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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
---------------------
RJR NABISCO HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 1-10215 13-3490602
(State or other jurisdiction of (Commission file number) (I.R.S. Employer 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 of (Commission file number) (I.R.S. Employer 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.)
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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: MARCH 31, 1999:
RJR NABISCO HOLDINGS CORP.: 325,351,748 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
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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 March 31, 1999 and 1998........ 1
Consolidated Condensed Statements of Cash Flows--Three Months Ended March 31, 1999 and 1998.... 2
Consolidated Condensed Balance Sheets--March 31, 1999 and December 31, 1998.................... 3
Notes to Consolidated Condensed Financial Statements........................................... 4-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................... 15-23
PART II--OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 24-25
Item 2. Changes in Securities and Use of Proceeds...................................................... 25
Item 4. Submission of Matters to a Vote of Security Holders............................................ 25
Item 5. Other Information.............................................................................. 25
Item 6. Exhibits and Reports on Form 8-K............................................................... 26
Signatures................................................................................................ 27
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
MARCH 31, 1999 MARCH 31, 1998
---------------------- ----------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- ----------- --------- -----------
NET SALES*.......................................................... $ 4,221 $ 4,221 $ 3,947 $ 3,947
--------- ----------- --------- -----------
Costs and expenses:
Cost of products sold* (note 1)................................... 2,109 2,109 1,824 1,824
Selling, advertising, administrative and general expenses......... 1,550 1,550 1,391 1,392
Tobacco settlement and related expenses (notes 1 and 5)........... -- -- 312 312
Amortization of trademarks and goodwill........................... 154 154 158 158
--------- ----------- --------- -----------
OPERATING INCOME................................................ 408 408 262 261
Interest and debt expense........................................... (216) (183) (221) (197)
Other income (expense), net......................................... (39) (39) (28) (28)
--------- ----------- --------- -----------
INCOME BEFORE INCOME TAXES...................................... 153 186 13 36
Provision for income taxes.......................................... 70 84 22 33
--------- ----------- --------- -----------
INCOME (LOSS) BEFORE MINORITY INTEREST IN INCOME OF NABISCO
HOLDINGS...................................................... 83 102 (9) 3
Less minority interest in income of Nabisco Holdings................ 7 7 11 11
--------- ----------- --------- -----------
NET INCOME (LOSS)............................................... $ 76 $ 95 $ (20) $ (8)
--------- ----------- --------- -----------
--------- ----------- --------- -----------
BASIC NET INCOME (LOSS) PER SHARE................................... $ .22 $ (0.10)
DILUTED NET INCOME (LOSS) PER SHARE................................. $ .22 $ (0.10)
DIVIDENDS PER SHARE OF COMMON STOCK................................. $ .5125 $ .5125
- ------------------------
* Excludes excise taxes of $707 million and $828 million for the three months
ended March 31, 1999 and 1998, respectively.
SEE NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998
-------------------- ----------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- --------- ----------- ---------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income (loss)................................................... $ 76 $ 95 $ (20) $ (8)
--------- --------- ----- ---------
Adjustments to reconcile net income (loss) to net cash flows used in
operating activities:
Depreciation and amortization................................... 275 275 284 284
Deferred income tax benefit..................................... (38) (38) (17) (17)
Changes in working capital items, net........................... (41) (27) (869) (838)
Initial, upfront tobacco settlement and related expenses, net of
cash payments................................................. (316) (316) 312 312
Other, net...................................................... 10 10 26 26
--------- --------- ----- ---------
Total adjustments............................................. (110) (96) (264) (233)
--------- --------- ----- ---------
Net cash flows used in operating activities....................... (34) (1) (284) (241)
--------- --------- ----- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Capital expenditures................................................ (80) (80) (136) (136)
Disposition of businesses and certain assets........................ 2 2 6 6
Repurchases of Nabisco Holdings' Class A common stock............... -- -- (26) (26)
Proceeds from exercise of Nabisco Holdings' Class A common stock
options........................................................... 2 2 15 15
--------- --------- ----- ---------
Net cash flows used in investing activities....................... (76) (76) (141) (141)
--------- --------- ----- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net borrowings (repayments) of long-term debt....................... (8) (8) 1,004 1,004
Increase (decrease) in short-term borrowings........................ 226 226 (575) (575)
Dividends paid on common and preferred stock........................ (183) (9) (191) (9)
Other, net (including intercompany transfers and payments).......... 29 (177) 55 (146)
--------- --------- ----- ---------
Net cash flows from financing activities.......................... 64 32 293 274
--------- --------- ----- ---------
Effect of exchange rate changes on cash and cash equivalents.......... (8) (8) -- --
--------- --------- ----- ---------
Net change in cash and cash equivalents........................... (54) (53) (132) (108)
Cash and cash equivalents at beginning of period...................... 300 299 348 348
--------- --------- ----- ---------
Cash and cash equivalents at end of period............................ $ 246 $ 246 $ 216 $ 240
--------- --------- ----- ---------
--------- --------- ----- ---------
Income taxes paid, net of refunds..................................... $ 38 $ 38 $ 166 $ 166
Interest paid......................................................... $ 233 $ 201 $ 213 $ 189
Tobacco settlement payments........................................... $ 316 $ 316 $ 47 $ 47
SEE NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
2
RJR NABISCO HOLDINGS CORP.
RJR NABISCO, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(DOLLARS IN MILLIONS)
MARCH 31, 1999 DECEMBER 31, 1998
-------------------- --------------------
RJRN RJRN
HOLDINGS RJRN HOLDINGS RJRN
--------- --------- --------- ---------
ASSETS
Current assets:
Cash and cash equivalents........................................... $ 246 $ 246 $ 300 $ 299
Accounts and notes receivable, net.................................. 1,160 1,154 1,118 1,102
Inventories......................................................... 2,353 2,353 2,293 2,293
Prepaid expenses and excise taxes................................... 728 728 733 733
--------- --------- --------- ---------
TOTAL CURRENT ASSETS............................................ 4,487 4,481 4,444 4,427
--------- --------- --------- ---------
Property, plant and equipment, net.................................... 5,180 5,180 5,298 5,298
Trademarks, net....................................................... 7,202 7,202 7,266 7,266
Goodwill, net......................................................... 11,325 11,325 11,449 11,449
Other assets and deferred charges..................................... 438 426 435 423
--------- --------- --------- ---------
$ 28,632 $ 28,614 $ 28,892 $ 28,863
--------- --------- --------- ---------
--------- --------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings............................................... $ 279 $ 279 $ 260 $ 260
Accounts payable and accrued liabilities............................ 3,721 3,544 3,983 3,792
Current maturities of long-term debt................................ 407 407 225 225
Income taxes accrued................................................ 277 304 235 228
--------- --------- --------- ---------
TOTAL CURRENT LIABILITIES....................................... 4,684 4,534 4,703 4,505
--------- --------- --------- ---------
Long-term debt (less current maturities).............................. 8,630 8,630 8,655 8,655
Minority interest in Nabisco Holdings................................. 727 727 752 752
Other noncurrent liabilities.......................................... 2,277 1,764 2,279 1,967
Deferred income taxes................................................. 3,149 3,085 3,162 3,098
Contingencies (note 5)
RJRN Holdings' obligated mandatorily redeemable preferred securities
of subsidiary trusts holding solely junior subordinated
debentures*......................................................... 1,327 -- 1,327 --
Stockholders' equity:
ESOP preferred stock................................................ 201 -- 205 --
Common stock (1999--328,729,048 shares issued, 1998-- 328,385,148
shares issued).................................................... 3 -- 3 --
Paid-in capital..................................................... 8,842 10,861 9,004 10,862
Retained earnings (accumulated deficit)............................. (501) (421) (577) (516)
Accumulated other comprehensive income (loss)....................... (566) (566) (460) (460)
Treasury stock, at cost............................................. (100) -- (100) --
Other stockholders' equity.......................................... (41) -- (61) --
--------- --------- --------- ---------
TOTAL STOCKHOLDERS' EQUITY.................................... 7,838 9,874 8,014 9,886
--------- --------- --------- ---------
$ 28,632 $ 28,614 $ 28,892 $ 28,863
--------- --------- --------- ---------
--------- --------- --------- ---------
- ------------------------
* The sole assets of the subsidiary trusts are junior subordinated debentures
of RJRN Holdings. The outstanding junior subordinated debentures have
aggregate principal amounts of approximately $978 and $385 million, annual
interest rates of 10% and 9 1/2%, respectively and mature in December, 2044
and September, 2047, respectively. The preferred securities will be
mandatorily redeemed upon redemption of the junior subordinated debentures.
SEE NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
3
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 period amounts have been reclassified to conform to the
current period 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, 1998.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
On January 1, 1999, RJRN Holdings and RJRN adopted SOP No. 98-5, Reporting
on the Costs of Start-Up Activities. SOP No. 98-5 established standards on
accounting for start-up and organization costs and, in general, requires such
costs to be expensed as incurred. The adoption of SOP No. 98-5 did not have a
material effect on RJRN Holdings' or RJRN's financial position or results of
operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
During the second quarter of 1998, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"), which must be
adopted by January 1, 2000, with early adoption permitted. SFAS No. 133 requires
that all derivative instruments be recorded on the consolidated balance sheet at
their fair value. Changes in the fair value of derivatives will be recorded each
period in earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. RJRN Holdings and RJRN have not yet determined the timing
of adoption or the impact that adoption or subsequent application of SFAS No.
133 will have on their financial position or results of operations.
COMPREHENSIVE INCOME
Total comprehensive income for the three months ended March 31, 1999 and
1998 was $(30) million and $(20) million, respectively for RJRN Holdings and
$(11) million and $(8) million, respectively for RJRN. Total comprehensive
income includes net income (loss), foreign currency translation adjustments and
minimum pension liability adjustments.
1998 RESTRUCTURING EXPENSES
In the second and fourth quarters of 1998, Nabisco recorded restructuring
expenses of $406 million ($216 million after-tax, net of minority interest) and
$124 million ($75 million after-tax, net of minority interest), respectively.
These restructuring programs were undertaken to streamline operations and
improve profitability and will result in a workforce reduction of approximately
6,500 employees of which 3,825 positions were eliminated as of March 31, 1999.
The restructuring programs will require cash expenditures of approximately $205
million, of which $16 million was paid in the first quarter of 1999, primarily
for severance and benefits. In addition, the programs will require additional
expenses of approximately $134 million, of which $15 million ($7 million
after-tax, net of minority interest) was
4
NOTE 1 -- INTERIM REPORTING (CONTINUED)
incurred in the first quarter of 1999. These additional expenses are principally
for implementation and integration of the programs and include costs for
relocation of employees and equipment and training.
For the three months ended March 31, 1999, $33 million of the accrual was
utilized as follows: $17 million for severance and benefits, $9 million for the
disposal of assets and $7 million for other exit costs.
In the fourth quarter of 1998, Reynolds International recorded a pre-tax
restructuring charge of $73 million to retool its operations in Russia and other
countries in the CIS region in response to continuing depressed economic
conditions in these countries. The pre-tax charge, which had no associated
income tax benefit, included severance and related benefits associated with a
workforce reduction of 2,900 employees of approximately $19 million as well as
the rationalization of manufacturing facilities of approximately $54 million.
For the three months ended March 31, 1999, $3 million of the accrual was
utilized for severance and related benefits and $3 million was utilized for the
rationalization of manufacturing facilities (costs incurred to close a facility
in Lviv). Cash expenditures amounted to approximately $3 million of the total
charges applied against the reserve.
1997 RESTRUCTURING EXPENSE
In the fourth quarter of 1997, RJRN Holdings recorded a pre-tax
restructuring expense of $301 million ($235 million after-tax) to reorganize its
worldwide tobacco operations. For the three months ended March 31, 1999, $8
million of the tobacco restructuring accruals were utilized primarily for
employee severance and related benefits. All of the charges applied against the
reserve were cash expenditures.
1996 RESTRUCTURING EXPENSE
The 1996 restructuring program, which was undertaken to streamline
operations and improve profitability of the food business, has been completed
and the balance remaining at December 31, 1998 of $2 million for severance costs
was paid during the first quarter of 1999.
TOBACCO SETTLEMENT AND RELATED EXPENSES
In the first quarter of 1998, $312 million ($199 million after-tax) was
recorded for initial, upfront tobacco settlement costs relating to the
agreements between RJRT and the Minnesota state attorney general and Blue Cross
and Blue Shield of Minnesota. Ongoing tobacco settlement costs recorded in the
first quarter of 1999 are included in cost of products sold.
In the fourth quarter of 1998, RJRT recorded a $151 million expense for a
workforce reduction of approximately 1,300 employees in response to changing
business conditions which will likely result from the multi-state settlement
agreement signed in November 1998. For the three months ended March 31, 1999,
RJRT incurred $5 million of payments, which were applied against the reserve.
NOTE 2 -- INVENTORIES
The major classes of inventory are as follows:
MARCH 31, DECEMBER 31,
1999 1998
------------- -------------
Finished products............................................... $ 736 $ 695
Leaf tobacco.................................................... 1,039 1,058
Raw materials................................................... 228 191
Other........................................................... 350 349
------ ------
$ 2,353 $ 2,293
------ ------
------ ------
5
NOTE 3 -- EARNINGS PER SHARE
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------
1999 1998
------------------------ ------------------------
BASIC DILUTED BASIC DILUTED
----------- ----------- ----------- -----------
Net income (loss) applicable to common stock:
Net income......................................................... $ 76 $ 76 $ (20) $ (20)
Preferred stock dividends.......................................... (4) (4) (11) (11)
----------- ----------- ----------- -----------
$ 72 $ 72 $ (31) $ (31)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average number of common and common equivalent shares
outstanding (in thousands):
Common shares...................................................... 324,053 324,053 323,798 323,798
Assumed exercise of RJRN Holdings' stock options................... -- 248 -- --
----------- ----------- ----------- -----------
324,053 324,301 323,798 323,798
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Shares of ESOP convertible preferred stock of 12,543,347 and 13,432,872 were
not included in computing diluted earnings per share for 1999 and 1998,
respectively, because the effect would have been antidilutive. Common shares
also exclude approximately 949,100 and 966,000 shares of restricted stock as the
vesting provisions had not been met at March 31, 1999 and 1998, respectively.
NOTE 4 -- SEGMENT REPORTING
RJRN Holdings is a holding company whose subsidiaries are engaged
principally in the manufacture, distribution and sale of tobacco products,
cookies, crackers, and other food products. RJRN Holdings is organized and
reports its results of operations in five operating segments: R.J. Reynolds
Tobacco, Reynolds International, Nabisco Biscuit, the U.S. Foods Group and the
International Food Group which are segregated by both product and geographic
location.
RJRN Holdings management evaluates the performance of its operating segments
based upon ongoing Operating Company Contribution ("OCC"). OCC for each
reportable segment is operating income before amortization of trademarks and
goodwill, restructuring expenses and other items deemed unusual by management.
These items include restructuring related costs in 1999 and initial, upfront
tobacco settlement and related costs in 1998.
SEGMENT PROFIT/(LOSS) INFORMATION:
THREE MONTHS ENDED MARCH 31 1999 1998
- -------------------------------------------------------------------------------------------- --------- ---------
Net sales from external customers:
R.J. Reynolds Tobacco..................................................................... $ 1,651 $ 1,176
Reynolds International.................................................................... 715 809
Nabisco Biscuit........................................................................... 867 850
U.S. Foods Group.......................................................................... 435 530
International Food Group.................................................................. 553 582
--------- ---------
Consolidated net sales from external customers.......................................... $ 4,221 $ 3,947
--------- ---------
--------- ---------
Ongoing OCC:
R.J. Reynolds Tobacco..................................................................... $ 275 $ 340
Reynolds International.................................................................... 120 173
Nabisco Biscuit........................................................................... 121 143
U.S. Foods Group.......................................................................... 49 63
International Food Group.................................................................. 32 32
Corporate................................................................................. (20) (19)
--------- ---------
Consolidated OCC........................................................................ $ 577 $ 732
--------- ---------
--------- ---------
6
NOTE 4 -- SEGMENT REPORTING (CONTINUED)
A reconciliation of consolidated OCC to consolidated income before income
taxes is as follows:
THREE MONTHS ENDED MARCH 31 1999 1998
- -------------------------------------------------------------------------------------------- --------- ---------
Ongoing OCC................................................................................. $ 577 $ 732
Items excluded from OCC:
Goodwill and trademark amortization....................................................... (154) (158)
Interest and debt expense................................................................. (216) (221)
Other income (expense), net............................................................... (39) (28)
Tobacco settlement and related expenses................................................... -- (312)
Restructuring related costs............................................................... (15) --
--------- ---------
Income before income taxes.............................................................. $ 153 $ 13
--------- ---------
--------- ---------
NOTE 5 -- CONTINGENCIES
TOBACCO 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 and RJRN Holdings) 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 first quarter of 1999, 35 new actions were served against RJRT and/or
its affiliates or indemnitees (as against 72 in the first quarter of 1998) and
49 actions were dismissed or otherwise resolved in favor of RJRT and/or its
affiliates or indemnitees without trial. There have been noteworthy increases in
the number of cases pending. On March 31, 1999, there were 647 active cases
pending, as compared with 550 on March 31, 1998 and 278 on March 31, 1997. As of
April 28, 1999, 661 active cases were pending against RJRT and/or its affiliates
or indemnitees: 655 in the United States; 3 in Canada; 1 in each of the Marshall
Islands, Nigeria and Puerto Rico.
The U.S. cases are pending in 41 U.S. states and the District of Columbia,
although four states -- West Virginia, Florida, New York and California --
account for 61% of these cases. The breakdown is as follows: 125 in West
Virginia; 112 in New York; 111 in Florida; 53 in California; 34 in
Massachusetts; 25 in Louisiana; 18 in Texas; 16 in each of Pennsylvania and
Tennessee; 15 in D.C.; 11 in New Jersey; 10 in Alabama; nine in each of Illinois
and Mississippi; seven in Ohio; six in Iowa; five in each of Indiana, Maryland,
Minnesota Missouri and Nevada; four in each of Arkansas, Georgia, Oklahoma,
Rhode Island and Virginia; three in each of Arizona, Canada, New Mexico,
Washington and Wisconsin; two in each of Colorado, Hawaii, Kentucky, Michigan,
North Carolina, North Dakota, South Carolina, South Dakota and Utah; and one in
each of Kansas, New Hampshire, and Oregon. Of the 655 active U.S. cases, 168 are
pending in federal court, 482 in state court and five in tribal court). Most of
these cases were brought by individual plaintiffs, but an increasing number,
discussed below, seek recovery on behalf of third parties or large classes of
claimants.
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, antitrust, Racketeer
Influenced and Corrupt Organization Act ("RICO"), indemnity, medical monitoring
and common law public nuisance. Punitive damages, often in amounts ranging into
the hundreds of millions or even billions of dollars, are specifically pleaded
in a number of cases in addition to compensatory and other damages. Nine of the
655 active cases in the United States involve alleged non- smokers claiming
injuries purportedly resulting from exposure to environmental tobacco smoke.
Fifty-nine cases purport to be class actions on behalf of thousands of
individuals. Purported classes include individuals claiming to be addicted to
cigarettes, individuals and their estates claiming illness and death from
cigarette smoking, persons making claims based on alleged exposure to
environmental tobacco smoke, African-American smokers claiming their civil
rights have been violated by
7
NOTE 5 -- CONTINGENCIES (CONTINUED)
the sale of menthol cigarettes, purchasers of cigarettes claiming to have been
defrauded and seeking to recover their costs, and Blue Cross/Blue Shield
subscribers seeking reimbursement for premiums paid. Approximately 102 of the
active cases seek, INTER ALIA, recovery of the cost of Medicaid payments or
other health-related costs paid for treatment of individuals suffering from
diseases or conditions allegedly related to tobacco use. Nine, brought by
entities administering asbestos liability, seek contribution for the costs of
settlements and judgments.
DEFENSES. The defenses raised by RJRT and/or its affiliates, where
applicable, include preemption by the Federal Cigarette Labeling and Advertising
Act of some or all such claims arising after 1969; the lack of any defect in the
product; assumption of the risk; contributory or comparative fault; lack of
proximate cause; and statutes of limitations or repose; and, when applicable,
additional statutory, equitable, constitutional and other defenses. RJRN and
RJRN Holdings have asserted additional defenses, including jurisdictional
defenses, in many of these cases in which they are named.
INDUSTRY TRIAL RESULTS. Juries have found for plaintiffs in five smoking
and health cases in which RJRT was not a defendant. 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. That case, CARTER V. BROWN & WILLIAMSON,
was overturned on appeal on June 22, 1998. In another Florida case brought by
the same attorney, WIDDICK V. BROWN & WILLIAMSON, a state court jury awarded the
plaintiff approximately $1 million in compensatory and punitive damages on June
10, 1998. On January 29, 1999, the Florida Court of Appeals reversed this
verdict and ordered a new trial in a different location (Palm Beach County). On
February 9-10, 1999, in HENLEY V. PHILIP MORRIS, INC., a San Francisco state
court jury awarded an individual smoker $1.5 million in compensatory damages and
$50 million in punitive damages. Philip Morris moved to have this verdict set
aside or reduced. On April 16, 1999, the trial judge reduced the punitive
damages award to $25 million, but otherwise denied Philip Morris' motions.
Philip Morris will appeal the verdict. On March 30, 1999, in WILLIAMS V. PHILIP
MORRIS, an Oregon state court jury returned a verdict against Philip Morris in
the amount of $1.5 million in compensatory damages and $79 million in punitive
damages. Philip Morris will also appeal that case.
On May 5, 1997, in an individual case filed against RJRT, brought by the
same attorney who represented plaintiffs in the CARTER and WIDDICK cases, a
Florida state court jury found no RJRT liability (CONNOR V. R. J. REYNOLDS
TOBACCO CO.). On October 31, 1997, in still another case (KARBIWNYK V. R.J.
REYNOLDS TOBACCO COMPANY) brought by the same attorney, another Florida state
court jury found no RJRT liability. On March 19, 1998, an Indiana state court
jury found for RJRT, RJRN Holdings and other defendants in an individual case,
DUNN V. RJR NABISCO HOLDINGS CORP., in which plaintiffs sought damages for the
alleged harm caused to a non-smoker by environmental tobacco smoke. Finally, on
March 18, 1999, the jury in an Ohio federal district court found for the
defendants, including RJRT, on all counts in a class-action union trust-fund
case, IRONWORKERS LOCAL 17 V. PHILIP MORRIS. A verdict is expected during the
first week of May in NEWCOMB V. R.J. REYNOLDS TOBACCO CO., one of three
individual cases in Tennessee state court which have been consolidated for
trial.
CERTAIN CLASS-ACTION SUITS. In May 1996, in an early class action case,
CASTANO V. AMERICAN TOBACCO COMPANY, the Fifth Circuit Court of Appeals
overturned the certification of a purported nationwide class of persons whose
claims related to alleged addiction to tobacco. Since this ruling by the Fifth
Circuit, most purported class-action suits have sought certification of
statewide rather than nationwide classes.
Putative class-action suits based on claims similar to those asserted in
CASTANO have been brought against RJRT and in some cases RJRN in state and, in a
few instances, federal courts in Alabama, Arkansas, California, the District of
Columbia (D.C. court), Florida, Hawaii, Illinois, Indiana, Iowa, Louisiana,
Maryland, Massachusetts, Michigan, Minnesota, Missouri, New Mexico, Nevada, New
Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina,
Tennessee, Texas, Utah,
8
NOTE 5 -- CONTINGENCIES (CONTINUED)
Virginia, and West Virginia. A putative class action filed in Tennessee seeks
reimbursement of Blue Cross/ Blue Shield premiums paid by subscribers throughout
the United States. On October 19, 1998, a putative class action was filed in
federal court in Philadelphia, Pennsylvania, on behalf of "all living Black
Americans who have purchased or consumed menthol tobacco products since 1954
(including minors through their legal representatives)" seeking redress of
alleged violations of the plaintiffs' civil rights. A purported class action
suit against RJRT in Texas claims that the marketing of "lights" and
"ultralight" cigarettes is deceptive. Similar claims have been made in other
lawsuits. Other types of class- action suits have also been filed in additional
jurisdictions and there are also putative class action suits pending in Canada,
Puerto Rico and Nigeria. Most of these suits assert claims on behalf of classes
of individuals who claim to be addicted, injured, or at greater risk of injury
by the use of tobacco or exposure to environmental tobacco smoke, or are the
legal survivors of such persons.
Despite the marked increase of purported class actions brought against
tobacco companies, very few purported class actions have been certified, or if
certified, have survived on appeal. Most recently, on April 12, 1999, in
CHAMBERLAIN V. AMERICAN TOBACCO COMPANY, a federal district court in Ohio
refused to certify a class of "nicotine-dependent" Ohio residents. On April 13,
1999, in AVALLONE V. AMERICAN TOBACCO COMPANY, a state court judge in New Jersey
refused to certify a purported class of casino workers exposed to environmental
tobacco smoke. Class certification was granted in 1998, however, by a Maryland
state court in RICHARDSON V. PHILIP MORRIS.That decision is being reviewed by
the Maryland Court of Appeals. In addition, on November 5, 1998 a Louisiana
state appeals court affirmed the certification of a medical monitoring and/or
smoking cessation class of Louisiana residents who were smokers on or before May
24, 1996 (SCOTT V. AMERICAN TOBACCO COMPANY). On February 26, 1999, the
Louisiana Supreme Court denied the defendants' petition for writ of certiorari
and/or review. Finally, defendants settled another class-action suit, BROIN V.
PHILIP MORRIS, in October, 1997. This settlement was challenged but was approved
by the Florida Court of Appeals on March 24, 1999.
Trial is underway in a class-action suit pending in Florida, ENGLE V. R. J.
REYNOLDS TOBACCO COMPANY, in which a class consisting of Florida residents or
their survivors who claim to have diseases or medical conditions caused by their
alleged "addiction" to cigarettes has been certified. The trial is divided into
three phases. The initial phase, which includes common issues related to
liability and general causation, entitlement to punitive damages and possibly
the basis or ratio for assessment of punitive damages, is expected to last
several more weeks, but even if potential liability is confirmed in this phase
of the trial, no actual liability would be established until the subsequent
phases which could last for some years.
HEALTH-CARE COST RECOVERY CASES. In June 1994, the Mississippi attorney
general brought an action, MOORE V. AMERICAN TOBACCO COMPANY, against various
industry members including RJRT. This case was brought on behalf of the state to
recover state funds paid for healthcare and medical and other assistance to
state citizens suffering from diseases and conditions allegedly related to
tobacco use. By making the State the plaintiff in the case and basing its claims
on economic loss rather than personal injury, the State sought to avoid the
defenses otherwise available against an individual plaintiff. Following the
filing of the MOORE case, most other states, through their attorneys general
and/or other state agencies, sued RJRT and other U.S. cigarette manufacturers
based on similar theories. The first four of these cases scheduled to come to
trial, those of Mississippi, Florida, Texas and Minnesota, were settled by
separate agreements between the state and the cigarette manufacturer defendants
in each case.
On November 23, 1998, the major U.S. cigarette manufacturers, including
RJRT, entered into a Master Settlement Agreement ("MSA") with attorneys general
representing the remaining 46 states, the District of Columbia, Puerto Rico,
Guam, the Virgin Islands, American Samoa and the Northern Marianas (the
"Settling States"). The MSA settles all the health-care cost recovery actions
brought by the Settling States and contains releases of certain additional
present and future claims. For a more detailed description of the MSA, see the
Registrants' Annual Report on Form 10-K for the fiscal year ended December 31,
1998, filed with the Securities and Exchange Commission on March 26, 1999.
9
NOTE 5 -- CONTINGENCIES (CONTINUED)
The MSA, when judicially approved, will release RJRT (and certain of its
indemnitees), RJRN and RJRN Holdings from: (i) all claims of the Settling States
(and their respective political subdivisions and other recipients of state
health-care funds) relating to past conduct arising out of the use, sale,
distribution, manufacture, development, advertising, marketing or health effects
of, the exposure to, or research, statements or warnings about, tobacco
products; and (ii) all monetary claims relating to future conduct arising out of
the use of, or exposure to, tobacco products which have been manufactured in the
ordinary course of business.
The MSA is scheduled to become effective on the earlier of June 30, 2000 or
the date on which final approval of the settlement has been obtained in courts
of 80% of the Settling States (both by number and percentage share of the
settlement payments due). As of April 20, 1999, final approval was obtained in
the requisite number of Settling States (42) but those states' percentage shares
comprise only 54.18% (rather than the necessary 80%) of the payments due.
Payments for all tobacco litigation settlement agreements currently in
effect (including the MSA and four individual state settlements) will be
approximately $1.6 billion in 1999 and will be funded through price increases.
Payments in future years are estimated to exceed $2.0 billion per year, but
these payments will be subject to, among other things, the volume of cigarettes
sold by RJRT, RJRT's market share and inflation adjustments.
On April 20, 1999, the Canadian Province of British Columbia brought a case,
similar to the U.S. attorney-general cases, against RJRT and other Canadian and
U.S. tobacco companies and their parent companies (including RJRN) in British
Columbia Provincial Court. This lawsuit relies heavily upon recently enacted
legislation in British Columbia which is being separately challenged by Canadian
tobacco companies. An agreement has been reached with the government in British
Columbia that these separate constitutional challenges will be litigated prior
to the health-care recovery action. These constitutional challenges are
scheduled to be heard by the Canadian courts in the autumn of 1999.
UNION CASES. Although the MSA settled some of the most potentially
burdensome healthcare cost recovery actions, many other such cases have been
brought by other types of plaintiffs. Approximately 70 lawsuits have been
brought by union trust funds against cigarette manufacturers and others in the
past two years. The funds seek recovery of payments made by them for medical
expenses of their participants' union members and their dependents allegedly
injured by cigarettes. The claims in these cases are almost identical, and more
than 30 of the cases purport to be class actions on behalf of all union trust
funds in a particular state.
The defendants in these actions argue, among other things, the settled law
that one who pays an injured person's medical expenses is legally too remote to
maintain an action against the person allegedly responsible for the injury. In
addition, they argue that the traditional subrogation remedy cannot be
supplanted by a direct right of action for the trust fund that strips defendants
of the defenses they would ordinarily have against the allegedly injured
individual.
In the first of these cases to be considered by a federal court of appeals,
on March 29, 1999, the Third Circuit Court of Appeals affirmed a district court
ruling dismissing a case, STEAMFITTERS LOCAL UNION 420 V. PHILIP MORRIS, on
remoteness grounds. Then, a week later, the Second Circuit handed down its
decision in LABORERS LOCAL 17 V. PHILIP MORRIS, reversing a district court's
decision and remanding the case for dismissal, again on remoteness grounds. On
May 3, 1999, the U.S. Court of Appeals for the Ninth Circuit heard oral argument
in OREGON LABORERS V. PHILIP MORRIS. Numerous trial court judges have also
dismissed these cases on remoteness grounds, including most recently, on April
29, 1999, a federal district court in Minnesota (LYONS V. PHILIP MORRIS).
Nonetheless, in other federal circuits, there are still some union cases that
have survived motions to dismiss and that may proceed to trial. Most recently,
on March 31, 1999, a federal district court denied defendants' motion to dismiss
in UTAH LABORERS V. PHILIP MORRIS. One such case, NORTHWEST LABORERS V. PHILIP
MORRIS, is scheduled for trial in September 1999.
10
NOTE 5 -- CONTINGENCIES (CONTINUED)
The first union case to survive motions to dismiss and go to trial was IRON
WORKERS LOCAL NO. 17 V. PHILIP MORRIS. This case, in which a class of
approximately 111 union trust funds was certified by a federal district court in
Ohio, went to trial on February 22, 1999 on the counts that survived motions to
dismiss both state and federal RICO claims and civil conspiracy claims. The
federal RICO claim was dismissed during the trial, and after the conclusion of
plaintiffs' case, the court directed a verdict dismissing RJRN and RJRN Holdings
from the case. On March 18, 1999, the jury in this case returned a unanimous
verdict for the defendants on all surviving counts.
OTHER HEALTH-CARE COST RECOVERY AND AGGREGATED CLAIMS PLAINTIFFS. Similar
cases have been filed by Native American tribes, five in tribal courts and one
putative class action in San Diego Superior Court. Four groups of health-care
insurers, as well as a private entity that purported to self-insure its employee
health-care programs, have also advanced claims similar to those found in the
union health-care cost recovery actions. Two of these "insurer" cases, WILLIAMS
& DRAKE V. AMERICAN TOBACCO, and REGENCE BLUESHIELD V. PHILIP MORRIS, were
dismissed in their entirety on "remoteness" grounds by federal district courts
in Pennsylvania and Washington respectively. In a third "Insurers" case, GROUP
HEALTH PLAN, INC. V. PHILIP MORRIS, a federal district judge in Minnesota, on
April 29, 1999, dismissed all claims except a state anti-trust claim and a
conspiracy claim. Four foreign countries have also brought health-care cost
recovery suits in U.S. courts. Other cost recovery suits have been brought by,
among others, local governmental jurisdictions, taxpayers (on behalf of a
governmental jurisdiction), a university and a hospital. Finally, nine actions
have been filed against RJRT by asbestos companies and/or asbestos-related trust
funds based on the theory that the plaintiffs "overpaid" claims brought against
them to the extent that tobacco use, not asbestos exposure, was the cause of the
alleged personal injuries for which they paid compensation. On April 29, 1999, a
federal district court judge in Minnesota dismissed the entire "asbestos
contribution" complaint in CONWED CORP. V. R.J. REYNOLDS TOBACCO COMPANY.
Plaintiffs have the right to replead.
RECENT AND SCHEDULED TRIALS. As of April 28, 1999, there were 14 cases
scheduled for trial in 1999 against RJRT alleging injuries relating to tobacco.
In addition, two of these cases, in which RJRT is a party, are currently in
progress: the ENGLE case in Florida; and NEWCOMB V. R.J. REYNOLDS TOBACCO
COMPANY, which is one of three consolidated individual cases being tried in
Memphis, Tennessee. Closing arguments in NEWCOMB are scheduled on May 3 and 4,
1999, and a verdict is expected shortly thereafter. Cases against other tobacco
company defendants are also scheduled for trial in 1999 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, some
involving claims for possibly billions of dollars, against RJRT and RJRN coming
to trial over the next year.
OTHER DEVELOPMENTS. In January of 1999, President Clinton announced that
the U.S. Department of Justice is preparing a litigation plan for a lawsuit by
the federal government to recover federal healthcare costs associated with
cigarette smoking, and press reports have indicated that the Justice Department
has engaged a private law firm to assist in such a lawsuit.
On April 9, 1999, a class action complaint (A.D. BEDELL WHOLESALE CO. V
PHILIP MORRIS INC.) was filed on behalf of cigarette wholesalers and
distributors against RJRT, Philip Morris and Brown & Williamson in the U.S.
District Court for the District of Pennsylvania alleging violations of the
federal antitrust laws based, in large part, on the MSA.
RJRT is aware of certain grand jury investigations being conducted in New
York and Washington, D.C. which relate to the cigarette business. In addition,
RJRT received a document subpoena, dated September 17, 1998, from a federal
grand jury convened in the Eastern District of Pennsylvania by the Antitrust
Division of the Department of Justice. RJRT understands that the grand jury is
investigating possible violations of the antitrust laws related to tobacco leaf
buying practices. RJRT is responding to the subpoena.
On December 22, 1998, a now inactive tobacco subsidiary that was part of
Reynolds International's business, Northern Brands International, Inc. ("NBI"),
entered into a plea agreement with the United
11
NOTE 5 -- CONTINGENCIES (CONTINUED)
States Attorney for the Northern District of New York. NBI was charged with
aiding and abetting certain customers who brought merchandise into the United
States "by means of false and fraudulent practices. . . ." NBI agreed to pay a
$10 million forfeiture and a $5.2 million fine and special assessment. In the
plea agreement, the U.S. Attorney agreed not to bring additional criminal
charges in the Northern District against NBI or its corporate affiliates
(including RJRN Holdings, RJRN, RJRT and Reynolds International) for actions
(from 1985 through 1998) that are related to those that gave rise to the
agreement. RJR-MacDonald, Reynolds International's operating company in Canada,
is cooperating with an investigation now being conducted by the Royal Canadian
Mounted Police relating to the same events that gave rise to the NBI
investigation. Management cannot predict whether any other authorities in the
United States or Canada will seek to take further actions with regard to these
events.
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 Master Settlement Agreement
referred to above. These developments may negatively affect the outcomes of
tobacco-related legal actions and encourage the commencement of additional
similar litigation.
Although it is impossible to predict the outcome of such events on pending
litigation and the rate at which new lawsuits are filed against RJRT, RJRN and
RJRN Holdings, a significant increase in litigation and/or in adverse outcomes
for tobacco defendants could have an adverse effect on any one or all of these
entities. RJRT, RJRN and RJRN Holdings each believe that they have a number of
valid defenses to any such actions and intend to defend such actions vigorously.
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.
NOTE 6 -- THE REORGANIZATION
On March 9, 1999, RJRN and RJRT entered into a definitive agreement to sell
the international tobacco business for approximately $8 billion, including the
assumption of approximately $200 million of net debt, to Japan Tobacco Inc.
("Japan Tobacco"). Under the terms of the agreement, Japan Tobacco will acquire
substantially all of the business including intellectual property rights of
Reynolds International, including the international rights to the Camel, Winston
and Salem brand names. Proceeds from the sale will be used to reduce debt and
for general corporate purposes, which is expected to substantially strengthen
the financial position of RJRN and RJRT. The sale is subject to certain
regulatory conditions and receipt of certain consents from RJRN Holdings'
security holders and RJRN's bondholders.
Also on March 9, 1999, RJRN Holdings announced that its board of directors
had approved a plan to separate the domestic tobacco business conducted by RJRT,
from the food business conducted by operating subsidiaries of Nabisco Holdings.
Under the plan, the separation of the businesses will be accomplished by a
tax-free spin-off to RJRN Holdings shareholders of shares in the domestic
tobacco business.
Upon completion of the spin-off, RJRN Holdings will be renamed Nabisco Group
Holdings and continue to exist as a holding company, owning 80.5% of Nabisco
Holdings. The re-named Nabisco Group
12
NOTE 6 -- THE REORGANIZATION (CONTINUED)
Holdings and Nabisco Holdings will each continue to trade as separate companies
on the New York Stock Exchange and shares of tobacco company stock will also
trade separately.
On April 13, 1999, RJRN Holdings offered to purchase any and all of its 9.5%
trust preferred securities and sought consents from the holders of those
securities to waive certain covenants that might have prevented some of the
transactions described above. The expiration date for the consent solicitation
is May 17, 1999, unless extended by RJRN Holdings.
Also on April 13, 1999, RJRN offered to purchase substantially all of its
outstanding debt securities and sought consents from the holders of those
securities to waive covenants that might have prevented some of the transactions
described above. These consents were received as of April 26, 1999. The offer to
purchase is subject to consummation of the sale of the international tobacco
business to Japan Tobacco Inc. RJRN expects the sale to close before the end of
May 1999, and the transfer of RJRN's interest in Nabisco to take place shortly
thereafter.
In connection with the reorganization, on April 29, 1999, RJRN issued a
preliminary private placement offering memorandum to issue $500 million of notes
due 2003 and $500 million of notes due 2006. The net proceeds received will be
used for general corporate purposes.
The unaudited pro forma information below reflects adjustments to the
historical results of operations and financial condition of RJRN Holdings and
RJRN. The unaudited pro forma balance sheet gives effect to the following
transactions as if they occurred on March 31, 1999, as applicable: (i) the sale
of Reynolds International and application of the net proceeds to reduce debt and
for general corporate purposes: (ii) the issuance of new debt by RJRN; (iii) the
transfer from of Nabisco Holdings from RJRN to RJRN Holdings through a merger
transaction; and (iv) the spin-off of RJRN to RJRN Holdings' shareholders. The
unaudited pro forma income statement gives effect to the above transactions and
the adjustment to selling, advertising, administrative and general expenses to
reflect the estimated level of RJRN's administrative expenses after the
completion of the RJRN spin-off, as if the transactions occurred on January 1,
1999. No adjustment has been made for one-time or non-recurring items in the
unaudited pro forma income statement.
Management believes that the assumptions used provide a reasonable basis on
which to present the pro forma consolidated financial data based on transactions
and events that are currently probable to occur. THE UNAUDITED PRO FORMA
FINANCIAL STATEMENTS OF RJRN HOLDINGS AND RJRN ARE PROVIDED FOR INFORMATIONAL
PURPOSES ONLY AND SHOULD NOT BE CONSTRUED TO BE INDICATIVE OF THE RESULTS OF
OPERATIONS OR FINANCIAL POSITION HAD THE TRANSACTIONS AND EVENTS DESCRIBED ABOVE
BEEN CONSUMMATED ON THE DATES ASSUMED AND DO NOT PROJECT THE RESULTS OF
OPERATIONS OR FINANCIAL POSITION FOR ANY FUTURE DATE OR PERIOD.
13
NOTE 6 -- THE REORGANIZATION (CONTINUED)
MARCH 31, 1999
------------------------------
RJRN HOLDINGS RJRN
-------------- --------------
ASSETS
Cash and cash equivalents........................................................ $ 159 $ 2,786
Accounts and other receivables, net.............................................. 488 151
Inventories...................................................................... 803 527
Prepaid expenses and excise taxes................................................ 69 424
------- -------
Total current assets........................................................... 1,519 3,888
------- -------
Property, plant and equipment, net............................................... 2,859 1,101
Trademarks, net.................................................................. 3,335 3,150
Goodwill, net.................................................................... 3,132 7,759
Other assets and deferred charges................................................ 86 153
------- -------
Total assets................................................................... $ 10,931 $ 16,051
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings............................................................ $ 67 $ --
Accounts payable and accrued liabilities......................................... 1,369 1,606
Current maturities of long-term debt............................................. 265 12
Income taxes accrued............................................................. 8 2,267
------- -------
Total current liabilities...................................................... 1,709 3,885
------- -------
Long-term debt (less current maturities)......................................... 3,692 1,815
Minority interest in Nabisco Holdings............................................ 727 --
Other noncurrent liabilities..................................................... 706 1,343
Deferred income taxes............................................................ 1,270 1,453
Total stockholders' equity....................................................... 2,827 7,555
------- -------
Total liabilities and stockholders' equity..................................... $ 10,931 $ 16,051
------- -------
------- -------
THREE MONTHS ENDED
MARCH 31, 1999
------------------------------
RJRN HOLDINGS RJRN
-------------- --------------
Net sales........................................................................ $ 1,855 $ 1,693
Costs and expenses............................................................... 1,671 1,408
Amortization of trademarks and goodwill.......................................... 53 92
-------------- --------------
Operating income............................................................... 131 193
Interest expense and other income (expense), net................................. (75) (39)
Income tax provision............................................................. 22 68
Minority interest................................................................ 7 --
-------------- --------------
Income from continuing operations.............................................. $ 27 $ 86
-------------- --------------
-------------- --------------
------------------------
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion and analysis of the consolidated financial
condition and results of operations of RJRN Holdings. It illustrates operating
company contribution on a basis consistent with how management manages the
ongoing businesses. It excludes all items management considers unusual in
nature, which impact the comparability of historic results. These items are
described below. It should be read in conjunction with the historical financial
information included in the Consolidated Condensed Financial Statements.
RESULTS OF OPERATIONS
THREE MONTHS
ENDED MARCH 31,
-----------------------------------
1999 1998 % CHANGE
--------- --------- -------------
(DOLLARS IN MILLIONS)
NET SALES:
RJRT................................................................................. $ 1,651 $ 1,176 40%
Reynolds International............................................................... 715 809 (12)
--------- ---------
Total Tobacco.................................................................... 2,366 1,985 19
--------- ---------
Nabisco Biscuit...................................................................... 867 850 2
U.S. Foods Group..................................................................... 435 530 (18)
International Food Group............................................................. 553 582 (5)
--------- ---------
Total Food....................................................................... 1,855 1,962 (5)
--------- ---------
$ 4,221 $ 3,947 7
--------- ---------
--------- ---------
ONGOING OPERATING COMPANY CONTRIBUTION:(1)
RJRT(2).............................................................................. $ 275 $ 340 (19)%
Reynolds International............................................................... 120 173 (31 )
--------- ---------
Total Tobacco.................................................................... 395 513 (23 )
--------- ---------
Nabisco Biscuit(3)................................................................... 121 143 (15 )
U.S. Foods Group(3).................................................................. 49 63 (22 )
International Food Group(3).......................................................... 32 32 --
--------- ---------
Total Food....................................................................... 202 238 (15 )
--------- ---------
Headquarters......................................................................... (20) (19) (5 )
--------- ---------
$ 577 $ 732 (21 )
--------- ---------
--------- ---------
- ------------------------------
(1) Ongoing operating company contribution represents operating income before
amortization of trademarks and goodwill, restructuring expense and unusual
items (see notes (2) and (3) below).
(2) 1998 excludes a charge of $312 million ($199 million after-tax or $.62 per
diluted common share) for initial, upfront tobacco settlement costs relating
to the agreements between RJRT and the Minnesota state attorney general and
Blue Cross and Blue Shield of Minnesota.
(3) 1999 excludes a charge of $15 million ($7 million after-tax, net of minority
interest or $0.02 per diluted share) related to the implementation of the
1998 restructuring of the food business ($13 million at Biscuit, $1 million
at U.S. Foods Group and $1 million at International).
UNLESS OTHERWISE NOTED ALL OPERATING COMPANY CONTRIBUTION COMPARISONS WITHIN THE
FOLLOWING DISCUSSIONS ARE BASED ON ONGOING RESULTS, WHICH EXCLUDE UNUSUAL ITEMS
DISCLOSED ABOVE.
See note 6 to the Consolidated Condensed Financial Statements regarding the
pending sale by RJRN and RJRT of the international tobacco business and the
separation of the domestic tobacco and food businesses.
15
TOBACCO
The tobacco line of business is conducted by RJRT and R.J. Reynolds
International ("Reynolds International").
RJRT's net sales for the first quarter were $1.65 billion, $475 million
higher than the comparable period in 1998. The increase is primarily
attributable to higher pricing ($649 million), partially offset by lower volume
($172 million). The pricing increase is before competitive discounting. See the
operating company contribution discussion below. Volume for the first quarter of
1999 decreased 14% from the comparable 1998 period. Industry volume decreased
10% for the period.
RJRT's overall retail share of market for the first quarter of 1999
decreased to 24.41% from 25.44% in the prior year comparable period. RJRT's
full-price share of market declined to 15.54% from 16.47%, while its savings
share of market decreased to 8.87% from 8.97%. Industry-wide shipments for the
full-price category increased to 74% of total shipments from 73% in 1998. RJRT's
full-price shipments as a percentage of its total shipments were consistent with
the first quarter of 1998 at 62%.
Camel shipments were down 9% in the quarter compared to 1998, slightly
better than the overall industry decline. Due to heavy competitive discounting
and promotion, Winston shipments were down 18% for the quarter. In addition, the
first quarter of 1998 included strong shipments of the repositioned, "No Bull"
Winston. Salem volume declined 13% for the first quarter versus the 1998
comparable period. New packaging and marketing programs for Salem were rolled
out nationwide during the first quarter after a year of successful testing in
New York City. Salem's positioning, "Its Not What You Expect", blends
attention-grabbing advertising, new product styles and innovative promotional
programs to gain competitive leverage. The campaign's primary focus will be in
selected high-potential markets. Volume for Doral, the industry's leading
savings brand, was down for the quarter by 16% versus the comparable 1998
period, slightly above the industry category decline, due to overall aggressive
promotion in the savings segment. Doral's retail share of market declined .07
share points for the period.
RJRT's operating company contribution decreased 19% to $275 million for the
first quarter of 1999 from $340 million in 1998 (excluding initial, upfront
tobacco settlement costs of $312 million in 1998). The decrease is due primarily
to increased ongoing tobacco settlement costs, ($468 million), lower volume
($145 million) and competitve discounting (marketing) ($80 million), partially
offset by higher pricing ($649 million).
Reynolds International's net sales were $715 million for the first quarter
of 1999, a decrease of 12% over the comparable 1998 quarter, due primarily to
lower volume, partially offset by favorable foreign currency translation.
Overall volume for the quarter of 42.4 billion units was down 13% versus 1998,
primarily due to a 33% volume decrease in the CIS and Baltics region caused by
deteriorating economic conditions in those countries. The poor economy and
uncertain conditions fostered a decline in consumer purchasing power and weak
demand for mid- and premium priced products. Lower margin Russian brands' volume
increased approximately 11% as a result of brand substitution.
Volume in the Southern Europe/Northern Africa region was up 11%, driven by
increases in Camel volume in Italy and the Canary Islands and an increase in
Winston volume in Spain.
Operating company contribution was $120 million for the quarter, a decrease
of 31% from the comparable period in 1998. The decrease in the first quarter of
1999 is mainly attributable to the volume decline and brand substitution in the
CIS and Baltics region.
GOVERNMENTAL ACTIVITY
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. Regulations
establishing 18 as the national minimum age for the sale of cigarettes and
requiring age identification from purchasers who appear to be under age 26
became effective in February 1997.
16
Implementation of the remaining regulations, which prohibit or impose stringent
limits on a broad range of sales and marketing practices, was stayed by the U.S.
District Court for the Middle District of North Carolina (COYNE BEAHM V. UNITED
STATES FOOD & DRUG ADMINISTRATION) pending appeal of denial of motions for
summary judgment by RJRT and others in the tobacco industry. On August 14, 1998,
the U.S. Court of Appeals for the Fourth Circuit reversed a portion of the
District Court ruling, finding that the FDA had exceeded its authority by
regulating tobacco products. On April 26, 1999, The U.S. Supreme Court agreed to
hear the FDA's appeal of the Fourth Circuit's ruling. RJRT is unable to predict
the ultimate outcome of this litigation seeking to find the FDA's regulations to
be unlawful. If the ruling by the Fourth Circuit were reversed, and if the full
regulations do go into effect, they could be expected to have an adverse effect
on cigarette sales and RJRT.
In December 1992, the U.S. Environmental Protection Agency (the "EPA")
issued a report entitled, "Respiratory Health Effects of Passive Smoking: Lung
Cancer and Other Disorders," which classified environmental tobacco smoke as a
Group A (known human) carcinogen. On June 22, 1993, RJRT and others filed suit
in the U.S. District Court for the Middle District of North Carolina (FLUE-CURED
STABILIZATION CORP. V. U.S. ENVIRONMENTAL PROTECTION AGENCY) to challenge the
validity of the EPA report. On July 17, 1998, the court's ruling on the
plaintiffs' motion for summary judgment found that the EPA's classification of
environmental tobacco smoke was invalid, and vacated those portions of the EPA
report dealing with lung cancer. The government appealed this ruling to the
Court of Appeals for the Fourth Circuit where oral argument is expected in June
1999.
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 order, a trade-secret disclosure that RJRT believes could damage the
competitive position of its brands. RJRT, together with other cigarette
manufacturers, 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 was filed by
manufacturers of smokeless tobacco products. The court granted a preliminary
injunction that enjoined Massachusetts officials from enforcing the law relating
to ingredient reporting. Massachusetts appealed that decision. Both the
manufacturers and Massachusetts are now seeking summary judgment from the
district court. The case has been briefed and argued.
In 1997, Texas enacted legislation very similar to the Massachusetts law,
except that the Texas statute authorizes confidentiality of trade secrets. The
Texas Department of Health (TDH) promulgated regulations that require both
ingredient and nicotine-yield reports to be filed by December 1, 1999.
In 1997, the Minnesota legislature enacted a requirement that manufacturers
of tobacco products sold in Minnesota report annually the presence of five
substances in each brand of their products in its "unburned" and "burned"
states. Enforcement of this reporting requirement was to begin when the date and
form for reporting were announced by the Minnesota Department of Health. The
Department has now prescribed a form and set the reporting date for February 15,
1999.
In August 1998, the Massachusetts Department of Health issued regulations
for public comment that would require (beginning July 1, 2000) annual reporting
on a brand-by-brand basis of 43 smoke constituents in both mainstream smoke and
sidestream smoke. RJRT and the other manufacturers believe that the Department
lacks legal authority to promulgate these proposed regulations. Nevertheless,
RJRT and the other manufactures proposed conducting a cooperative benchmarking
study to address certain DOH concerns. The DOH has agreed not to finalize or
amend these regulations until it has reviewed the results of the manufacturers
study.
The Canadian province of British Columbia has also enacted ingredient
disclosure legislation. RJR-MacDonald is challenging this legislation.
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,
17
Reynolds International or the cigarette industry generally, but such legislation
or regulations could have a material effect on RJRT, Reynolds International or
the cigarette industry generally.
For a description of certain litigation affecting RJRT and its affiliates,
including the effects on results of operations of certain attorney general
agreements, see note 5 to the Consolidated Condensed Financial Statements.
FOOD
The food line of business is conducted through the operating subsidiaries of
Nabisco Holdings Corp. ("Nabisco Holdings"). Nabisco Holdings' businesses in the
United States are comprised of Nabisco Biscuit and the U.S. Foods Group. Nabisco
Holdings' businesses outside the United States are conducted by Nabisco Ltd and
Nabisco International, Inc. (collectively, the "International Food Group").
Biscuit's net sales increased 2% reflecting price increases and volume gains
in core cookies and crackers, partially offset by lower volumes in SnackWell's
and breakfast snacks. Net sales increased 4% after adjusting for fewer selling
days in the first quarter of 1999.
Net sales for the U.S. Foods Group decreased 18% from the first quarter of
1998, due primarily to divestitures of business in 1998 (College Inn broths, the
tablespreads and egg substitute businesses, Plush Pippin frozen pies and the
chocolate yogurt businesses). Excluding the impact of these divestitures, net
sales increased 7% primarily due to increased volumes from Planters nuts, Life
Savers candy, and A.1. steak sauces.
The International Food Group's net sales decreased 5% primarily due to
currency devaluation in Brazil and Canada and volume declines in Brazil,
Argentina, Colombia and Ecuador, partially offset by price increases in Brazil,
and volume gains in Canada, Mexico, and the Caribbean.
Nabisco Biscuit's operating company contribution decreased by 15% primarily
due to increased marketing spending for core brands and higher costs associated
with the implementation of the redesigned direct store delivery sales force.
Price increases and lower manufacturing fixed overhead costs resulting from the
impact of restructuring programs partially offset these higher costs.
The U.S. Foods Group's operating company contribution decreased 22% from the
comparable 1998 period primarily due to businesses divested in 1998. Excluding
the results of divested businesses in both periods, the U.S. Foods Group's
operating company contribution increased 11% as a result of volume gains in
Planters nuts, Life Savers candy and A.1. steak sauces. Also contributing to the
improvement was the impact of restructuring programs on fixed overhead costs,
partially offset by increased marketing costs.
The International Food Group's operating company contribution remained
unchanged from a year ago. Although earnings increased in Brazil as a result of
the elimination of unprofitable product lines and lower fixed overhead costs,
the net impact of operations in other Latin American countries and Canada offset
these gains.
1998 RESTRUCTURING EXPENSE
In the second and fourth quarters of 1998, Nabisco recorded restructuring
expenses of $406 million ($216 million after-tax, net of minority interest) and
$124 million ($75 million after-tax, net of minority interest), respectively.
These restructuring programs were undertaken to streamline operations and
improve profitability and will result in a workforce reduction of approximately
6,500 employees, of which 3,825 positions were eliminated as of March 31, 1999.
The restructuring programs will require cash expenditures of approximately $205
million, of which $16 million was paid in the first quarter of 1999 primarily
for severance and benefits. In addition, the programs will require additional
expenses of approximately $134 million, of which $15 million ($7 million
after-tax, net of minority interest) was incurred in the first quarter of 1999.
These additional expenses are principally for implementation and integration of
the programs and include costs for relocation of employees and equipment and
training.
18
Pre-tax savings in 1999 are expected to be approximately $80 million and, after
completion of the programs, are expected to be approximately $145 million
annually.
For the three months ended March 31, 1999, $33 million of the accrual was
utilized as follows: $17 million for severance and benefits, $9 million for the
disposal of assets and $7 million for other exit costs.
In the fourth quarter of 1998, Reynolds International recorded a pre-tax
restructuring charge of $73 million to retool its operations in Russia and other
countries in the CIS region in response to continuing depressed economic
conditions in these countries. The pre-tax charge, which had no associated
income tax benefit, included severance and related benefits associated with a
workforce reduction of 2,900 employees of approximately $19 million as well as
the rationalization of manufacturing facilities of approximately $54 million.
Pre-tax savings in 1999 are expected to be approximately $20 million and, after
completion of the program, are expected to be approximately $28 million
annually. As of March 31, 1999, $3 million of the accrual was utilized for
severance and related benefits and $3 million was utilized for the
rationalization of manufacturing facilities (costs incurred to close a facility
in Lviv). Cash expenditures amounted to approximately $3 million of the total
charges applied against the reserve.
1997 RESTRUCTURING EXPENSE
In the fourth quarter of 1997, RJRN Holdings recorded a pre-tax
restructuring expense of $301 million ($235 million after-tax) to reorganize its
worldwide tobacco operations. The restructuring program is expected to yield
approximately $155 million in annual pre-tax savings beginning in the year 2000.
As of March 31, 1999, $8 million of the tobacco restructuring accruals were
utilized primarily for employee severance and related benefits. All of the
charges applied against the reserve were cash expenditures.
1996 RESTRUCTURING EXPENSE
The 1996 restructuring program, which was undertaken to streamline
operations and improve profitability of the food business, has been completed
and the balance remaining at December 31, 1998 of $2 million for severance costs
was paid during the first quarter of 1999.
TOBACCO SETTLEMENT AND RELATED EXPENSES
In the first quarter of 1998, $312 million ($199 million after-tax) was
recorded for initial, upfront tobacco settlement costs relating to the
agreements between RJRT and the Minnesota state attorney general and Blue Cross
and Blue Shield of Minnesota. Ongoing tobacco settlement costs recorded in the
first quarter of 1999 are included in cost of products sold.
In the fourth quarter of 1998, RJRT recorded a $151 million expense for a
workforce reduction of approximately 1,300 employees in response to changing
business conditions which will likely result from the multi-state settlement
agreement signed in November 1998. Pre-tax savings in 1999 and 2000 are expected
to be approximately $60 million and $95 million, respectively. For the three
months ended March 31, 1999, RJRT incurred $5 million of payments, which were
applied against the reserve.
PROVISION FOR INCOME TAXES
The decrease in the effective tax rate from 169.2% in 1998 to 45.8% in 1999
is due primarily to the relative impact of non-deductible goodwill amortization
on income before income taxes.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENT
On January 1, 1999, RJRN Holdings and RJRN adopted Statement of Position No.
98-5, Reporting on the Costs of Start-up activities. See note 1 to the
Consolidated Condensed Financial Statements for further discussion.
19
See note 1 to the Consolidated Condensed Financial Statements for a
discussion regarding recently issued accounting pronouncements.
LIQUIDITY AND FINANCIAL CONDITION
Net cash flows used in operating activities were $34 million in the first
quarter of 1999 compared to a use of $284 million for the first quarter of 1998.
The decrease in cash used primarily reflects the increased pricing of domestic
tobacco products, the timing of payments for leaf purchases and certain other
accounts payable, and lower income tax and restructuring payments, partially
offset by an increase in tobacco settlement payments and lower domestic tobacco
product volume.
Net cash flows used in investing activities for the first quarter of 1999
were $76 million, compared to a use of $141 million in 1998. The decrease is due
to lower capital expenditures at Reynolds International and Nabisco.
Net cash flows from financing activities were $64 million for the first
three months of 1999, compared to $293 million in 1998. The decrease was
primarily due to a decrease in borrowings.
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 per the Consolidated Statements of Cash
Flows, adjusted for acquisitions and divestitures of businesses, less preferred
stock dividends. Free cash flow resulted in an outflow of $54 million and an
outflow of $323 million for the first three months of 1999 and 1998,
respectively. The decrease in the outflow primarily reflects the increased
pricing of domestic tobacco products, the timing of payments for leaf purchases
and certain other accounts payable, lower income tax and restructuring payments
and a decrease in capital expenditures, partially offset by the increase in
tobacco settlement payments and lower domestic tobacco product volume.
Total estimated payments in 1999 for all tobacco ligitation settlement
agreements currently in effect and their associated costs, including the
multi-state settlement agreement and all other attorney general agreements and
related amendments and fee payment agreements will be approximately $1.6
billion, $316 million of which has been paid as of March 31, 1999. Payments will
be funded primarily by cash flows from operating and financing activities.
Payments in future years are estimated to exceed $2.0 billion per year, but
these amounts will be subject to, among other things, the volume of cigarettes
sold by RJRT, RJRT's market share and inflation adjustments. For further
discussion of the potential impact of regulatory and litigation issues and
various litigation settlements, including the effects of certain attorney
general agreements, see note 5 to the Consolidated Condensed Financial
Statements.
Capital expenditures were $80 million for the first three months of 1999.
Management expects the current level of capital expenditures for 1999 to be
approximately $350 million to $400 million (approximately 56% Food and 44%
Tobacco), which will be funded primarily by cash flows from operating and
financing activities. Management expects its capital expenditures program will
continue at a level sufficient to support the strategic and operating needs of
RJRN Holdings' operating subsidiaries.
RJRN maintains a three-year revolving credit facility, of which no
borrowings were outstanding at March 31, 1999, and a 364-day credit facility
primarily to support commercial paper issuances, of which the entire facility
was substantially available at March 31, 1999. The commitments under the
revolving credit facility decline to approximately $2.1 billion in 1999, to $2.0
billion in 2000 and to $1.7 billion in 2001 and terminate upon consummation of
the sale of the international tobacco business. RJRN anticipates that it will
negotiate the terms and amounts of a new credit facility to support the
operations of the domestic tobacco business after the completion of the
separation of the food and tobacco businesses. See note 6 to the Consolidated
Condensed Financial Statements for further discussion.
On April 13, 1999, RJRN Holdings offered to purchase any and all of its 9.5%
trust preferred securities and sought consents from the holders of those
securities to waive certain covenants that might
20
have prevented some of the transactions described in note 6 to the Consolidated
Condensed Financial Statements. The expiration date for the consent solicitation
is May 17, 1999, unless extended by RJRN Holdings.
Also on April 13, 1999 RJRN offered to purchase substantially all of its
outstanding debt securities and sought consents from the holders of those
securities to waive covenants that might have prevented some of the transactions
described in note 6 to the Consolidated Condensed Financial Statements. These
consents were received as of April 26, 1999. The offer to purchase is subject to
consummation of the sale of the international tobacco business to Japan Tobacco
Inc. RJRN expects the sale to close before the end of May 1999, and the transfer
of RJRN's interest in Nabisco to take place shortly thereafter.
In connection with the reorganization, on April 29, 1999, RJRN issued a
preliminary private placement offering memorandum to issue $500 million of notes
due 2003 and $500 million of notes due 2006. The net proceeds received will be
used for general corporate purposes.
FOREIGN MARKET RISK
Nabisco is exposed to the current volatility of financial markets in Brazil,
which impacted the International Food Group's financial position. As of March
31, 1999, Brazil's currency, the REAL, suffered a devaluation of approximately
50% from December 31, 1998, compared to the U.S. Dollar, which resulted in an
unfavorable foreign currency translation adjustment of approximately $125
million.
Current volatility of financial markets and political uncertainty in Russia
and the rest of the CIS region have and could continue to adversely impact
RJRN's results of operations. Reynolds International's sales, volume and profits
for the first quarter of 1999 suffered from deteriorating economies in Russia
and the rest of the CIS region. In Russia, domestic and imported volume declined
21% during the first quarter compared to 1998, while sales declined 47% and
operating company contribution declined to a loss of approximately $32 million
from income of approximately $16 million. The poor economy and uncertain
conditions has fostered a decline in consumer purchasing power and weak demand
for mid- and premium-priced products. These conditions have adversely impacted
Reynolds International's results of operations over the past six to nine months.
At this time, RJRN is unable to predict with any certainty the long-term impact
of these developments in Russia, but anticipates that these factors could
continue to have an adverse effect on RJRN's results of operations in 1999.
YEAR 2000 ISSUE
RJRN Holdings is implementing plans to address the implications of the year
2000 on its computer systems and business operations. The year 2000 issue stems
from computer applications that were written using two digits rather than four
digits to define the applicable year. The issue is whether computer systems will
properly interpret date-sensitive information when the year changes to 2000. The
status of RJRN Holdings' year 2000 compliance effort as of March 31, 1999
follows.
A revised reporting mechanism was implemented at Reynolds International for
the purpose of collecting more detailed and consistent status data from each of
their sites. The refined data provides management with the means to more
accurately assess the current status of each year 2000 activity at the sites and
enables earlier detection of potential problem areas. As a result, the current
status is a better indicator of Reynolds International's progress on year 2000
initiatives.
RJRN Holdings has inventoried and assessed its financial, information and
operational systems, and has developed detailed plans for required systems
modifications or replacements. This process has been completed for all
information technology systems ("IT systems"). Management estimates that this
process is approximately 95% complete for information systems with embedded
technology ("non-IT systems"), which include, but are not limited to, process
control, automated factory/assembly lines, environmental safety, quality control
and facilities. This phase is anticipated to be completed during the second
quarter of 1999. Management believes that the risk of critical issues arising
from the remaining items to be
21
inventoried is minimized due to the duplication of equipment across facilities
within each operating company.
Software remediation (modifying existing programs to make them year 2000
compliant) is progressing and, in the case of IT systems, is approximately 98%
complete for Nabisco Holdings, approximately 99% complete for RJRT, and
approximately 88% complete for Reynolds International. Management expects this
phase of year 2000 readiness to be complete by the end of the second quarter of
1999. In the case of non-IT systems, software remediation efforts are ongoing
and estimated completion dates are the end of the third quarter of 1999 for
Nabisco Holdings and the second quarter of 1999 for Reynolds International. RJRT
has completed this phase of year 2000 readiness for non-IT systems.
Software testing following remediation is approximately 92% complete for IT
systems at Nabisco Holdings and RJRT and is approximately 82% complete at
Reynolds International. Management expects that testing at Nabisco Holdings and
RJRT will be complete during the third quarter of 1999 and at Reynolds
International by the end of the second quarter of 1999. With respect to non-IT
systems, testing is ongoing at Nabisco Holdings, with anticipated completion by
the end of the third quarter of 1999. This phase is approximately 90% complete
at RJRT and approximately 82% complete at Reynolds International, with the
balance expected to be complete by the end of the third and second quarters of
1999, respectively.
Approximately 90% of IT systems at Nabisco Holdings are compliant and in
production. Management expects the remainder to be complete during the third
quarter of 1999. Approximately 88% of IT systems at RJRT are compliant and in
production. Management anticipates the balance to be complete by the end of the
third quarter of 1999. Approximately 76% of IT systems at Reynolds International
have been tested and are in production. Management anticipates the balance to be
complete during the second quarter of 1999. Approximately 89% of non-IT Systems
at RJRT and approximately 65% at Reynolds International are compliant and in
production. Management anticipates all non-IT systems will be fully year 2000
compliant in the third quarter of 1999. Approximately 79% of Nabisco Holdings'
non-IT systems are compliant, with the balance anticipated to be completed by
November of 1999.
RJRN Holdings is also in contact with suppliers, vendors, service providers
and customers to assess the potential impact on operations if key third parties
are not successful in converting their systems in a timely manner. In early
1999, Nabisco Holdings initiated an effort to obtain a more accurate and up-to-
date status of third parties' year 2000 compliance. This involved re-contacting
all previously contacted third parties, as well as contacting additional
selected third parties. Nabisco Holdings has received responses from 37% of
identified third parties, with 35% of identified third parties confirming that
they are currently compliant, 1% are not in compliance but assure that they will
be compliant by the end of 1999, and 1% confirming they will not be in
compliance. RJRT has received responses from 99% of identified third parties, as
follows: 84% of identified third parties have confirmed that they are fully
compliant, 14% are not currently compliant but expect to be by the end of 1999,
and 1% will not be in compliance. Reynolds International has received
correspondence from 56% of identified third parties. Approximately 39% of
identified third parties are currently in compliance, with the remaining 17%
assuring they will achieve full compliance by the end of the fourth quarter of
1999. Internationally, however, many governmental agencies and utilities have
not been proactive in addressing the year 2000 problem and have not provided
sufficient assurances regarding their state of year 2000 readiness. The status
of year 2000 efforts for those third parties that have been identified as
critical will continue to be monitored and contingency plans specific to those
third parties are being, or have been, developed.
Incremental costs, which include contractor costs to modify or replace
existing systems, and costs of internal resources dedicated to achieving year
2000 compliance are charged to expense as incurred and are
22
funded by operating cash flows. Costs are expected to total approximately $90
million, of which $50 million has been spent as of March 31, 1999, details of
which are as follows:
TOTAL COSTS AS OF ANTICIPATED TOTAL
MARCH 31, 1999 PROJECT COSTS
------------------- -------------------
BY SYSTEM TYPE
IT Systems............................................... $ 45 $ 71
Non-IT Systems........................................... 5 19
BY WORK PERFORMED
Remediation.............................................. $ 47 $ 84
Replacement.............................................. 3 6
INTERNAL/EXTERNAL
Internal Cost............................................ $ 28 $ 41
Replacement/Contractor Costs............................. 22 49
Progress against year 2000 compliance plans is monitored by management at
each of the operating companies as well as the internal audit department.
Results are reported to the board of directors on a regular basis.
RJRN Holdings' systems risk management program includes emergency backup and
recovery procedures to be followed in the event of failure of a
business-critical system. However, these procedures have been expanded to
include additional procedures for potential year 2000 issues. In addition,
contingency plans to protect the business from year 2000-related interruptions
are being developed, which will include development of backup procedures,
identification of alternate suppliers and possible increases in safety inventory
levels. These plans have already been completed at RJRT and will be complete at
Nabisco Holdings and Reynolds International by the end of the second and third
quarters of 1999, respectively. The possible consequences of RJRN Holdings or
key third parties not being fully year 2000 compliant include temporary plant
closings, delays in the delivery of products or receipt of supplies, invoice and
collection errors, and inventory obsolescence. However, RJRN Holdings believes
its year 2000 implementation plan, including contingency measures, should be
completed in all material respects by the end of 1999, thereby reducing the
possible material adverse effects of the year 2000 issue on its business,
results of operations or financial condition.
------------------------
The foregoing discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements particularly with respect to the level of capital expenditures,
foreign market risk, the implementation of a new bank credit facility, the
reorganization of the businesses of RJRN, the impact of proposed litigation
settlements, including certain attorney general agreements related to the
tobacco business and the impact of the year 2000 issue on computer systems and
applications, 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 and related legislative and
regulatory developments. 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.
23
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 and RJRN Holdings) 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 first quarter of 1999, 35 new actions were served against RJRT and/or
its affiliates or indemnitees (as against 72 in the first quarter of 1998) and
49 actions were dismissed or otherwise resolved in favor of RJRT and/or its
affiliates or indemnitees without trial. There have been noteworthy increases in
the number of cases pending. On March 31, 1999, there were 647 active cases
pending, as compared with 550 on March 31, 1998 and 278 on March 31, 1997. As of
April 28, 1999, 661 active cases were pending against RJRT and/or its affiliates
or indemnitees: 655 in the United States; 3 in Canada; 1 in each of the Marshall
Islands, Nigeria and Puerto Rico.
The U.S. cases are pending in 41 U.S. states and the District of Columbia,
although four states -- West Virginia, Florida, New York and California --
account for 61% of these cases. The breakdown is as follows: 125 in West
Virginia; 112 in New York; 111 in Florida; 53 in California; 34 in
Massachusetts; 25 in Louisiana; 18 in Texas; 16 in each of Pennsylvania and
Tennessee; 15 in D.C.; 11 in New Jersey; 10 in Alabama; nine in each of Illinois
and Mississippi; seven in Ohio; six in Iowa; five in each of Indiana, Maryland,
Minnesota Missouri and Nevada; four in each of Arkansas, Georgia, Oklahoma,
Rhode Island and Virginia; three in each of Arizona, Canada, New Mexico,
Washington and Wisconsin; two in each of Colorado, Hawaii, Kentucky, Michigan,
North Carolina, North Dakota, South Carolina, South Dakota and Utah; and one in
each of Kansas, New Hampshire, and Oregon. Of the 655 active U.S. cases, 168 are
pending in federal court, 482 in state court and five in tribal court). Most of
these cases were brought by individual plaintiffs, but an increasing number,
discussed below, seek recovery on behalf of third parties or large classes of
claimants.
Litigation is subject to many uncertainties and it is possible that some of
the tobacco-related legal actions, proceedings or claims could be decided
against 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, the various litigation settlements and the
release and wide availability of various industry documents referred to above.
These developments may negatively affect the outcomes of tobacco-related legal
actions and encourage the commencement of additional similar litigation.
Although it is impossible to predict the outcome of such events on pending
litigation and the rate at which new lawsuits are filed against RJRT, RJRN and
RJRN Holdings, a significant increase in litigation and/or in adverse outcomes
for tobacco defendants could have an adverse effect on any one or all of these
entities. RJRT, RJRN and RJRN Holdings each believe that they have a number of
valid defenses to any such actions and intend to defend such actions vigorously.
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
24
estimate of the amount or range of any possible loss in any particular quarterly
or annual period or in the aggregate.
For information about other litigation and legal proceedings, see note 5 to
the Consolidated Condensed Financial Statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Governmental
Activity."
ITEM 2--CHANGES IN SECURITIES AND USE OF PROCEEDS.
See Item 4.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On April 13, 1999, RJRN commenced cash tender offers and consent
solicitations for the debt securities listed below, which constitute
substantially all of RJRN's outstanding debt securities. The consents cover
amendments to the indentures under which these debt securities were issued which
will eliminate substantially all restrictive operating and financial covenants
contained in these indentures. Elimination of these covenants will facilitate
the reorganization and debt restructuring transactions currently underway. The
requisite consents were received as of April 26, 1999, and supplemental
indentures were executed which will become operative upon the acceptance for
payment of securities tendered pursuant to the tender offers, which is expected
to occur promptly following the current expiration date of May 17, 1999.
Title of Security
8.0% Notes due 2000
7.625% Medium Term Notes ("MTNs") due 2000
8.00% Notes due 2001
7.375% MTNs due 2001
7.63% MTNs due 2001
6.8% MTNs due 2001
8 5/8% Notes due 2002
7 5/8% Notes due 2003
8.25% Notes due 2004
8.75% Notes due 2005
8.5% Notes due 2007
8.75% Notes due 2007
9.25% Debentures due 2013
8.75% Senior Notes due 2004
Also on April 13, 1999, RJRN Holdings commenced a cash tender offer and
consent solicitation for any and all of the 9.5% Trust Originated Preferred
Securities ("TOPrS") of RJR Nabisco Holdings Capital Trust II. The consent
covers amendments and a waiver to the TOPrS indenture to facilitate the
reorganization and debt restructuring transactions of RJRN Holdings that are
currently underway. If the requisite consents are received, a supplemental
indenture will be executed and become operative upon the acceptance for payment
of securities tendered pursuant to the tender offer, which is expected to occur
promptly following the current expiration date of May 17, 1999.
ITEM 5. OTHER INFORMATION
None
------------------------
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
12.1 RJR Nabisco Holdings Corp. Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends for the three months ended March 31, 1999.
12.2 RJR Nabisco Holdings Corp. Computation of Ratio of Earnings to Fixed Charges for the
three months ended March 31, 1999.
12.3 RJR Nabisco, Inc. Computation of Ratio of Earnings to Fixed Charges for the three
months ended March 31, 1999.
27.1 RJR Nabisco Holdings Corp. Financial Data Schedule for the three months ended March
31, 1999.
27.2 RJR Nabisco, Inc. Financial Data Schedule for the three months ended March 31, 1999.
(b) Reports on Form 8-K
Report on Form 8-K dated March 9, 1999, (the "8-K") regarding an
announcement that: (i) RJR Nabisco, Inc. and its wholly-owned subsidiary R.J.
Reynolds Tobacco Company ("RJRT") had entered into a definitive agreement for
the sale of the international tobacco business of RJRT and its subsidiaries to
Japan Tobacco, Inc.; and (ii) the Board of Directors of RJR Nabisco Holdings
("RJRN Holdings") had approved a plan to distribute shares in its domestic
tobacco business to RJRN Holdings' shareholders in the form of a tax-free
spin-off transaction and attaching as an exhibit, the related RJRN Holdings
press release.
26
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: May 5, 1999 /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
27