amount
or range of any possible loss in any particular quarterly or annual period or in
the aggregate.
------------------------
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of RJRN Holdings' financial condition
and results of operations should be read in conjunction with the historical
financial information included in the Consolidated Condensed Financial
Statements.
RESULTS OF OPERATIONS
Summarized financial data for RJRN Holdings is as follows:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
1997 1996 % CHANGE 1997 1996 % CHANGE
------ ------ -------- ------ ------ --------
(DOLLARS IN MILLIONS)
NET SALES:
RJRT.................................................................. $1,216 $1,173 4% $2,292 $2,230 3%
Reynolds International................................................ 879 852 3 1,677 1,691 (1)
------ ------ ------ ------
Total Tobacco....................................................... 2,095 2,025 3 3,969 3,921 1
------ ------ ------ ------
Nabisco Biscuit....................................................... 907 914 (1) 1,708 1,785 (4)
U.S. Foods Group...................................................... 647 639 1 1,174 1,202 (2)
------ ------ ------ ------
Domestic Food Group................................................... 1,554 1,553 -- 2,882 2,987 (4)
International Food Group.............................................. 637 625 2 1,214 1,181 3
------ ------ ------ ------
Total Food.......................................................... 2,191 2,178 1 4,096 4,168 (2)
------ ------ ------ ------
$4,286 $4,203 2 $8,065 $8,089
------ ------ ------ ------
------ ------ ------ ------
OPERATING COMPANY CONTRIBUTION:(1)
RJRT.................................................................. $ 395 $ 390 1% $ 775 $ 770 1%
Reynolds International................................................ 179 162 10 374 359 4
------ ------ ------ ------
Total Tobacco....................................................... 574 552 4 1,149 1,129 2
------ ------ ------ ------
Nabisco Biscuit....................................................... 183 146 25 317 271 17
U.S. Foods Group...................................................... 93 81 15 158 144 10
------ ------ ------ ------
Domestic Food Group................................................... 276 227 22 475 415 14
International Food Group.............................................. 44 63 (30) 98 113 (13)
------ ------ ------ ------
Total Food.......................................................... 320 290 10 573 528 9
------ ------ ------ ------
Headquarters.......................................................... (18) (17) (6) (35) (34) (3)
------ ------ ------ ------
$ 876 $ 825 6 $1,687 $1,623 4
------ ------ ------ ------
------ ------ ------ ------
OPERATING INCOME:
RJRT.................................................................. $ 303 $ 298 2% $ 592 $ 587 1%
Reynolds International................................................ 167 151 11 352 338 4
------ ------ ------ ------
Total Tobacco....................................................... 470 449 5 944 925 2
------ ------ ------ ------
Domestic Food Group................................................... 226 (177) -- 374 (40) --
International Food Group.............................................. 38 (18) -- 86 26 231
------ ------ ------ ------
Total Food.......................................................... 264 (195) -- 460 (14) --
------ ------ ------ ------
Headquarters.......................................................... (18) (17) (6) (35) (34) (3)
------ ------ ------ ------
$ 716 $ 237 202 $1,369 $ 877 56
------ ------ ------ ------
------ ------ ------ ------
- ------------------------
(1) Operating Company Contribution represents operating income before
amortization of trademarks and goodwill and restructuring expense.
13
TOBACCO
The tobacco line of business is conducted by RJRT and R.J. Reynolds
International ("Reynolds International").
RJRT's net sales for the second quarter of 1997 were $1.22 billion, an
increase of $43 million or 4% from the second quarter of 1996, and $2.29 billion
for the first six months of 1997, an increase of $62 million or 3% over 1996.
The increase for both periods is mainly attributable to higher pricing,
partially offset by lower overall volume. Overall volume decreased 4% in both
the second quarter and the first six months of 1997 over the prior year. Full
price segment volume for the second quarter and the first six months of 1997
decreased 5% and 4%, respectively, over 1996, while savings segment volume
decreased 3% and 5%, respectively.
Industry volume was flat for the quarter but continues its shift to the full
price category with full price volume up 1% and savings volume down 5%. Industry
volume for the first six months of 1997 decreased 2% with full price volume flat
and savings volume down 5%. RJRT's overall market share decreased to 25.44%
during the second quarter of 1997 from 26.00% for the second quarter of 1996.
Overall market share for the first six months of 1997 decreased to 25.45% from
26.12% in 1996.
The Camel brand remained the company's strongest performing brand with
volume increases of 8% in both the second quarter and the first half of 1997.
The rollout of the Red Kamel line extension to single-pack-oriented retail
outlets was completed in April 1997 and market response to the Camel Menthol
styles introduced in January 1997 continues to be positive. Doral, the
industry's leading savings brand, posted volume gains of 4% for the second
quarter and first six months of 1997. Offsetting these increases were declines
in Winston and Salem and other low margin savings brands for both periods in
1997. The company continues its program of ceding market share of low margin
brands. RJRT continues to study Eclipse, a cigarette featuring 90% reduced
second-hand smoke, along with the Moonlight Tobacco Company brands, featuring
innovative packaging and product concepts. Additionally, during the second
quarter of 1997, RJRT announced that the Winston "No Bull" marketing campaign,
which had been tested in the state of Florida for the past year, will be rolled
out nationally during the third quarter of 1997. The new positioning will
establish Winston as a brand with a "straight-up" attitude leveraged by a unique
product point-of-difference: a 100-percent tobacco blend with no additives.
RJRT's operating company contribution increased 1% for the second quarter
and the first six months of 1997 to $395 million and $775 million, respectively,
compared to 1996. The increase in operating company contribution for both
periods is primarily due to increases in pricing and operating efficiencies,
partially offset by decreases in volume, higher marketing spending, and legal
costs. Operating income increased 2% for the second quarter and 1% for the first
six months of 1997 over the comparable 1996 periods due primarily to the
increases in operating company contribution.
Reynolds International's net sales amounted to $879 million for the second
quarter of 1997, a 3% increase over 1996 primarily due to an increase in volume
and pricing, partially offset by unfavorable foreign currency translation.
Excluding the impact of unfavorable foreign currency translation, net sales
would have increased 9% over 1996. Overall volume of 50.7 billion units
increased 13% from 1996 primarily due to a 37% gain from markets in the
Commonwealth of Independent States (CIS) and Baltic regions. Shipments into the
CIS and Baltic regions rebounded sharply after disruptions in the first quarter
of 1997. Volume in that region increased 62% in the second quarter versus the
first quarter of 1997. Sales in Russia remained strong during the second
quarter, with demand for the locally produced Peter 1st brand continuing to
exceed capacity. Volumes in Central Europe increased 22% over 1996, driven by
Turkey and Romania. Reynolds International continued to experience strong growth
in Japan where volume increased 35%, driven by the "low smoke, low smell"
Pianissimo brands. The company also reported volume momentum in South Africa and
strong performance in Tanzania, despite a difficult economic climate. Offsetting
this growth were declines in Western Europe, where flat to declining consumption
and price pressures in a number of markets, such as Spain and France,
contributed to volume softness. Reynolds
14
International is continuing to move aggressively to offer medium and
low-tar/nicotine alternatives in Western Europe. Camel Lights, now introduced in
30 countries, remained on a strong growth track, with volume up 19% for the
first six months of 1997. Reynolds International launched Camel Medium in
Holland, Greece, Germany, Switzerland, Belgium and Hungary during the second
quarter of 1997. New Winston Lights and Superlights brand styles were launched
in Switzerland, Greece and Spain as part of the company's plans to expand
participation of its largest-selling international brand in the growing
worldwide lights segment. Salem continued its strong performance in Asia, with
volume up 19% in the second quarter of 1997.
Reynolds International's net sales decreased slightly to $1.68 billion for
the first six months of 1997 over the 1996 comparable period primarily due to
unfavorable foreign currency translation and unfavorable region mix, partly
offset by increased pricing. Excluding the impact of unfavorable foreign
currency translation, net sales would have increased 4% over 1996. Overall
volume of 92.3 billion units increased slightly from 1996 as a result of the
volume gains in Central Europe which more than offset the volume softness in
Western Europe and the disruptions during the first quarter of 1997 in the CIS
and Baltic regions.
Operating company contribution of $179 million for the second quarter of
1997 increased 10% from 1996 driven primarily by increased pricing, partially
offset by unfavorable foreign currency developments. Operating company
contribution was $374 million for the first six months of 1997, an increase of
4% over the comparable 1996 period, due primarily to increased pricing and
region sales mix, partially offset by unfavorable foreign currency developments
and higher product costs. Operating income increased 11% and 4% for the second
quarter and first six months of 1997, respectively, primarily as a result of the
increases in operating company contribution.
Reynolds International has commenced a European distribution rationalization
program to improve productivity and reduce costs that will not have a material
impact on the consolidated financial statements. The program includes inventory
realignment, as well as the sale and closure of certain facilities.
GOVERNMENTAL ACTIVITY
If the legislation contemplated by the Memorandum discussed at Note 3 of the
Consolidated Condensed Financial Statements above ("Note 3") is enacted, RJRT
and other cigarette manufacturers would be subject to certain actions taken (or
to be taken) by certain governmental regulatory agencies that could be expected
to have an adverse effect on cigarette sales. As described in Note 3, RJRT would
be prepared to support the enactment of such legislation as part of a
comprehensive resolution of a variety of tobacco issues. Nonetheless, in the
absence of such legislation, regulatory initiatives such as the following remain
of significant importance to RJRT.
In August 1996, the U.S. Food and Drug Administration (the "FDA") asserted
jurisdiction over cigarettes and certain other tobacco products by declaring
such products to be medical devices and adopting regulations, first proposed in
1995, on the advertising, promotion and sale of cigarettes. The regulations
include a phased in schedule of effectiveness over a two year period. The first
phase began February 28, 1997, when regulations relating to the sale of
cigarettes to minors became effective. Among other things, the regulations would
prohibit or impose stringent limits on a broad range of sales and marketing
practices, including bans on sampling, sponsorship by brand name, and
distribution of non-tobacco items carrying brand names. The FDA's rules also
limit advertising in print and on billboards to black and white text and impose
new labeling language.
The purported purpose of the FDA's assertion of jurisdiction was to curb the
use of tobacco products by underage youth. RJRT believes, however, that the
assertion of jurisdiction and the scope of the proposed rules would materially
restrict the availability of cigarettes and RJRT's ability to market its
cigarette products to adult smokers. RJRT, together with the four other major
domestic cigarette manufacturers and an advertising agency, filed suit on the
day of the initial proposal in 1995 in the U.S.
15
District Court for the Middle District of North Carolina seeking to enjoin the
FDA's assertion of jurisdiction (COYNE BEAHM V. UNITED STATES FOOD & DRUG
ADMINISTRATION). On the day the final regulations were announced, the plaintiffs
filed an amended complaint challenging the regulations. Similar suits were filed
in the same court by manufacturers of smokeless tobacco products, by operators
of retail stores and by advertising interests. On April 26, 1997, the court
ruled on a motion for summary judgment, that based on the facts alleged by the
FDA, that agency was not barred from asserting jurisdiction over tobacco but
lacked authority to issue certain of the regulations bearing on marketing and
advertising. The court immediately certified its decision for appeal to the
Fourth Circuit Court of Appeals and stayed the effectiveness of that portion of
the regulations which had not yet been implemented pending appeal or further
court action. RJRT is unable to predict the ultimate outcome of this litigation
seeking to find the FDA's regulations to be unlawful. If the full regulations do
go into effect, they could be expected to have an adverse effect on cigarette
sales and RJRT.
On May 28, 1997, the Federal Trade Commission (the "FTC") issued an
unfairness complaint against RJRT, seeking to stop the use of Joe Camel
advertising, to require RJRT to undertake certain public education activities,
and to monitor sales and share of sales of each of RJRT's brands to smokers
under the age of 18. On June 17, 1997, RJRT filed suit against the FTC in the
Federal District Court for the Middle District of North Carolina, challenging
the FTC's action as procedurally improper. The FTC has moved to dismiss the
action.
In March 1994, the U.S. Occupational Safety and Health Administration
("OSHA") announced proposed regulations that would restrict smoking in the
workplace to designated smoking rooms that are separately exhausted to the
outside. Although RJRT cannot predict the form or timing of any regulations that
may be finally adopted by OSHA, if the proposed regulations are adopted, RJRT
expects that many employers who have not already done so would prohibit smoking
in the workplace rather than make expenditures necessary to establish designated
smoking areas to accommodate smokers. RJRT submitted comments on the proposed
regulations during the comment period which closed in February 1996. Because
many employers currently do not permit smoking in the workplace, RJRT cannot
predict the effect of any regulations that may be adopted, but incremental
restrictions on smokers could have an adverse effect on cigarette sales and
RJRT.
In July 1996, Massachusetts enacted legislation that would require
manufacturers of tobacco products sold in Massachusetts to report yearly,
beginning in 1997, the ingredients of each brand sold. RJRT believes that the
disclosure of trade secrets required by this law could damage the competitive
position of its brands. The statute requires the reporting of nicotine yield
ratings in accordance with procedures to be established. Together with other
cigarette manufacturers, RJRT has filed suit in the U.S. District Court for the
District of Massachusetts seeking to have the statute declared null and void and
to restrain Massachusetts officials from enforcing it. A similar suit has been
filed by manufacturers of smokeless tobacco products. The Massachusetts district
court denied the manufacturers' motion for summary judgment based on preemption
grounds, but certified the case for appeal of this issue to the First Circuit
which heard oral argument in June 1997. RJRT is unable to predict the outcome of
this litigation.
Minnesota and Texas have also recently enacted legislation requiring
ingredients reporting. RJRT believes that the Minnesota and Texas laws also
violate the U.S. Constitution. RJRT has filed suit in the U.S. District Court
for the District of Minnesota seeking to restrain the enforcement of the
Minnesota law. RJRT is unable to predict the outcome of this litigation.
A number of foreign countries have also taken steps to discourage cigarette
smoking, to restrict or prohibit cigarette advertising and promotion and to
increase taxes on cigarettes. Such restrictions are, in some cases, more onerous
than restrictions imposed in the United States. RJRT is unable to predict the
effect of the recent Memoranda on the regulatory environment for its products
abroad.
As part of a balanced budget agreement, subject to legislative enactment,
the White House and the U.S. Congress have agreed to increase the excise tax on
cigarettes by $.10 per pack in the year 2000 and an
16
additional $.05 in 2002. It is not possible to determine what additional
federal, state, local or foreign legislation or regulations relating to smoking
or cigarettes will be enacted or to predict any resulting effect thereof on
RJRT, Reynolds International or the cigarette industry generally, but such
legislation or regulations could have an adverse effect on RJRT, Reynolds
International or the cigarette industry generally.
For a description of certain litigation affecting RJRT and its affiliates,
see Note 3 to the Consolidated Condensed Financial Statements.
FOOD
The food business is conducted by operating subsidiaries of Nabisco
Holdings. Nabisco's businesses in the United States are comprised of the Nabisco
Biscuit company and the U.S. Foods Group (collectively, the "Domestic Food
Group"). The U.S. Foods Group is comprised of the Specialty Products,
LifeSavers, Planters, Tablespreads and Food Service companies. Nabisco's
businesses outside the United States are conducted by Nabisco Ltd and Nabisco
International, Inc. ("Nabisco International" and together with Nabisco Ltd, the
"International Food Group").
The Domestic Food Group's net sales were flat for the second quarter and 4%
lower for the first six months of 1997, with Nabisco Biscuit down 1% and 4%,
respectively, and the U.S. Foods Group up 1% and down 2%, respectively. The
declines in Nabisco Biscuit were primarily due to lower volume in SnackWell's
and breakfast snacks, which more than offset higher volume in core cookie and
cracker brands. The U.S. Foods Group's net sales increase in the second quarter
was primarily due to higher volume for nuts, candy and gum which was partially
offset by lower sales volume for tablespreads and condiments. The U.S. Foods
Group's decline in net sales for the first six months of 1997 was primarily due
to lower sales volume for tablespreads and condiments, partially offset by
higher sales volume for nuts, candy and gum. The International Food Group
reported net sales increases for the second quarter and first six months of 1997
of 2% and 3%, respectively. The increases in net sales were primarily driven by
the second half 1996 business acquisitions, principally Lucky in Taiwan and
Fontaneda in Spain, and improved results in Mexico, China and Venezuela.
Partially offsetting these gains were volume declines in Brazil, resulting from
aggressive competitive activity in the biscuit and milk categories, and
Argentina.
The Domestic Food Group's operating company contribution for the second
quarter and first six months of 1997 increased 22% and 14%, respectively.
Excluding the impact of one-time items in 1997 and 1996 discussed below,
operating company contribution increased 13% for the second quarter and 10% for
the first six months of 1997. On the same basis, Nabisco Biscuit was up 22% and
15%, respectively, and the U.S. Foods Group was down 2% and even, respectively.
The Nabisco Biscuit increases resulted largely from restructuring driven margin
improvements and on-going productivity initiatives. The U.S. Foods Group's
decline for the second quarter was primarily due to reduced sales of higher
margin condiment products, while the first six months' profit level was
maintained due to restructuring efficiencies and lower consumer promotion
expense. The International Food Group's operating company contribution for the
second quarter and first six months of 1997 decreased 30% and 13%, respectively.
Excluding the impact in 1997 of a one-time item discussed below, the
International Food Group's operating company contribution for the second quarter
and first six months of 1997 declined 19% and 7%, respectively, principally due
to lower earnings in Latin America, most notably lower sales in Brazil and lower
sales and increased expenses in Argentina. Higher expansion costs in China and
Indonesia also impacted the International Food Group's results unfavorably.
In 1997, Nabisco's U.S. Foods Group sold certain domestic regional brands
for $50 million resulting in a $32 million pre-tax gain. In addition, one-time
expenses of $31 million were recognized which included a $14 million provision
for the additional write-down of a business held for sale by the U.S. Foods
Group, $10 million of expenses for the reorganization of the U.S. Foods Group's
selling organization, and $7 million to relocate the International Food Group's
headquarters from New York City to New Jersey. In
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1996, restructuring related expenses of $4 million at Nabisco Biscuit and $6
million at the U.S. Foods Group were recognized in connection with the
implementation of the June 1996 restructuring program.
NET INCOME
Net income for the second quarter and six months of 1997 reflects a decrease
in the overall annual effective tax rate resulting primarily from lower taxes on
foreign earnings, the benefit of which was more than offset by unfavorable
foreign currency developments.
LIQUIDITY AND FINANCIAL CONDITION
Net cash flows from operating activities for the first six months of 1997
were $273 million, a decrease of $312 million from the six months of 1996 level.
The decrease in net cash flows from operating activities reflects increased
working capital requirements resulting from higher inventory levels and foreign
excise tax prepayments, and higher restructuring and related payments.
Free cash flow, another measure used by management to evaluate liquidity and
financial condition, represents cash available for the repayment of debt and
certain other corporate purposes such as common stock dividends, stock
repurchases and acquisitions. It is essentially net cash flow from operating
activities and investing activities from the Consolidated Condensed Statement of
Cash Flows adjusted for acquisitions and divestitures of businesses, less
preferred dividends. Free cash flow resulted in an outflow of $67 million for
the first six months of 1997 and an inflow of $297 million for the first six
months of 1996. The decrease in free cash flow from 1996 to 1997 primarily
reflects the higher working capital requirements and restructuring and related
payments and a higher level of proceeds from the disposition of businesses and
certain assets in the prior year.
In May 1997, 26,675,000 shares of Series C preferred stock mandatorily
converted into 53,350,000 shares of common stock.
In July 1997, RJRN issued $150 million 8.25% notes due 2004 and $200 million
8.50% notes due 2007. Interest on the notes is payable semi-annually on January
1 and July 1 of each year, beginning January 1, 1998. The net proceeds from the
issuance of the notes was used to repay a portion of outstanding commercial
paper borrowings.
Management of RJRN Holdings and its subsidiaries are continuing to review
various strategic transactions, including but not limited to, acquisitions,
divestitures, mergers and joint ventures. No assurance may be given that any
such transactions will be announced or completed.
Capital expenditures were $308 million for the first six months of 1997. The
current level of expenditures planned for 1997 is expected to be in the range of
approximately $825 million to $875 million (approximately 51% Food and 49%
Tobacco), which will be funded primarily by cash flows from operating
activities. The current planned level of capital expenditures for 1997 is higher
than 1996 primarily due to increased capital investments for Reynolds
International (notably in the CIS and Baltic regions). Management expects that
its capital expenditures program will continue at a level sufficient to support
the strategic and operating needs of RJRN Holdings' operating subsidiaries.
LITIGATION
For a description of certain litigation affecting RJRT and its affiliates,
see Note 3 to the Consolidated Condensed Financial Statements.
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The foregoing discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements, particularly with respect to capital expenditures, which reflect
management's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including, but not limited to, the effect on financial
performance and future events of competitive pricing for products, success of
new product innovations and acquisitions, local economic conditions and the
effects of currency fluctuations in countries in which RJRN Holdings and its
subsidiaries do business, the effects of domestic and foreign government
regulation, ratings of RJRN Holdings' or its subsidiaries' securities and, in
the case of the tobacco business, litigation. Due to such uncertainties and
risks, readers are cautioned not to place undue reliance on such forward-looking
statements, which speak only as of the date hereof.
------------------------
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PART II
ITEM 1. LEGAL PROCEEDINGS
TOBACCO-RELATED LITIGATION
OVERVIEW. Various legal actions, proceedings and claims are pending or may
be instituted against R.J. Reynolds Tobacco Company ("RJRT") or its affiliates
(including, with increasing frequency, RJRN) or indemnitees, including those
claiming that lung cancer and other diseases as well as addiction have resulted
from the use of or exposure to RJRT's tobacco products. During the second
quarter of 1997, 124 new actions were filed or served against RJRT and/or its
affiliates or indemnitees (as against only 44 in the second quarter of 1996) and
57 such actions were dismissed or otherwise resolved in favor of RJRT and/or its
affiliates or indemnitees without trial. Since the close of the second quarter,
through August 7, 1997, an unprecedented additional 117 suits have been filed or
served, and 14 dismissed. There have also been noteworthy increases in the
number of these cases pending. On August 7, 1997, there were 448 active cases
pending against RJRT and/or its affiliates or indemnitees, as compared with 203
cases in July 1996 and 68 in July 1995. Of these cases, 443 are in the United
States, one in Canada, three in Puerto Rico, and one in Guam.
The United States cases are in 44 states and are distributed as follows: 179
in Florida, 61 in New York, 36 in Texas, 18 in Louisiana, 11 in each of New
Jersey and Pennsylvania, ten in each of Alabama, California, and Ohio, eight in
each of Tennessee and Mississippi, six in West Virginia, five in each of Indiana
and Massachusetts, four in each of Kansas, Michigan, and Oklahoma, three in each
of Arizona, Colorado, District of Columbia, Hawaii, Minnesota, New Mexico,
Oregon, and Washington, two in each of Connecticut, Georgia, Illinois, Iowa,
Maryland Missouri, Montana, New Hampshire, South Dakota, and Wisconsin, and one
in each of Alaska, Arkansas, Idaho, Kentucky, Nevada, North Carolina, South
Carolina, Utah, and Vermont. Of the 443 active cases in the United States, 331
are pending in state court and 112 in federal court.
For additional information about tobacco-related litigation and other legal
proceedings, see Note 3-- Contingencies--Tobacco Litigation of Notes to
Consolidated Condensed Financial Statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Tobacco--Governmental
Activity."
------------------------
Litigation is subject to many uncertainties and it is possible that some of
the tobacco-related legal actions, proceedings or claims could be decided
against RJRT or its affiliates (including RJRN Holdings and RJRN) or
indemnitees. Determinations of liability or adverse rulings against other
cigarette manufacturers that are defendants in similar actions, even if such
rulings are not final, could adversely affect the litigation against RJRT or its
affiliates or indemnitees and could encourage an increase in the number of such
claims. There have been a number of political, legislative, regulatory and other
developments relating to the tobacco industry and cigarette smoking that have
received wide media attention, including the recent Liggett settlements of
certain health care recovery actions and a purported nationwide smoking and
health class action, and a decision by a federal district court on a motion for
summary judgment to uphold the FDA's regulation of cigarettes as "drugs" or
"medical devices." These developments, as well as the widespread media attention
given to the Memorandum referred to above, may negatively affect the outcomes of
tobacco-related legal actions and encourage the commencement of additional
similar litigation.
Although it is impossible to predict the outcome of such events on pending
litigation and the rate at which new lawsuits are filed against RJRT and RJRN, a
significant increase in litigation and/or in adverse outcomes for tobacco
defendants could have an adverse effect on RJRT and RJRN. RJRT and RJRN each
believe that they have a number of valid defenses to any such actions and intend
to defend vigorously all such actions in which they are named defendants.
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RJRN Holdings and RJRN believe that not withstanding the quality of defenses
available to them and RJRT in litigation matters, it is possible that the
results of operations or cash flows of RJRN Holdings or RJRN in particular
quarterly or annual periods or the financial condition of RJRN Holdings and RJRN
could be materially affected by the ultimate outcome of certain pending
litigation matters (including litigation costs). Management is unable to predict
the outcome of the litigation or to derive a meaningful estimate of the amount
or range of any possible loss in any particular quarterly or annual period or in
the aggregate.
------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
4.1 Registrants agree to furnish copies of any instruments defining the rights of holders
of long-term debt of the Registrants and their consolidated subsidiaries that does
not exceed 10 percent of the total assets of the Registrants and their consolidated
subsidiaries to the Securities and Exchange Commission upon request.
*10.1 RJR Nabisco Holdings Corp. 1990 Long-Term Incentive Plan as amended and restated
effective April 16, 1997.
*10.2 Form of Deferred Stock Unit Agreement between RJR Nabisco Holdings Corp. and the
Director named therein dated as of April 16, 1997.
*10.3 Form of Non-Qualified Stock Option Agreement between RJR Nabisco Holdings Corp. and
the Director named therein dated as of April 16, 1997.
*10.4 Form of Performance Unit Agreement between RJR Nabisco Holdings Corp. and the grantee
named therein (1997 grant--1 year period) dated as of February 28, 1997.
*10.5 Form of Restricted Stock Unit Agreement between RJR Nabisco Holdings Corp. and the
grantee named therein dated as of June 16, 1997.
*10.6 Fourth Amendment to the 364 Day Credit Agreement among RJR Nabisco Holdings Corp.,
RJR Nabisco, Inc. and certain lending institutions dated as of April 4, 1997.
*12.1 RJR Nabisco, Inc. Computation of Ratio of Earnings to Fixed Charges for the six
months ended June 30, 1997.
*27.1 RJR Nabisco Holdings Corp. Financial Data Schedule.
*27.2 RJR Nabisco, Inc. Financial Data Schedule.
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* Filed herewith.
(b) Reports on Form 8-K
Report on Form 8-K dated June 20, 1997, regarding the signing of a
Memorandum of Understanding setting forth concepts for federal
legislation and a contractual protocol to resolve a variety of
litigation and regulatory issues concerning tobacco and attaching as
exhibits, the Memorandum of Understanding and related RJRT press
release.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
(Registrants)
Date: August 8, 1997
/s/ DAVID B. RICKARD
- ------------------------------------------------
David B. Rickard
Senior Vice President and Chief
Financial Officer
/s/ RICHARD G. RUSSELL
- ------------------------------------------------
Richard G. Russell
Senior Vice President and Controller
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