UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 1-32258

 

Reynolds American Inc.

(Exact name of registrant as specified in its charter)

 

 

North Carolina

 

20-0546644

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

401 North Main Street

Winston-Salem, NC 27101

(Address of principal executive offices) (Zip Code)

(336) 741-2000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common stock, par value $.0001 per share

 

New York

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes       No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes       No  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes       No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes       No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  

 

 

Accelerated filer  

 

 

 

 

 

 

Non-accelerated filer  

(Do not check if a smaller reporting company)

 

Smaller reporting company  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes       No  

The aggregate market value of common stock held by non-affiliates of Reynolds American Inc. on June 30, 2016, was approximately $44 billion, based on the closing price of $53.93. Directors, executive officers and a significant shareholder of Reynolds American Inc. are considered affiliates for purposes of this calculation, but should not necessarily be deemed affiliates for any other purpose.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: January 23, 2017: 1,425,934,305 shares of common stock, par value $.0001 per share.

Documents Incorporated by Reference:

Portions of the Form 10-K/A of Reynolds American Inc. to be filed with the Securities and Exchange Commission on or before May 1, 2017, are incorporated by reference into Part III of this report.

 

 

 

 

 

 


 

INDEX

 

PART I

 

 

 

 

 

 

Item 1.

 

Business

2

 

 

 

Item 1A.

 

Risk Factors

13

 

 

 

Item 1B.

 

Unresolved Staff Comments

25

 

 

 

Item 2.

 

Properties

25

 

 

 

Item 3.

 

Legal Proceedings

25

 

 

 

Item 4.

 

Mine Safety Disclosures

25

 

 

 

PART II

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

26

 

 

 

Item 6.

 

Selected Financial Data

28

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

30

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

62

 

 

 

Item 8.

 

Financial Statements and Supplementary Data

65

 

 

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

177

 

 

 

Item 9A.

 

Controls and Procedures

177

 

 

 

Item 9B.

 

Other Information

177

 

 

 

PART III

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

178

 

 

 

Item 11.

 

Executive Compensation

178

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

178

 

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

178

 

 

 

Item 14.

 

Principal Accounting Fees and Services

178

 

 

 

PART IV

 

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

179

 

 

Signatures

186

 

 

 

1


 

Introduction

On January 17, 2017, Reynolds American Inc., referred to as RAI, announced that it had entered into a Merger Agreement, as defined below, with British American Tobacco p.l.c., a public company incorporated under the laws of England and Wales, referred to as BAT, BATUS Holdings Inc., a Delaware corporation and a wholly owned subsidiary of BAT, and Flight Acquisition Corporation, a North Carolina corporation and a wholly owned subsidiary of BAT, referred to as Merger Sub. Unless stated otherwise, all forward-looking information contained in this report does not take into account or give any effect to the impact of the BAT Merger, as defined below. For additional details regarding the BAT Merger, see “Business” contained in Part I, Item 1, of this report, “Risk Factors” contained in Part I, Item 1A, of this report, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Part II, Item 7, of this report, and Note 22 to RAI’s consolidated financial statements, contained in Part II, Item 8, of this report.

 

PART I

Item 1. Business

RAI is a holding company whose wholly owned operating subsidiaries include the second largest tobacco company in the United States, R. J. Reynolds Tobacco Company; the manufacturer and marketer of the leading super-premium cigarette brand, Santa Fe Natural Tobacco Company, Inc., referred to as SFNTC; the second largest smokeless tobacco products manufacturer in the United States, American Snuff Company, LLC, referred to as American Snuff Co.; R. J. Reynolds Vapor Company, referred to as RJR Vapor, a marketer of digital vapor cigarettes in the United States, manufactured on its behalf by R. J. Reynolds Tobacco Company; Niconovum USA, Inc. and Niconovum AB, marketers of nicotine replacement therapy products in the United States and Sweden, respectively; and until their sale on January 13, 2016, as described below, SFR Tobacco International GmbH, referred to as SFRTI, and various foreign subsidiaries affiliated with SFRTI. RAI was incorporated in the State of North Carolina on January 2, 2004, and its common stock is listed on the New York Stock Exchange, referred to as NYSE, under the symbol “RAI.” RAI’s headquarters are located in Winston-Salem, North Carolina. On July 30, 2004, the U.S. assets, liabilities and operations of Brown & Williamson Tobacco Corporation, now known as Brown & Williamson Holdings, Inc., referred to as B&W, an indirect, wholly owned subsidiary of BAT were combined with R. J. Reynolds Tobacco Company, a wholly owned operating subsidiary of R.J. Reynolds Tobacco Holdings, Inc., a wholly owned subsidiary of RAI, referred to as RJR. These transactions on July 30, 2004, generally are referred to as the B&W business combination. As a result of the B&W business combination and BAT Share Purchase, as defined below, BAT, through wholly owned subsidiaries, beneficially owns approximately 42% of RAI’s outstanding common stock.

References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco Company, a New Jersey corporation. References to RJR Tobacco on and subsequent to July 30, 2004 and until June 12, 2015, relate to the combined U.S. assets, liabilities and operations of B&W and R. J. Reynolds Tobacco Company. Concurrent with the completion of the B&W business combination, RJR Tobacco became a North Carolina corporation. References to RJR Tobacco on and subsequent to June 12, 2015, relate to R. J. Reynolds Tobacco Company, a North Carolina corporation, and reflect the effects of the Lorillard Merger and Divestiture, described below.

Proposed Merger with BAT

On January 16, 2017, RAI, BAT, a subsidiary of BAT, and Merger Sub entered into an Agreement and Plan of Merger, referred to as the Merger Agreement, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will merge with and into RAI, referred to as the BAT Merger, with RAI surviving as a wholly owned subsidiary of BAT.

The BAT Merger has been approved by the independent directors of RAI who formed a committee to negotiate with BAT, referred to as the Transaction Committee, given BAT’s existing ownership stake in RAI and representation on RAI’s Board, and by the Boards of Directors of both companies.

At the effective time of the BAT Merger, each share of RAI common stock (other than any shares of RAI common stock owned by BAT or any of its subsidiaries and by shareholders of RAI who have properly asserted and not lost or effectively withdrawn appraisal rights) will be converted into the right to receive 0.5260 of a BAT American Depositary Share, referred to as a BAT ADS, and $29.44 in cash, without interest, and subject to adjustment to prevent dilution.

The BAT Merger is subject to customary closing conditions, including RAI and BAT shareholder approvals, including the approval of the BAT Merger by a majority of the shares of RAI common stock not owned, directly or indirectly, by BAT or its subsidiaries or any of RAI’s subsidiaries, and regulatory approvals. The Merger Agreement contains certain other termination rights for each of RAI and BAT, including the right of each party to terminate the Merger Agreement if the BAT Merger has not been completed on or before December 31, 2017, subject to an extension of five business days if, on December 31, 2017, BAT has not

2


 

completed all or any portion of the financing it needs to fund the BAT Merger and the transactions contemplated by the Merger Agreement. Financing, however, is not a condition to the closing of the BAT Merger. Under certain circumstances, if the Merger Agreement is terminated, the terminating party must pay the non-terminating party a termination fee of $1 billion. In the event that the Merger Agreement is terminated due to an inability to obtain unconditional approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, referred to as the HSR Act, or any other antitrust laws, RAI will be entitled to receive a termination fee of $500 million from BAT. The BAT Merger is currently expected to close in the third quarter of 2017.

Each of RAI and BAT has made representations and warranties in the Merger Agreement. RAI and BAT each also have agreed to various covenants and agreements, including, among other things, to conduct their respective businesses in the ordinary course in all material respects during the period between the execution of the Merger Agreement and completion of the BAT Merger and not to engage in certain transactions during this period.

The foregoing description of the BAT Merger and the Merger Agreement is qualified in its entirety by reference to the Merger Agreement, a copy of which is attached as Exhibit 2.1 to RAI’s Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission, referred to as the SEC, on January 17, 2017, which is incorporated by reference herein.

There are a number of risks and uncertainties associated with the BAT Merger. For more information, see Item 1A. Risk Factors and “— Cautionary Information Regarding Forward-Looking Statements” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. In connection with the BAT Merger, BAT will file with the SEC a registration statement on Form F-4 that will include the proxy statement of RAI that also constitutes a prospectus of BAT. Shareholders are urged to read the proxy statement/prospectus on Form F-4 once it becomes available because it will contain important information about the BAT Merger, including relevant risk factors.

Lorillard Transactions

On June 12, 2015, RAI acquired Lorillard, Inc., n/k/a Lorillard, LLC, referred to as Lorillard, in a cash and stock transaction, valued at $25.8 billion, referred to as the Lorillard Merger. Also on June 12, 2015, a wholly owned subsidiary, n/k/a ITG Brands, LLC, referred to as ITG, of Imperial Brands, PLC, f/k/a Imperial Tobacco Group, PLC, referred to as Imperial, acquired for approximately $7.1 billion, in a transaction referred to as the Divestiture, certain assets (1) owned by RAI subsidiaries or affiliates relating to the cigarette brands WINSTON, KOOL and SALEM, and (2) owned by Lorillard subsidiaries or affiliates related to the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG), as well as Lorillard’s owned and leased real property, and certain transferred employees, together with associated liabilities. As a result of the Divestiture, RAI recognized a pre-tax gain of approximately $3.2 billion. Additionally, on June 12, 2015, shortly after the completion of the Lorillard Merger, Lorillard Tobacco Company, LLC, a wholly owned subsidiary of Lorillard, referred to as Lorillard Tobacco, merged with and into RJR Tobacco, with RJR Tobacco continuing as the surviving entity, referred to as the Lorillard Tobacco Merger.

On June 12, 2015, concurrently with the completion of the Lorillard Merger and Divestiture, BAT indirectly (through a wholly owned subsidiary) purchased 77,680,259 shares of RAI common stock, prior to giving effect to RAI’s 2015 two-for-one stock split, referred to as the BAT Share Purchase, for approximately $4.7 billion, which was sufficient for BAT and its subsidiaries collectively to maintain their approximately 42% beneficial ownership in RAI. For additional information on the Lorillard Merger and Divestiture, and related transactions, see Item 8, notes 2 and 13 to consolidated financial statements.

Sale of International Rights to the NATURAL AMERICAN SPIRIT Brand

On January 13, 2016, RAI, through various subsidiaries, referred to as the Sellers, completed the sale of the international rights to the NATURAL AMERICAN SPIRIT brand name and associated trademarks, along with SFRTI and other international companies that distributed and marketed the brand outside the United States, to JT International Holding BV, referred to as JTI Holding, a subsidiary of Japan Tobacco Inc., referred to as JTI, in an all-cash transaction of approximately $5 billion, and recognized a pre-tax gain of approximately $4.9 billion. The transaction did not include the rights to the NATURAL AMERICAN SPIRIT brand name and associated trademarks in the U.S. market, U.S. duty-free locations, and U.S. territories or in U.S. military outlets, all of which have been retained by SFNTC. With this transaction completed, the international rights to nearly all of RAI’s operating companies’ cigarette trademarks are now owned by international tobacco companies. For additional information on the transaction, see Item 8, notes 3 and 13 to consolidated financial statements.

Operating Segments

RAI’s reportable operating segments are RJR Tobacco, Santa Fe and American Snuff. The RJR Tobacco segment consists of the primary operations of R. J. Reynolds Tobacco Company. The Santa Fe segment consists of the primary operations of SFNTC. The American Snuff segment consists of the primary operations of American Snuff Co. Included in All Other, among other RAI

3


 

subsidiaries, are RJR Vapor, Niconovum USA, Inc., Niconovum AB, and until their sale on January 13, 2016, as described above , SFRTI and various foreign subsidiaries affiliated with SFRTI. The segments were identified based on how RAI’s chief operating decision maker allocates resources and assesses performance. Certain of RAI’s operating subsidiaries have entered into intercompany agreements for products or services with other subsidiaries. As a result, certain activities of an operating subsidiary may be included in a different segment of RAI. For net sales and operating income attributable to each segment, see — “Overview and Business Initiatives” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and Item 8, note 1 7 to consolidated financial statements.

RAI’s website address is www.reynoldsamerican.com . RAI’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, insider trading reports on Forms 3, 4 and 5 and all amendments to those reports are available through RAI’s website, as soon as reasonably practicable after such material is electronically filed with, or furnished to the SEC. RAI’s website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. RAI’s website is the primary source of publicly disclosed news about RAI and its operating companies.

All dollar amounts, other than per share amounts, are presented in millions, except as otherwise noted.

RAI Strategy

RAI’s strategy continues to focus on transforming tobacco to deliver sustainable earnings growth, strong cash flow and enhanced long-term shareholder value. This transformation strategy includes growing the core cigarette and moist-snuff businesses, focusing on innovation and engaging with adult tobacco consumers, while maintaining efficient and effective operations.

To achieve its strategy, RAI encourages the migration of adult smokers to smoke-free tobacco products and other non-combustible nicotine-containing products, which it believes aligns consumer preferences for new alternatives to traditional tobacco products in view of societal pressure to reduce smoking. RAI’s operating companies facilitate this migration through innovation, including the development of digital vapor cigarettes, CAMEL Snus, heat-not-burn cigarettes, and nicotine replacement therapy technologies. RAI remains committed to maintaining high standards of corporate governance and business conduct in a high-performing culture.

RJR Tobacco

Overview

RAI’s largest reportable operating segment, RJR Tobacco, is the second largest tobacco company in the United States. RJR Tobacco’s brands include three of the top four best-selling cigarettes in the United States: NEWPORT, CAMEL and PALL MALL. These brands, and its other brands, including DORAL, MISTY and CAPRI, are manufactured in a variety of styles and marketed in the United States. As part of its total tobacco strategy, RJR Tobacco offers a smoke-free tobacco product, CAMEL Snus. RJR Tobacco manages contract manufacturing of cigarettes and tobacco products through arrangements with BAT affiliates, and manages the export of tobacco products to U.S. territories, U.S. duty-free shops and U.S. overseas military bases. RJR Tobacco also manages the super-premium cigarette brands, DUNHILL and STATE EXPRESS 555, which are licensed from BAT.

RJR Tobacco primarily conducts business in the highly competitive U.S. cigarette market. The international rights to substantially all of RJR Tobacco’s brands were sold in 1999 to JTI, and no international rights were acquired in connection with the B&W business combination in 2004 or the Lorillard Merger in 2015. The U.S. cigarette market, which has a few large manufacturers and many smaller participants, is a mature market in which overall adult consumer demand has declined since 1981, and is expected to continue to decline. Management Science Associates, Inc., referred to as MSAi, reported that U.S. cigarette shipments declined 2.4% in 2016, to 258.0 billion cigarettes, 0.1% in 2015 and 3.2% in 2014. From year to year, shipments are impacted by various factors including price increases, excise tax increases and wholesale inventory adjustments.

Profitability of the U.S. cigarette industry and RJR Tobacco continues to be adversely impacted by decreases in consumption, increases in state excise taxes and governmental regulations and restrictions, such as marketing limitations and product standards.

Competition

RJR Tobacco’s primary competitors are Philip Morris USA Inc. and ITG, as well as manufacturers of deep-discount brands. Deep-discount brands are brands manufactured by companies that are not original or subsequent participants in the Master Settlement Agreement, referred to as the MSA, and other state settlement agreements with the States of Mississippi, Florida, Texas and Minnesota, which together with the MSA are collectively referred to as the State Settlement Agreements. Accordingly, these manufacturers do not have cost structures burdened with payments related to State Settlement Agreements to the same extent as the

4


 

original or subsequent participating manufacturers. For further discussion of the State Settlement Agreements, see “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases — State Settlement Agreements” in Item 8, note 1 3 to consolidated financial statements.

Based on data collected by SymphonyIRI Group, Inc. and Capstone Research Inc., collectively referred to as IRI/Capstone, and processed and managed by MSAi, during each of 2016 and 2015, RJR Tobacco had an overall retail share of the U.S. cigarette market of 32.3%, reflecting the impact of the Lorillard Merger and Divestiture. During each of these same years, Philip Morris USA Inc. had an overall retail share of the U.S. cigarette market of 49.9%. RJR Tobacco believes that deep-discount brands made by small manufacturers had combined shipments of approximately 7% of total U.S. industry shipments during each of 2016 and 2015.

Domestic industry shipment volume and retail share of market data that appear in this document have been obtained from MSAi and IRI/Capstone, respectively. These organizations are the primary sources of volume and market share data relating to the tobacco industry. This information is included in this document because it is used primarily as an indicator of the relative performance of industry participants, brands and market trends. All share results that appear, except as noted otherwise, in this document are based on U.S. cigarette (or smokeless tobacco products, as applicable) shipments to retail outlets, referred to as STR data, based on information submitted by wholesale locations and processed and managed by MSAi. However, you should not rely on the STR data reported by MSAi as being a precise measurement of actual market share as the shipments to retail outlets do not reflect actual consumer sales and do not track all volume and trade channels. Accordingly, the STR data of the U.S. tobacco industry as reported by MSAi may overstate or understate actual market share. Moreover, you should be aware that in a product market experiencing overall declining consumption, a particular product can experience increasing market share relative to competing products, yet still be subject to declining consumption volumes.

Competition is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence, as well as finding efficient and effective means of balancing market share and profit growth. Cigarette brands produced by the major manufacturers generally require competitive pricing, substantial marketing support, retail programs and other incentives to maintain or improve market position or to introduce a new brand or brand style. Competition among the major cigarette manufacturers continues to be highly competitive and includes product innovation and expansion into smoke-free tobacco categories.

Marketing

RJR Tobacco is committed to building and maintaining a portfolio of profitable brands. RJR Tobacco’s marketing programs are designed to strengthen brand image, build brand awareness and loyalty, and switch adult smokers of competing brands to RJR Tobacco brands. In addition to building strong brand equity, RJR Tobacco’s marketing approach utilizes a retail pricing strategy, including discounting at retail, to defend certain brands’ shares of market against competitive pricing pressure. RJR Tobacco’s competitive pricing methods may include list price changes, discounting programs, such as retail and wholesale buydowns, periodic price reductions, off-invoice price reductions, dollar-off promotions and consumer coupons. Retail buydowns refer to payments made to the retailer to reduce the price that consumers pay at retail. Consumer coupons are distributed by a variety of methods.

RJR Tobacco provides trade incentives through trade terms, wholesale partner programs and retail incentives. Trade discounts are provided to wholesalers based on compliance with certain terms. The wholesale partner programs provide incentives to RJR Tobacco’s direct buying customers based on performance levels. Retail incentives are paid to the retailer based on compliance with RJR Tobacco’s contract terms.

RJR Tobacco’s cigarette brand portfolio strategy is based upon two brand categories: drive and other. The drive brands consist of two premium brands, NEWPORT and CAMEL, and the largest traditional value brand, PALL MALL. These three drive brands are managed for long-term market share and profit growth, and receive the vast majority of RJR Tobacco’s equity support with an emphasis on the NEWPORT and CAMEL brands. The other brand category includes the premium brand, CAPRI, and the value brands, DORAL and MISTY, along with other smaller brands. All of the other brands receive limited marketing support and are managed to maximize profitability.

The key objectives of the portfolio strategy are designed to balance the long-term market share growth and profitability of the drive brands while managing the other brands for long-term sustainability and profitability. Consistent with that strategy, RJR Tobacco continues to evaluate some of its non-core cigarette styles for potential elimination.

RJR Tobacco’s portfolio also includes CAMEL Snus, a smoke-free, heat-treated tobacco product sold in individual pouches that provide convenient tobacco consumption.

5


 

Anti-tobacco groups continue to attempt to restrict cigarette sales, cigarette advertising, and the testing and introduction of new tobacco products as well as encourage smoking bans. The MSA and federal, state and local laws and regulations, including the Family Smoking Prevention and Tobacco Control Act, referred to as the FDA Tobacco Act, discussed below, and related regulations, restrict or prohibit utilization of television, radio or billboard advertising or certain other marketing and promotional tools for cigarettes and smoke-free tobacco products. RJR Tobacco continues to use direct mailings, websites and other means to market its brands and enhance their appeal among age-verified adults who use tobacco products. RJR Tobacco continues to advertise and promote at retail locations and in adult venues and also uses print advertising in newspapers and consumer magazines in the United States, where permitted.

Manufacturing and Distribution

RJR Tobacco owns its manufacturing facilities, located in the Winston-Salem, North Carolina area. RJR Tobacco has a total production capacity of approximately 115 billion cigarettes per year. RJR Tobacco distributes its cigarettes primarily through a combination of direct wholesale deliveries from two local distribution centers and public warehouses located throughout the United States.

RJR Tobacco has entered into various transactions with affiliates of BAT. RJR Tobacco sells contract-manufactured cigarettes, tobacco leaf and processed tobacco to BAT affiliates. In January 2016, RJR Tobacco received written notice from a BAT affiliate terminating the cigarette contract manufacturing agreement effective January 5, 2019. In July 2016, RJR Tobacco amended the contract manufacturing agreement with a BAT affiliate to permit an early transition of the cigarette production, covered by the agreement, to BAT facilities, which began in the fourth quarter of 2016. Net sales, primarily of cigarettes, to BAT affiliates represented approximately 2% of RAI’s total net sales in each of 2016 and 2015 and 4% in 2014. For additional information, see Item 8, notes 18 and 22 to consolidated financial statements.

Raw Materials

In its production of tobacco products, RJR Tobacco uses U.S. and foreign, grown primarily in Brazil, burley and flue-cured leaf tobaccos, as well as Oriental tobaccos grown primarily in Turkey, Macedonia and Bulgaria. RJR Tobacco believes there is a sufficient supply of leaf in the worldwide tobacco market to satisfy its current and anticipated production requirements.

RJR Tobacco purchases the majority of its U.S. flue-cured and burley leaf directly through contracts with tobacco growers. These short-term contracts are frequently renegotiated. RJR Tobacco believes the relationship with its leaf suppliers is good.

RJR Tobacco also uses other raw materials such as filter tow, filter rods and fire standards compliant paper, which are sourced from either one supplier or a few suppliers. RJR Tobacco believes it has reasonable measures in place designed to mitigate the risk posed by the limited number of suppliers of certain raw materials.

Santa Fe

Overview

RAI’s reportable operating segment, Santa Fe, manufactures and markets super-premium cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand in the U.S.

Competition

Santa Fe competes in the U.S. cigarette market with its Natural American Spirit brand, which is the fastest growing super-premium cigarette brand and is a top 10 best-selling cigarette brand. It is priced higher than most other competitive brands. Competition in the cigarette category is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence. Based upon data collected by IRI/Capstone and processed and managed by MSAi, during 2016 and 2015, Santa Fe had an overall retail share of the U.S. cigarette market of 2.2% and 1.9%, respectively.

Marketing

Santa Fe has a commitment to its natural tobacco products, the environment and its consumers and uses its marketing programs to promote this commitment. SFNTC is a subsequent participating manufacturer in the MSA. The MSA and federal, state and local laws and regulations, including the FDA Tobacco Act and related regulations, restrict or prohibit utilization of television, radio or billboard advertising or certain other marketing and promotional tools for cigarettes and other tobacco products. Santa Fe continues to use direct mailings, websites and other means to market its brand and enhance its appeal among age-verified adults who use tobacco

6


 

products. Santa Fe continues to advertise and promote at retail locations and in adult venues, and uses print advertising in consumer magazines and other publications in the United States, where permitted.

Manufacturing and Distribution

SFNTC owns its manufacturing facility, which is located in Oxford, North Carolina. Santa Fe distributes its products primarily through a combination of direct wholesale deliveries from a distribution center in North Carolina and public warehouses located throughout the United States.

Raw Materials

Santa Fe’s support for sustainable agriculture and natural resources is part of its commitment to the environment. Santa Fe contracts directly with independent farmers and advocates earth-friendly practices through its two growing programs, Purity Residue Clean, which utilizes environmentally friendly cultivation practices, and Certified Organic, which follows the guidelines of the United States Department of Agriculture’s National Organic Program. In the production of its tobacco products, Santa Fe purchases electricity generated from renewable sources, including wind power, and operates a zero waste-to-landfill manufacturing facility.

American Snuff

Overview

RAI’s reportable operating segment, American Snuff, is the second largest smokeless tobacco products manufacturer in the United States, and offers adult tobacco consumers a range of differentiated smokeless tobacco products, primarily moist snuff. The moist snuff category is divided into premium, price-value and popular-price brands. American Snuff’s primary brands include its largest selling moist snuff brands, GRIZZLY, in the price-value category, and KODIAK, in the premium category.

In contrast to the declining U.S. cigarette market, U.S. moist snuff retail volumes grew approximately 3.6%, 2.0% and 2.3% in 2016, 2015 and 2014, respectively. Moist snuff’s growth is partially attributable to cigarette smokers switching from cigarettes to smokeless tobacco products or using both.

Moist snuff has been the key driver to American Snuff’s overall growth and profitability within the U.S. smokeless tobacco market and accounted for approximately 91%, 90% and 89% of its revenue in 2016, 2015 and 2014, respectively. Profit margins on moist snuff products are generally higher than on cigarette products.

Competition

American Snuff is dependent on the U.S. smokeless tobacco products market and competes in that market with other domestic and international companies. The highly competitive moist snuff category has developed many of the characteristics of the larger cigarette market, including multiple pricing tiers, focused marketing programs and significant product innovation. Similar to the cigarette market, competition is based primarily on brand positioning and price, as well as product attributes and packaging, consumer loyalty, promotions, advertising and retail presence.

American Snuff’s retail share of the U.S. moist snuff market, according to data collected by IRI/Capstone and processed and managed by MSAi, was 33.4% and 33.7% in 2016 and 2015, respectively. GRIZZLY moist snuff had a market share of 30.8% and 30.9% in 2016 and 2015, respectively. American Snuff’s largest competitor is U.S. Smokeless Tobacco Company LLC, referred to as USSTC, which had approximately 54.7% and 54.0% of the U.S. moist snuff market share in 2016 and 2015, respectively.

Marketing

American Snuff is committed to building and maintaining a portfolio of profitable brands. American Snuff’s marketing programs are designed to enhance brand image, build brand awareness and loyalty, and switch adult smokeless tobacco consumers of competing brands to American Snuff brands. Federal, state and local laws and regulations, including the FDA Tobacco Act and related regulations, restrict or prohibit utilization of television, radio or billboard advertising or certain other marketing and promotional tools for smoke-free tobacco products.

American Snuff’s brand portfolio strategy consists of the drive brand GRIZZLY, a leading moist snuff brand in the United States, and non-support brands that consist of all other brands. American Snuff is focusing on growing market share and profitability of its GRIZZLY branded products through equity-building initiatives and promotions. American Snuff also offers GRIZZLY pouches, which provide pre-measured portions that are more convenient than traditional, loose moist snuff. Pouches are the fastest growing

7


 

segment in the moist snuff category and represented approximately 20 % of the total U.S. moist snuff market as of December 31, 201 6 . During 201 6 , demand for pouches continued to grow at more than triple the overall category rate.

Manufacturing and Distribution

American Snuff Co. owns its manufacturing facilities located in Memphis, Tennessee; Clarksville, Tennessee; and Winston-Salem, North Carolina. American Snuff distributes its products primarily through a combination of direct wholesale deliveries from a distribution center in North Carolina and public warehouses located throughout the United States.

Raw Materials

In its production of moist snuff, American Snuff uses U.S. fire-cured and air-cured tobaccos as well as foreign, primarily Brazilian, burley and air-cured leaf tobaccos. American Snuff purchases the majority of its U.S. fire-cured and air-cured leaf directly through contracts with tobacco growers. These short-term contracts are frequently renegotiated. American Snuff believes the relationship with its leaf suppliers is good, and there is a sufficient supply of leaf in the worldwide tobacco market to satisfy its current and anticipated production requirements.

All Other

RJR Vapor is the marketer of VUSE Digital Vapor Cigarette products, which include VUSE Solo, VUSE Fob and VUSE Vibe. The national expansion of VUSE was completed in early 2015, and it is available in more than 110,000 retail outlets across the United States. VUSE is the top-selling vapor product in convenience/gas stores, and its innovative digital technology is designed to deliver a consistent flavor and vapor experience. In March 2016, RJR Vapor introduced its VUSE Fob power unit. This next-level VUSE Fob, which integrates Bluetooth® technology, offers an on-device display with information about battery and cartridge levels. When paired with the VUSE App, the device can be locked, preventing the use of the device by minors and others. VUSE Fob is available online to adult tobacco consumers. RJR Vapor began national distribution, in November 2016, of its VUSE Vibe high-volume cartridge and closed-tank system with a rechargeable battery. VUSE Vibe offers more liquid than previous VUSE products, as well as a stronger and longer-lasting battery.

Since the fourth quarter of 2015, all production of VUSE Solo cartridges is performed at RJR Tobacco’s manufacturing facility, pursuant to a services agreement between RJR Tobacco and RJR Vapor. For additional information, see Item 8, note 6 to consolidated financial statements.

Niconovum USA, Inc. is a marketer of a nicotine replacement therapy gum, ZONNIC, which is available in about 35,000 retail outlets across the United States. Niconovum AB is a marketer of nicotine replacement therapy products in Sweden under the ZONNIC brand name.

On January 13, 2016, RAI, through the Sellers, completed the sale of the international rights to the NATURAL AMERICAN SPIRIT brand name and associated trademarks, along with SFRTI and other international companies that distributed and marketed the brand outside the United States, to JTI Holding. For additional information, see Item 8, note 3 to consolidated financial statements.

Consolidated RAI

Customers

The largest customer of RJR Tobacco, Santa Fe and American Snuff is McLane Company, Inc., referred to as McLane. Sales to McLane, a distributor, constituted approximately 28% of RAI’s consolidated revenue in each of 2016 and 2015 and 31% in 2014. RJR Tobacco, Santa Fe and American Snuff sales to Core-Mark International, Inc., referred to as Core-Mark, a distributor, represented approximately 14%, 10% and 11% of RAI’s consolidated revenue in 2016, 2015 and 2014, respectively. No other customer accounted for 10% or more of RAI’s consolidated revenue during those periods. Sales of RJR Tobacco, Santa Fe and American Snuff to McLane and Core-Mark are not governed by any written supply contract. RJR Tobacco, Santa Fe and American Snuff believe that their relationships with McLane and Core-Mark are good. No significant backlog of orders existed at RJR Tobacco, Santa Fe or American Snuff as of December 31, 2016 or 2015.

Sales to Foreign Countries

RAI’s operating subsidiaries’ sales to foreign countries, including sales to BAT affiliates, for the years ended December 31, 2016, 2015 and 2014 were $351 million, $482 million and $497 million, respectively.

8


 

Raw Materials

In 2004, legislation was passed eliminating the U.S. government’s tobacco production controls and price support program. The buyout of tobacco quota holders provided for in the Fair and Equitable Tobacco Reform Act, referred to as FETRA, was funded by a direct quarterly assessment on every tobacco product manufacturer and importer, on a market-share basis measured on volume to which federal excise tax was applied. The aggregate cost of the buyout to the tobacco industry was approximately $9.9 billion, including approximately $9.6 billion payable to quota tobacco holders and growers through industry assessments over ten years, to 2014, and approximately $290 million for the liquidation of quota tobacco stock. The FETRA assessment expired in September 2014. RAI’s operating subsidiaries’ overall share of the buyout approximated $2.5 billion prior to the deduction of permitted offsets under the MSA. For additional information, see “— Tobacco Buyout Legislation” in Item 8, note 13 to consolidated financial statements.

Research and Development

The research and development activities of RAI’s operating subsidiaries are primarily conducted at RJR Tobacco’s facility in Winston-Salem, North Carolina through various intercompany service agreements. Scientists and engineers continue to explore the development of innovative products, packaging and processes, as well as harm reduction technologies, modified risk tobacco products and analytical methodologies. Another key activity for research and development is to assist RAI’s operating companies in complying with regulations of the U.S. Food and Drug Administration, referred to as the FDA, and to adhere to future FDA regulations and approval processes.

RAI’s operating subsidiaries’ research and development expense for the years ended December 31, 2016, 2015 and 2014, was $101 million, $107 million and $88 million, respectively.

Intellectual Property

RAI’s operating subsidiaries own or have the right to use numerous trademarks, including the brand names of their products and the distinctive elements of their packaging and displays, and numerous patents. RAI’s operating subsidiaries’ material patents and trademarks are registered with the U.S. Patent and Trademark Office, and certain corresponding patents and trademarks are registered in other countries throughout the world. Rights in the U.S. patents will expire in accordance with their individual statutory terms, and rights in the trademarks in the United States will last as long as RAI’s subsidiaries continue to use the trademarks. The operating subsidiaries consider the distinctive blends and recipes used to make each of their brands to be trade secrets. These trade secrets are not patented, but RAI’s operating subsidiaries take appropriate measures to protect the unauthorized disclosure of such information.

In 1999, RJR Tobacco sold most of its trademarks and patents outside the United States in connection with the sale of the international tobacco business to JTI. The sale agreement granted JTI the right to use certain of RJR Tobacco’s trade secrets outside the United States, but details of the ingredients or formulas for flavors and the blends of tobacco may not be provided to any sub-licensees or sub-contractors. The agreement also generally prohibits JTI and its licensees and sub-licensees from the sale or distribution of tobacco products of any description employing the purchased trademarks and other intellectual property rights in the United States. In 2005, the U.S. duty-free and U.S. overseas military businesses relating to certain brands were re-acquired from JTI.

In addition to intellectual property rights it directly owns, RJR Tobacco has certain rights with respect to BAT intellectual property that were available for use by B&W prior to the completion of the B&W business combination.

On June 12, 2015, pursuant to the Divestiture, ITG acquired certain assets (1) owned by RAI subsidiaries or affiliates relating to the cigarette brands WINSTON, KOOL and SALEM, and (2) owned by Lorillard subsidiaries or affiliates related to the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG).

On January 13, 2016, RAI, through the Sellers, completed the sale of the international rights to the NATURAL AMERICAN SPIRIT brand name and associated trademarks, along with SFRTI and other international companies that distributed and marketed the brand outside the United States to JTI Holding. Pursuant to that transaction, RAI has agreed not to, and agreed to cause its controlled affiliates not to, engage in the business of producing, selling, distributing and developing natural, organic and additive-free combustible tobacco cigarettes and roll-your-own or make-your-own tobacco products outside of the United States, and JTI has agreed not to, and agreed to cause its controlled affiliates not to, engage in the conduct of such business in the United States, in each case, for five years following the closing of the transaction.

For additional information, see Item 8, notes 2, 3 and 5 to consolidated financial statements.

9


 

Regulation and Taxation

Tobacco products are subject to a variety of federal, state and local laws and regulations. Since 1966, federal law has required a warning statement on cigarette packaging. In 2009, the FDA Tobacco Act was adopted, granting the FDA broad authority over the manufacture, sale, marketing and packaging of tobacco products. In 2016, the FDA issued a regulation deeming certain products, including e-cigarettes, to be subject to the FDA Tobacco Act. Many state, local and municipal governments and agencies have adopted laws or regulations prohibiting or restricting the public use of tobacco products. Cigarettes and other tobacco products also are subject to substantial taxation at both the federal and state levels. For more information regarding the nature of the regulation and taxation of tobacco products, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Governmental Activity.”

Litigation and Settlements

Litigation, claims and other legal proceedings relating to the use of, exposure to, or purchase of tobacco products are pending or may be instituted in the future against RJR Tobacco (including as successor by merger to Lorillard Tobacco), American Snuff Co., SFNTC, RJR Vapor, RAI, Lorillard, other RAI affiliates, and indemnitees, including but not limited to B&W, sometimes referred to collectively as Reynolds Defendants. Reynolds Defendants have been named in a number of tobacco-related legal actions, proceedings or claims seeking damages in amounts ranging into the hundreds of millions or even billions of dollars. As of December 31, 2016, RJR Tobacco had paid approximately $239 million since January 1, 2014, related to unfavorable smoking and health litigation judgments.

RAI’s management continues to conclude that the loss of any particular pending smoking and health tobacco-related litigation claims against Reynolds Defendants, or the loss of any particular case concerning the use of smokeless tobacco products against American Snuff Co., when viewed on an individual case-by-case basis, is not probable or estimable, except for certain Engle Progeny cases, as described in “— Litigation Affecting the Cigarette Industry — Overview” in Item 8, note 13 to consolidated financial statements. RAI and its subsidiaries believe that they have valid bases for appeal of adverse verdicts in their pending cases and valid defenses to all actions and intend to defend all actions vigorously. Nonetheless, the possibility of material losses related to tobacco-related litigation is more than remote. Litigation is subject to many uncertainties, and generally it is not possible to predict the outcome of the litigation pending against Reynolds Defendants, or to reasonably estimate the amount or range of any possible loss. Moreover, notwithstanding the quality of defenses available to it and its affiliates in tobacco-related litigation matters, it is possible that RAI’s consolidated results of operations, cash flows or financial position could be materially adversely affected by the ultimate outcome of certain pending or future litigation matters or difficulties in obtaining the bonds required to stay execution of judgments on appeal.

In 1998, RJR Tobacco, Lorillard Tobacco, B&W, SFNTC and the other major U.S. cigarette manufacturers entered into the MSA with attorneys general representing most U.S. states, territories and possessions. The State Settlement Agreements, of which the MSA is the most wide-reaching, impose a perpetual stream of future payment obligations on RJR Tobacco and the other major U.S. cigarette manufacturers and place significant restrictions on their ability to market and sell cigarettes in the future. The State Settlement Agreements have materially adversely affected RJR Tobacco’s shipment volumes. RAI believes that these settlement obligations may materially adversely affect the results of operations, cash flows or financial position of RAI and RJR Tobacco in future periods. The degree of the adverse impact will depend, among other things, on the rate of decline in U.S. cigarette sales in the premium and value categories, RJR Tobacco’s share of the domestic premium and value cigarette categories, and the effect of any resulting cost advantage of manufacturers not subject to the State Settlement Agreements.

For disclosure of legal proceedings involving RAI and its operating subsidiaries, see Item 8, note 13 to consolidated financial statements. For a description of RAI’s and its operating subsidiaries’ accounting treatment for tobacco-related litigation contingencies, see Item 8, note 13 “—Tobacco Litigation — General — Accounting for Tobacco-Related Litigation Contingencies.” For additional information related to State Settlement Agreements, see Item 8, note 1 “— Cost of Products Sold”, and note 13 “— Litigation Affecting the Cigarette Industry — State Settlement Agreements — Enforcement and Validity; Adjustments,” to consolidated financial statements.

Employees

At December 31, 2016, RAI and its subsidiaries had approximately 5,500 full-time employees and approximately 50 part-time employees. The 5,500 full-time employees include approximately 3,700 RJR Tobacco employees, 500 Santa Fe employees and 600 American Snuff employees. No employees of RAI or its subsidiaries are unionized.

10


 

Executive Officers and Certain Significant Employees of the Registrant

The executive officers of RAI are set forth below:

Debra A. Crew. Ms. Crew, 46, became President and Chief Executive Officer of RAI on January 1, 2017, after serving as President and Chief Executive Officer – Elect since October 2016. Ms. Crew also became President of RAI Services Company, a wholly owned subsidiary of RAI, and referred to as RAISC, on January 1, 2017. In addition, she joined the Board of RAI effective January 1, 2017. Ms. Crew served as President and Chief Operating Officer of RJR Tobacco from October 2015 to October 2016. She was previously the President and Chief Commercial Officer of RJR Tobacco from October 2014 to September 2015. Prior to joining RJR Tobacco, Ms. Crew was the President and General Manager of PepsiCo North America Nutrition from August 2014 to September 2014. She served as President of PepsiCo Americas Beverage from September 2012 until August 2014. Ms. Crew was also President of the Western Europe Region of PepsiCo Europe from April 2010 to August 2012. Prior to joining PepsiCo, Inc. in 2010, Ms. Crew held various positions with Mars, Incorporated, Nestle S.A. and Kraft Foods, Inc. Ms. Crew served in the U.S. Army from 1993 to 1997, rising to the rank of captain and military intelligence officer. She serves on the board of directors of Stanley Black & Decker, Inc.

Michael P. Auger. Mr. Auger, 49, became President of RAI Trade Marketing Services Company on November 14, 2016. He was Executive Vice President — Trade Marketing of RJR Tobacco from January 1, 2015 to December 31, 2016. Mr. Auger served as Vice President — Trade Marketing Development of RJR Tobacco from May 2011 to December 2014. Prior to 2011, Mr. Auger held numerous managerial positions with RJR Tobacco, including Area Vice President from May 2006 to April 2011. Prior to this, Mr. Auger held various additional positions with both RJR Tobacco and B&W. Mr. Auger currently serves on the Eckerd College Alumni Leadership Council and serves on the board of directors for Big Brothers Big Sisters Services, Inc. in Winston-Salem.

Lisa J. Caldwell. Ms. Caldwell, 56, has been Executive Vice President and Chief Human Resources Officer of RAI since May 2009, RAISC since January 2010 and RJR Tobacco since October 2014. Ms. Caldwell has served on the board of directors of RAISC since January 2010. She was previously Executive Vice President and Chief Human Resources Officer for RJR Tobacco from May 2009 to January 2010. Ms. Caldwell served as Executive Vice President — Human Resources of RAI and RJR Tobacco from June 2008 to May 2009. She served as Senior Vice President — Human Resources of RAI from November 2006 to June 2008, after having served as Vice President — Human Resources of RAI from September 2004 to November 2006. She also served as Senior Vice President — Human Resources of RJR Tobacco from July 2007 to June 2008, after having served as Vice President — Human Resources of RJR Tobacco from January 2002 to November 2006. Prior to 2002, Ms. Caldwell held numerous human resources positions with RJR Tobacco since joining RJR Tobacco in 1991. Ms. Caldwell serves on the Wake Forest University School of Business board of visitors and the board of directors for the Industries for the Blind Solutions (IFB Solutions).

Susan M. Cameron.  Ms. Cameron, 58, resigned as the President and Chief Executive Officer of RAI on October 19, 2016, effective as of the close of business on December 31, 2016, and was elected by RAI’s Board of Directors to serve as Executive Chairman of the Board, effective January 1, 2017. Ms. Cameron had served as President and Chief Executive Officer of RAI since May 2014. Ms. Cameron also served as President of RAISC, from May 2014 to December 31, 2016, after previously serving as the President and Chief Executive Officer of RAI from 2004 through her retirement in February 2011. She also served as the Chairman of the Board of RAI from 2006 to October 2010. In addition, Ms. Cameron served as Chairman of the Board of RJR Tobacco from July 2004 to May 2008. From July 2004 to December 2006, she also served as Chief Executive Officer of RJR Tobacco. She served as President and Chief Executive Officer of B&W from 2001 to 2004, and also served as a director of B&W from 2000 to 2004, and Chairman of the Board from January 2003 to 2004. Prior to 2001, Ms. Cameron held various marketing positions with B&W and BAT after joining B&W in 1981. Ms. Cameron served on the Board of RAI from January 2004 through her retirement in February 2011 and then recommenced serving on the Board in December 2013. She also is a member of the boards of directors of R. R. Donnelley & Sons Company and Tupperware Brands Corporation. In addition, Ms. Cameron is a member of the board of visitors of the Wake Forest University School of Business.

Daniel A. Fawley.  Mr. Fawley, 59, has served as Senior Vice President and Treasurer of RAI, RJR Tobacco and RJR since September 2004, and Senior Vice President and Treasurer of RAISC since January 2010. Since joining RJR in 1999, he was Vice President and Assistant Treasurer of RJR until August 2004. Mr. Fawley is a member of the boards of directors of the Reynolds American Foundation, Santa Fe Natural Tobacco Company Foundation, Novant Health Clemmons Medical Center Foundation, the Arts Council Endowment Fund, Inc. and the Finance Advisory Board for the Finance Academy. Mr. Fawley also serves on the Abbott Capital Private Equity Advisory Board.

McDara P. Folan, III.  Mr. Folan, 58, has been Senior Vice President, Deputy General Counsel and Secretary of RAI since July 2004, and Senior Vice President, Deputy General Counsel and Secretary of RAISC since January 2010. He also serves as Assistant Secretary of RJR Tobacco. Prior to 2004, Mr. Folan served in various positions with RJR and RJR Tobacco since joining RJR in 1999.

11


 

Mr. Folan serves on the board of trustees for Salem College and Academy and the board s of directors of the Dow ntown Winston-Salem Foundation, the Arts Council Endowment Fund, Inc. and the UNC School of the Arts Foundation, Inc.

Joseph P. Fragnito.  Mr. Fragnito, 44, became President and Chief Commercial Officer of RJR Tobacco on October 24, 2016. Mr. Fragnito served as the President of the U.S. Beverages and Snack Nuts business unit of The Kraft Heinz Company from June 2015 to August 2016. He was Vice President of Marketing for a number of key brands for Kraft Foods Group, Inc., referred to as Kraft Foods Group, from July 2013 to June 2015, at which time Kraft Foods Group merged with H.J. Heinz Company. Mr. Fragnito was Senior Director of Marketing for Kraft Foods Group from January 2011 to June 2013. Prior to 2011, he served in various other marketing and innovations roles with Kraft Foods Group after joining Kraft in 2000.

Andrew D. Gilchrist. Mr. Gilchrist, 44, has been Executive Vice President and Chief Financial Officer of RAI, and Executive Vice President, Chief Financial Officer and Chief Information Officer of RAISC since March 1, 2015. Mr. Gilchrist was the Executive Vice President of RAI from October 2014 to March 2015. He previously served as President and Chief Commercial Officer of RJR Tobacco from January 1, 2011 to September 30, 2014. He previously served as Executive Vice President and Chief Financial Officer of RJR Tobacco and Executive Vice President and Chief Information Officer of RAISC from January 2010 to December 2010. He previously served as Executive Vice President, Chief Financial Officer and Chief Information Officer of RJR Tobacco from July 2008 until January 2010. Mr. Gilchrist has served on the board of directors of RAISC since March 2015 and served on the board of directors of RJR Tobacco from May 2008 to March 2015. He also served as Senior Vice President and Chief Financial Officer of RJR Tobacco from November 2006 to July 2008, after having served as Vice President — Integrated Business Management of RJR Tobacco from January 2006 to November 2006. Prior to 2006, Mr. Gilchrist served as Senior Director — Business Development since joining RAI in 2004. Prior to July 2004, Mr. Gilchrist held various positions with B&W and its parent company, BAT. Mr. Gilchrist serves on the board of directors for the Winston-Salem Alliance.

Nancy H. Hawley. Ms. Hawley, 54, has been Executive Vice President of Operations at RJR Tobacco since October 2015. Ms. Hawley previously served as Senior Vice President of Operations for RJR Tobacco from July 2014 to October 2015. Prior to that, Ms. Hawley was Vice President of Manufacturing for RJR Tobacco from October 2008 through June 2014. Ms. Hawley joined RJR Tobacco in 1984 as a staff engineer and held a number of operations positions. Ms. Hawley currently serves on the boards of directors for the Foundation of Forsyth Technical College and the Reynolds American Foundation. In addition, Ms. Hawley currently serves as a member of the United Way Basic Needs Impact Committee and serves as a member of the Wake Forest School of Business Alumni Development Council.

Daniel J. Herko. Mr. Herko, 56, has been Executive Vice President – Scientific and Regulatory Affairs of RAISC since January 1, 2016, and Executive Vice President – Research and Development of RJR Tobacco since October 2015. Mr. Herko served as Executive Vice President of RAISC from October 2015 until December 2015. Mr. Herko previously served as Senior Vice President – Research and Development of RJR Tobacco from March 2008 to September 2015, after serving as Vice President – Product Development from November 2007 to March 2008. Mr. Herko joined RJR Tobacco in 1980 in the manufacturing division and held a variety of production positions in manufacturing before joining JTI, following the sale of the international tobacco business to JTI in 1999. In 2002, Mr. Herko returned to RJR Tobacco as Director of Product Development until becoming Senior Director of Product Development in 2005. He serves on the board of directors of the Riverwood Therapeutic Riding Center.

Martin L. Holton III.  Mr. Holton, 59, has been Executive Vice President, General Counsel and Assistant Secretary of RAI and RAISC and Executive Vice President and General Counsel of RJR Tobacco since January 2011. Mr. Holton previously served as Senior Vice President and Deputy General Counsel of RAISC from January 2010 through December 2010 and Senior Vice President, General Counsel and Secretary of RJR Tobacco from November 2006 through December 2010. In addition, Mr. Holton has served on the board of directors of RAISC since January 2011. Previously, Mr. Holton served as Senior Vice President, Deputy General Counsel and Secretary of RJR Tobacco from February 2005 to November 2006 and Vice President and Assistant General Counsel — Litigation from July 2004 to February 2005. Mr. Holton serves on the board of managers for YMCA Camp Hanes and the boards of directors for the Winston-Salem Symphony and the United Way Forsyth County.

Cressida Lozano.  Ms. Lozano, 43, has served as Executive Vice President — Consumer Marketing of RJR Tobacco since March 2016, after having served as Senior Vice President — Cigarettes of RJR Tobacco from March 2015 to March 2016. Ms. Lozano served as Vice President – Trade and Consumer Marketing of SFNTC from January 2012 to February 2015, and also was on the Board of SFNTC from December 2011 to February 2015. She also served as Vice President – Brand Stewardship for RJR Tobacco during January 2010, after previously serving as Vice President – Brand Stewardship for Reynolds Innovations Inc. from January 2009 to December 2009. Ms. Lozano was Vice President – Camel Business Unit of RJR Tobacco from January 2006 to January 2009, after serving as Vice President – Marketing for SFNTC from July 2003 to January 2006. Ms. Lozano is also the Chairman and President of the Santa Fe Natural Tobacco Company Foundation.

12


 

J. Brice O’Brien.  Mr. O’Brien, 4 8 , has served as Executive Vice President Public Affairs and Chief Communications Officer for RAI, RJR Tobacco, RAISC, RAI Innovations Inc. and RJR Vapor since March 2016. Previously, Mr. O’Brien served as Executive Vice President — Consumer Marketing of RJR Tobacco from January 2010 to February 2016, after having served as President of Reynolds Innovations Inc. since January 2009 to December 2009 . Mr. O’Brien served as Senior Vice President — Consumer Marketing of RJR Tobacco from January 2006 until January 2009, after serving as Vice President — Marketing from October 2004 through December 2005 . Prior to 2004, Mr. O’Brien held various positions with RJR Tobacco after joining RJR Tobacco in 1995.

Frederick W. Smothers.  Mr. Smothers, 53, has served as Senior Vice President and Chief Accounting Officer of RAI since January 2008 and RAISC since January 2010. Mr. Smothers served as Vice President and Corporate Controller of RAI from October 2007 to December 2007. Prior to joining RAI, Mr. Smothers was an independent management consultant from 2002 until 2007, serving as Chief Executive Officer of ATRS Consulting from 2005 until October 2007, providing general management consulting to consumer products and manufacturing clients, including RAI. Prior to 2002, Mr. Smothers was employed by the accounting firm of Deloitte & Touche LLP, including four years as partner.

Other significant employees of the Registrant include the chief executive officers of SFNTC and American Snuff Co., as listed below:

Michael A. Little.  Mr. Little, 57, has served as President of SFNTC since December 2011. Previously, he served as Senior Vice President — Manufacturing of SFNTC from January 2002 until November 2011. Prior to 2002, Mr. Little held various positions with SFNTC after joining SFNTC in 1995.

Randall M. (Mick) Spach. Mr. Spach, 58, has been President of American Snuff Co. since January 2011. Previously he served as Vice President — Operations of American Snuff Co. from February 2009 until December 2010. Mr. Spach served as Vice President — Manufacturing/R&D of American Snuff Co. from August 2007 to February 2009. He served as Assistant Vice President — Manufacturing at American Snuff Co. from 2001 to August 2007. Between 1977 and 2001, Mr. Spach held various positions with American Snuff Co.

 

 

Item 1A. Risk Factors

RAI and its subsidiaries operate with certain known risks and uncertainties that could have a material adverse effect on their results of operations, cash flows and financial position. The risks below are not the only ones that could impact RAI and its subsidiaries. Additional risks not currently known or currently considered immaterial also could affect RAI’s business. You should carefully consider the following risk factors in connection with other information included in this Annual Report on Form 10-K and in other documents filed with the SEC.

Adverse litigation outcomes could have an adverse effect on the results of operations, cash flows and financial position of RAI. Additionally, RAI’s operating subsidiaries could be subject to substantial liabilities and bonding difficulties from litigation related to cigarette products or other products, which could also have an adverse effect on their results of operations, cash flows and financial position.

Reynolds Defendants have been named in a number of tobacco-related legal actions, proceedings or claims. The claimants seek recovery on a variety of legal theories, including negligence, strict liability in tort, design defect, failure to warn, fraud, misrepresentation, deceptive and unfair trade practices, conspiracy, medical monitoring, and violations of state and federal antitrust and racketeering laws. Various forms of relief are sought, including compensatory damages, attorneys’ fees, and, where available, punitive damages in amounts ranging in some cases into the hundreds of millions or even billions of dollars.

The tobacco-related legal actions range from individual lawsuits to class-actions and other aggregate claim lawsuits. In Engle v. R. J. Reynolds Tobacco Co ., the Florida Supreme Court issued a ruling that, while determining that the case could not proceed further as a class action, permitted members of the Engle class to file individual claims, including claims for punitive damages, through January 11, 2008. The decision preserved several of the Engle jury findings for use in adjudicating these subsequent individual actions, which are now known as Engle Progeny cases. As of December 31, 2016, RJR Tobacco had been served in 2,822 pending Engle Progeny cases filed on behalf of approximately 3,645 individual plaintiffs. Many of these cases are in active discovery or nearing trial. In all Engle Progeny cases tried to date, a central issue has been the proper use of the preserved Engle findings. RJR Tobacco has argued that use of the Engle findings to establish individual elements of claims (such as defect, negligence and concealment) is a violation of federal due process. In 2013, both the Florida Supreme Court and the U.S. Court of Appeals for the Eleventh Circuit rejected that argument.

13


 

The Engle Progeny cases have resulted in increased litigation and trial activity, including an increased number of adverse verdicts, and increased expenses. Through December 31, 2016, RJR Tobacco or Lorillard Tobacco cumulatively paid $297.9 million in compensatory and punitive damages and $107.7 million for attorneys’ and statutory interest, for a total of $405.6 million, in these cases. In addition, outstanding jury verdicts in favor of the Engle Progeny plaintiffs had been entered against RJR Tobacco or Lorillard Tobacco in the amount of $212.2 million in compensatory damages (as adjusted) and in the amount of $227.3 million in punitive damages, for a total of $439.5 million. All of these verdicts are in various stages in the appellate process and have been bonded as required by Florida law under the $200 million bond cap passed by the Florida legislature in 2009. Bills are pending in the Florida legislature that would repeal the existing $200 million bond cap. Such a repeal, depending upon the amount of any adverse judgment, could increase the amount RJR Tobacco would be required to bond. Although RJR Tobacco cannot currently predict when or how much it may be required to bond and pay, RJR Tobacco will likely be required to bond and pay additional judgments as the litigation proceeds. For a more complete description of this litigation, see “— Litigation Affecting the Cigarette Industry — Engle and Engle Progeny Cases” in Item 8, note 13 to consolidated financial statements.

Class-action suits have been filed in a number of states against individual cigarette manufacturers, including RJR Tobacco, and their parents, including RAI, alleging that the use of the terms “lights” and “ultra-lights” constitutes unfair and deceptive trade practices. In 2008, the U.S. Supreme Court ruled that neither the Federal Cigarette Labeling and Advertising Act nor the Federal Trade Commission’s regulation of “tar” and nicotine disclosures preempts (or bars) such claims. This ruling limits certain defenses available to RJR Tobacco and other cigarette manufacturers and has led to the filing of additional lawsuits. In addition, several class actions have been filed against SFNTC and RAI asserting that use of the terms “natural”, “additive-free” and “organic” in the product labeling and advertising for SFNTC’s NATURAL AMERICAN SPIRIT cigarette brand violates state disclosure, and deceptive and unfair trade practice, statutes. In addition, RJR Tobacco tendered to JTI the defense of the health-care cost reimbursement actions that Canadian provinces filed against RJR Tobacco and one of its affiliates, and RJR Tobacco also requested indemnification. JTI has accepted the defense of these cases, subject to full reservation of rights. In the event RJR Tobacco, SFNTC or their affiliates and indemnitees, or JTI lose one or more of the pending class-action or health-care reimbursement suits, RJR Tobacco, SFNTC or their affiliates and indemnitees could face, depending upon the amount of any damages ordered, difficulties in their ability to pay the judgment or obtain any bond required to stay execution of the judgment. For a more complete description of class-action litigation, see “— Class-Action Suits ” in Item 8, note 13 to consolidated financial statements.

In 1999, the U.S. Department of Justice bought an action against RJR Tobacco, Lorillard Tobacco, B&W, and other tobacco companies pursuant to the civil provisions of the federal Racketeer Influenced and Corrupt Organizations Act, referred to as RICO. The government sought, among other remedies, disgorgement of profits in an amount of approximately $280 billion allegedly earned as a consequence of a RICO racketeering “enterprise” and injunctive relief. In February 2005, an appellate court ruled that disgorgement was not an available remedy. In 2006, the trial court found certain defendants, including RJR Tobacco, liable for the RICO claims (but did not impose any direct financial penalties), enjoined the defendants from committing future racketeering acts, and ordered the defendants to issue “corrective communications” on five subjects, including smoking and health and addiction. The trial court’s “corrective-statements” remedy is subject to continuing proceedings to determine, among other things, whether the “corrective statements” will have to be displayed at retail points-of-sale. Implementation of the “corrective-statements” remedy could cause RJR Tobacco to incur significant compliance costs, have an adverse effect on the sales of RJR Tobacco’s products, and impact legal actions pending against Reynolds Defendants. For a more complete description of this litigation, see “— Health-Care Cost Recovery Cases — U.S. Department of Justice Case ” in Item 8, note 13 to consolidated financial statements.

It is likely that legal actions, proceedings and claims arising out of the sale, distribution, manufacture, development, advertising, marketing and claimed health effects of cigarettes and other tobacco products will continue to be filed against Reynolds Defendants and other tobacco companies for the foreseeable future. Actions by the FDA may further trigger such legal actions, proceedings and claims against RAI and its subsidiaries.

Victories by plaintiffs in highly publicized cases against RJR Tobacco and other tobacco companies regarding the health effects of smoking may stimulate further claims. A material increase in the number of pending claims could significantly increase defense costs. In addition, adverse outcomes in pending cases could have adverse effects on the ability of RJR Tobacco and its indemnitees, including B&W, to prevail in other smoking and health litigation.

Any or all of the events described above could impose substantial monetary obligations on RAI and its operating subsidiaries and could have an adverse effect on the results of operations, cash flows and financial position of these companies and RAI. For a more complete description of the above cases and other significant litigation involving RAI and its operating subsidiaries, including RJR Tobacco, Lorillard Tobacco and American Snuff Co., see “— Litigation Affecting the Cigarette Industry” and “— Smokeless Tobacco Litigation” in Item 8, note 13 to consolidated financial statements.

14


 

Any action by the FDA or any other governmental authority that could have the effect of banning or materially restricting the use of menthol in tobacco products could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

As a result of the Lorillard Merger, RAI, through its subsidiaries, acquired Lorillard’s NEWPORT brand, the leading U.S. menthol cigarette brand. NEWPORT menthol cigarette styles were added to the brand portfolio of RAI’s operating companies, a portfolio which includes other brands with menthol styles. RAI estimates that approximately 50% of its total net sales were attributable to menthol cigarettes for the year ended December 31, 2016. See Item 8, note 2 to consolidated financial statements.

In 2013, the FDA issued its preliminary scientific evaluation regarding menthol cigarettes, concluding that menthol cigarettes adversely affect initiation, addiction and cessation compared to non-menthol cigarettes. In 2013, the FDA also issued an Advance Notice of Proposed Rulemaking, seeking comments on various issues relating to the potential regulation of menthol cigarettes. Although it is not possible to predict whether or when the FDA will take actions, if the FDA or any other governmental authority were to adopt regulations banning or severely restricting the use of menthol in tobacco products or the sale of menthol cigarettes, those regulations could have a material adverse effect on sales of the NEWPORT brand, and the menthol styles of other brands in the portfolio of RAI’s operating companies. Such an effect on sales could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

In addition to regulatory action affecting the use of menthol in cigarettes, the FDA could regulate tobacco products, including electronic cigarettes, in other aspects that could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

The FDA Tobacco Act grants the FDA broad authority over the manufacture, sale, marketing and packaging of tobacco products. FDA actions taken pursuant to the FDA Tobacco Act could result in a decrease in cigarette and smokeless tobacco product sales in the United States, including sales of RJR Tobacco’s, American Snuff Co.’s and SFNTC’s brands, and has resulted in an increase in costs to RJR Tobacco, American Snuff Co. and SFNTC, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

The ability of RAI’s operating companies to introduce new tobacco products, a critical component of RAI’s strategy of focusing on innovation to transform the tobacco industry, could be adversely affected by FDA rules and regulations. Under the FDA Tobacco Act, for a manufacturer to launch a new tobacco product or modify an existing tobacco product after March 22, 2011, the manufacturer must obtain an order from the FDA’s “Center for Tobacco Products,” referred to as the CTP, allowing the new or modified product to be marketed. Similarly, a manufacturer that introduced a product between February 15, 2007, and March 22, 2011, was required to file a substantial equivalence report with the CTP demonstrating either (1) that the new or modified product had the same characteristics as a product commercially available as of February 15, 2007, referred to as a predicate product, or (2) if the new or modified product had different characteristics than the predicate product, that it did not raise different questions of public health. A product subject to such report is referred to as a provisional product. A manufacturer may continue to market a provisional product unless and until the CTP issues an order that the provisional product is not substantially equivalent, referred to as an NSE order, in which case the FDA could then require the manufacturer to remove the provisional product from the market. On September 15, 2015, the CTP issued four NSE orders to RJR Tobacco, determining that four cigarette styles were not substantially equivalent to their respective predicate products, and ordering that RJR Tobacco immediately stop all distribution, importation, sale, marketing and promotion of these provisional products. RJR Tobacco has complied with these NSE orders. Although the sales of the provisional products subject to the foregoing NSE orders are not material to RJR Tobacco, substantially all of RAI’s operating companies’ products currently on the market are provisional products. If the CTP were to issue NSE orders with respect to other provisional products of RAI’s operating companies, such orders, if not withdrawn or invalidated, would have an adverse impact on the sales of the products subject to the orders, and could have an adverse impact on the results of operations, cash flows and financial position of RAI and its subsidiaries.

On May 10, 2016, the FDA issued a final regulation deeming e-cigarettes and certain other tobacco products to be subject to the FDA’s regulatory authority under the FDA Tobacco Act. As a result, such newly “deemed” tobacco products will be subject to many of the same requirements of the FDA Tobacco Act that currently apply to cigarettes and smokeless tobacco products. Under the final regulation, any newly “deemed” tobacco products, including e-cigarettes, that were not on the market as of February 15, 2007, will be considered a new tobacco product subject to premarket review by the FDA. Neither RJR Vapor’s VUSE e-cigarette, nor virtually any other e-cigarette, was on the market as of such date. As a result, e-cigarette manufacturers, including RJR Vapor, will not be able to utilize the substantial equivalence pathway for clearing these products, but instead will have to file premarket tobacco product applications. These applications must be filed by August 8, 2018, for e-cigarette products in the market as of August 8, 2016. A manufacturer that files a premarket application for such a product may continue to market the product for a certain period of time pending the FDA’s review of the application. For products that were not in the market by August 8, 2016, manufacturers must file and await clearance of such premarket applications before placing such products into commerce.

15


 

For the FDA to clear a premarket tobacco product application covering an e-cigarette, the applicant must show that the marketing of the e-cigarette would be appropriate for the protection of the public health. At present, there is substantial uncertainty over how the FDA will interpret that standard when determining whether to clear an e-cigarette premarket tobacco application. If RJR Vapor is unable to obtain FDA clearance, or obtains FDA clearance on a delayed basis, of premarket applications for VUSE and other e-cigarette products, then there could be an adverse effect on RJR Vapor’s business which could have an adverse effect on the results of operations, cash flows, and financial position of RAI and its subsidiaries, including RJR Vapor.

On August 27, 2015, the FDA sent a warning letter to SFNTC claiming that SFNTC’s use of the terms “Natural” and “Additive Free” in the product labeling and advertising for Natural American Spirit cigarettes violates the Modified Risk Tobacco Products provision of the FDA Tobacco Act.  Following discussions between the parties, on January 23, 2017, the FDA and SFNTC reached an agreement whereby, among other things, SFNTC committed to phasing out use of the terms “Natural” and “Additive Free” from product labeling and advertising for Natural American Spirit cigarettes on an established timeframe.  The agreement also specifies that SFNTC may continue to use the term “Natural” in the Natural American Spirit brand name and trademarks.  SFNTC’s scheduled deletion of the terms “Natural” and “Additive Free” from the labeling and advertising of its Natural American Spirit cigarettes could have an adverse effect on the sale of such cigarettes and, as a result, on the results of operations, cash flows and financial position of SFNTC and RAI .

 

Further, the FDA has the authority to require the reduction of nicotine levels under the FDA Tobacco Act and also may require reduction or elimination of other constituents. For instance, the FDA has proposed a rule that, if adopted, would require the reduction, over a three-year period, of the levels of N-nitrosonornicotine (NNN) contained in smokeless tobacco products.  The adoption of this proposed rule is currently suspended by virtue of a federal regulatory freeze imposed by the U.S. President.  It is not known whether or when this proposed rule will be adopted, and, if adopted, whether the final rule will be the same as or similar to the proposed rule.  If the proposed rule is adopted, however, in its current form (or in a form substantially similar to its current form), management expects that compliance or the inability to comply could have a material adverse effect on the results of operations, cash flows and financial position of American Snuff and RAI.  

For a detailed description of the FDA Tobacco Act, see “— Governmental Activity” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

Significant monetary obligations imposed under the State Settlement Agreements into perpetuity, may have an adverse effect on the results of operations, cash flows and financial position of RAI and RJR Tobacco. Certain amounts incurred pursuant to the MSA have been disputed by RJR Tobacco and are subject to future arbitration proceedings that may result in rulings that reduce or eliminate the recovery of disputed amounts by RJR Tobacco.

In 1998, RJR Tobacco, Lorillard Tobacco and the other major U.S. cigarette manufacturers entered into the MSA with attorneys general representing most U.S. states, territories and possessions. The State Settlement Agreements, of which the MSA is the most wide-reaching, impose a perpetual stream of future payment obligations on RJR Tobacco and the other major U.S. cigarette manufacturers, and place significant restrictions on their ability to market and sell tobacco products in the future. They have materially adversely affected RJR Tobacco’s shipment volumes, and they may have an adverse effect on the results of operations, cash flows and financial position of RAI and RJR Tobacco in future periods.

RJR Tobacco and Lorillard Tobacco disputed a total of $5.6 billion and $1.2 billion, respectively, in potential MSA non-participating manufacturer adjustment, referred to as the NPM Adjustment, claims for the years 2003 through 2014. A nationwide arbitration, referred to as the Arbitration Panel, was initiated with respect to the 2003 NPM Adjustment claim.

During the arbitration of the 2003 NPM Adjustment claim, RJR Tobacco, Lorillard Tobacco, SFNTC and certain other participating manufacturers, referred to as the PMs, and certain “signatory” states entered into a binding Term Sheet that set forth terms to resolve NPM Adjustment claims for 2003 through 2012. The Term Sheet also set forth a restructured NPM Adjustment process to be applied to future volume years, starting with the 2013 volume year. Under the settlement, RJR Tobacco is to receive more than $1.1 billion worth of credits, a portion of which has been applied to its MSA payments in 2014, 2015 and 2016, with the remainder to be applied against its 2017 and 2018 MSA payments. In addition, RJR Tobacco, SFNTC and certain other participating manufacturers entered into a settlement agreement with the state of New York that resolved NPM Adjustment claims for 2004 through 2014 and put in place a new method to determine future adjustment from 2015 forward as to New York.

In September 2013, the Arbitration Panel issued final awards on the 2003 NPM Adjustment claim. Unfavorable rulings against two states remain unresolved and are subject to lawsuits in those respective state courts. After the above NPM Adjustment settlements, $1.9 billion and $400 million of the 2004 through 2014 NPM Adjustment remain in dispute for RJR Tobacco and Lorillard Tobacco,

16


 

respectively. The arbitration proceeding of the 2004 NPM Adjustment claim is underway. RJR Tobacco’s and Lorillard Tobacco’s remaining claim with respect to 2004 is approximately $251 million.

Due to the uncertainty over the final resolutions of the NPM Adjustment asserted by RJR Tobacco and Lorillard Tobacco, no assurances can be made related to the amounts, if any, that will be realized or any amounts (including interest) that will be owed.

For a more complete description of the State Settlement Agreements and the Arbitration Panel’s awards, see “— Health-Care Cost Recovery Cases — State Settlement Agreements” and “— Health-Care Cost Recovery Cases — State Settlement Agreements — Enforcement and Validity; Adjustments” in Item 8, note 13 to consolidated financial statements.

RAI, through its subsidiaries, is dependent on the U.S. cigarette market, which is expected to continue to decline. In addition, RAI is dependent on premium and super-premium cigarette brands. The continued decline in U.S. cigarette consumption, or the transition of consumers away from premium cigarette brands, could have an adverse effect on the consolidated results of operations, cash flows and financial position of RAI.

RAI’s subsidiaries’ U.S. combustible cigarette brands include, among others, NEWPORT, CAMEL, PALL MALL and NATURAL AMERICAN SPIRIT. RAI’s sales in the United States attributable to combustible cigarettes represented approximately 89% of RAI’s 2016 net sales. U.S. cigarette consumption has declined since 1981 for a variety of reasons including, for example, price increases, restrictions on advertising and promotions, smoking prevention campaigns, increases in regulation and excise taxes, health concerns, a decline in the social acceptability of smoking, governmental and private restrictions on the locations where smoking is permitted, increased pressure from anti-tobacco groups, and migration to smoke-free products. U.S. consumption is expected to continue to decline. MSAi reported that, on a year-over-year basis, U.S. cigarette shipments declined 2.4% in 2016, 0.1% in 2015 and 3.2% in 2014.

The sale of the international rights to the NATURAL AMERICAN SPIRIT brand name to JTI Holding in early 2016 increased the reliance of RAI’s operating subsidiaries on the U.S. cigarette market. In addition, pursuant to that transaction, RAI has agreed not to, and agreed to cause its controlled affiliates not to, engage in the business of producing, selling, distributing and developing natural, organic and additive-free combustible tobacco cigarettes and roll-your-own or make-your-own tobacco products outside of the United States for a period of five years after the closing.

In addition, RAI’s subsidiaries’ brands are subject to consumer price sensitivities, with certain brands subject to greater price sensitivities than others or competitors’ brands. Some consumers may switch to a lower-priced brand than the brands offered by RAI’s subsidiaries. As a result of the acquisition of Lorillard’s subsidiaries’ brands, which principally consist of NEWPORT, RAI’s subsidiaries’ concentration of premium and super-premium brands increased significantly and in 2016, accounted for approximately 73% of RAI’s subsidiaries’ cigarette volume. As a result, RAI’s subsidiaries are more susceptible to consumer price sensitivities following the Lorillard Merger. A downturn in the economy or other adverse financial or economic conditions could increase the number of consumers switching to a lower-priced brand.

The continued decline in U.S. cigarette consumption, or the transition of consumers away from premium cigarette brands, could have an adverse effect on the consolidated results of operations, cash flows and financial position of RAI.

If RJR Tobacco and RAI’s other operating companies are not able to develop, produce or market new alternative products profitably, the results of operations, cash flows and financial position of RAI and its operating subsidiaries could be adversely affected.

Consumer health concerns, changes in adult tobacco consumer preferences and changes in regulations have prompted RJR Tobacco and other RAI operating companies to introduce new alternative products. Consumer acceptance of these new products, such as CAMEL Snus and e-cigarettes, may fall below expectations, in which event RAI’s operating subsidiaries may be unable to replace all or any significant portion of lost revenues resulting from the continuing decline in cigarette consumption generally.

Further, while VUSE, an RJR Vapor e-cigarette product, is currently the number one e-cigarette product sold in convenience/gas stores, sales of closed system products like VUSE continue to decline in comparison to the sale of tanks and liquid nicotine containers typically sold in vapor shops and on-line. The future success of VUSE and other RJR Vapor e-cigarette offerings, including VUSE Vibe, will depend on the ability to innovate in an evolving category of alternative tobacco products.

In addition, RAI’s operating companies may not be able to establish or maintain relationships, on favorable commercial terms, with vendors willing to produce alternative products, or components or raw materials used in such products, resulting in additional expenditures for RAI’s operating companies.

17


 

If RJR Tobacco and RAI’s other operating companies are not able to develop, produce or market new alternative products to replace declining cigarette sales, then there could be an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

Competitive actions and pricing pressures in the marketplace could have an adverse effect on the results of operations, cash flows and financial position of RJR Tobacco, Santa Fe and American Snuff.

The tobacco industry is highly competitive. Among the major manufacturers, brands primarily compete on product quality, price, brand recognition, brand imagery and packaging. Substantial marketing support, merchandising display, discounting, promotions and other financial incentives generally are required to maintain or improve a brand’s market position or introduce a new brand. Competitors may also have certain advantages, including stronger financial position and liquidity, enabling them to better withstand the effects of competition and declines in price.

In addition, substantial payment obligations under the State Settlement Agreements adversely affect RJR Tobacco’s ability to compete with manufacturers of deep-discount cigarettes that are not subject to such substantial obligations. For a more complete description of the State Settlement Agreements, see “— Health-Care Cost Recovery Cases — State Settlement Agreements” in Item 8, note 13 to consolidated financial statements.

Inability to compete effectively may result in loss of market share, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

In the United States, tobacco products are subject to substantial and increasing regulation and taxation, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

A wide variety of federal, state and local laws limit the advertising, sale and/or use of tobacco products. These laws have proliferated in recent years. For example, some local laws prohibit the sale of certain tobacco products. Another example is that some local laws prohibit certain types of marketing practices, such as consumer coupons. In addition, there are many local laws that prohibit the consumption of cigarettes and other tobacco products in restaurants and other public places. Private businesses also have adopted policies that prohibit or restrict, or are intended to discourage, smoking and tobacco use. These laws and regulations could result in a decline in the overall sales volume of tobacco products, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

Tobacco products are subject to substantial federal and state excise taxes in the United States. Certain city and county governments also impose substantial excise taxes on tobacco products sold. Over the last several years, these taxing authorities have significantly increased the magnitude of excise taxes on tobacco products. Increased excise taxes have resulted in declines in overall sales volume and shifts by consumers to less expensive brands, and additional increases could result in future sales declines. For additional information on the issues described above, see “— Governmental Activity” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

RAI’s largest operating subsidiaries are subject to significant limitations on advertising and marketing of tobacco products, which could harm the value of their existing brands and their ability to launch new brands, and could have an adverse effect on the results of operations, cash flows and financial position of these companies and RAI.

In the United States, television and radio advertisements of cigarettes have been prohibited since 1971, and television and radio advertisements of smokeless tobacco products have been prohibited since 1986. Under the MSA, RAI’s operating subsidiaries, RJR Tobacco and SFNTC, cannot use billboard advertising, cartoon characters, sponsorship of certain events, non-tobacco merchandise bearing their brand names and various other advertising and marketing techniques. The MSA also prohibits targeting of youth in advertising, promotion or marketing of tobacco products, including the smokeless tobacco products of RJR Tobacco. American Snuff Co. is not a participant in the MSA. Although these restrictions were intended to ensure that tobacco advertising was not aimed at young people, some of the restrictions also may limit the ability of RAI’s operating subsidiaries to communicate with adult tobacco consumers. In addition, pursuant to the FDA Tobacco Act, the FDA has reissued regulations addressing advertising and marketing restrictions that were originally promulgated in 1996. Additional restrictions under the FDA regulations, or otherwise, may be imposed or agreed to in the future. These limitations on the advertising and marketing of tobacco products inhibit RAI’s operating subsidiaries from promoting and maintaining the value of their existing brands and limit their ability to launch new brands, which could have an adverse effect on the results of operations, cash flows and financial position of these companies and RAI.

18


 

Fluctuations in the availability, quality and price of raw materials and commodities, including tobacco leaf, used in the products of RAI’s subsidiaries could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

Possible fluctuations in the availability, quality and price of raw materials and commodities, including tobacco leaf, used in RAI’s operating subsidiaries’ products could cause profits to decline which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

RAI’s operating subsidiaries rely on a limited number of suppliers for certain raw materials. An interruption in service from any of these suppliers could have an adverse effect on the results of operations, cash flows and financial position of RAI.

RAI’s operating subsidiaries rely on a limited number of suppliers for raw materials. If a supplier fails to meet any of RAI’s operating subsidiaries’ demands for raw materials, any such operating subsidiary may fail to operate effectively and may fail to meet shipment demand, which could have an adverse effect on the results of operations, cash flows and financial position of such subsidiary and RAI.

Fire, violent weather conditions and other disasters that affect manufacturing and other facilities of RAI’s operating subsidiaries, or of their suppliers and vendors, could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

A major fire, violent weather conditions or other disasters that affect manufacturing and other facilities of RAI’s operating subsidiaries, or of their suppliers and vendors, could have a material adverse effect on the operations of RAI’s operating subsidiaries. In particular, RJR Tobacco’s cigarette manufacturing is conducted primarily at a single facility. Additionally, SFNTC’s cigarette manufacturing is conducted at a single facility. Despite RAI’s insurance coverage for some of these events, a prolonged interruption in the manufacturing operations of RAI’s operating subsidiaries could have a material adverse effect on the ability of such subsidiaries to effectively operate their businesses, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries.

Certain of RAI’s operating subsidiaries may be required to write down intangible assets, including goodwill, due to impairment, thus reducing operating profit.

Intangible assets include goodwill, trademarks and other intangibles. The determination of fair value involves considerable estimates and judgment. For goodwill, the determination of fair value of a reporting unit involves, among other things, RAI’s market capitalization, and application of the income approach, which includes developing forecasts of future cash flows and determining an appropriate discount rate. If goodwill impairment is implied, the fair values of individual assets and liabilities, including unrecorded intangibles, must be determined. During the annual testing in the fourth quarter of 2016, the estimated fair value of each of RAI’s reporting units was substantially in excess of its respective carrying value.

Trademarks and other intangible assets with indefinite lives also are tested for impairment annually, in the fourth quarter. At December 31, 2016, the aggregate fair value of RAI’s operating units’ trademarks and other intangible assets was substantially in excess of their aggregate carrying value. However, at December 31, 2016, the individual fair values of five trademarks were less than 15% in excess of their respective carrying values. The aggregate carrying value of these five trademarks was $27.3 billion at December 31, 2016.

The methodology used to determine the fair value of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate.

The carrying value of intangible assets is at risk of impairment if future projected revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate.

Goodwill, trademarks and other intangible assets are tested more frequently if events and circumstances indicate that the asset might be impaired. The carrying value of these intangible assets could be impaired if a significant adverse change in the use, life, or brand strategy of the asset is determined, or if a significant adverse change in the legal and regulatory environment, business or competitive climate occurs that would adversely impact the asset.

For additional information, see Item 8, note 5 to consolidated financial statements.

19


 

Increases in pension and postretirement expense that reduce profitability, or increases in pension and postretirement contributions that are required to be made, could have an adverse effect on the results of operations, cash flows and financial position of RAI.

RAI’s profitability is affected by the costs of pension and postretirement benefits available to employees, generally those hired prior to 2004. Adverse changes in investment returns earned on pension assets, discount rates and other assumptions used to calculate pension and postretirement obligations, which in most cases are beyond RAI’s control, may have an unfavorable impact on pension and postretirement expense. In addition, changes to pension legislation or changes in pension accounting may adversely affect pension and postretirement expense. As such, there can be no assurance that pension and postretirement expense will not increase in the future, and such increases may have an adverse effect on the results of operations and financial position of RAI.

In 2016, RAI contributed $335 million to its pension plans and $66 million to its postretirement plans. During 2017, RAI expects to contribute $111 million to its pension plans and $78 million to its postretirement plans. RAI may be required to make additional contributions beyond what is currently contemplated to fund its pension and postretirement benefit plans, and those contributions could have an adverse effect on the cash flows and financial position of RAI.

For additional information, see Item 8, note 16 to consolidated financial statements.

Certain of RAI’s operating subsidiaries face a customer concentration risk. The loss of such a customer would result in a decline in revenue and could have an adverse effect on the results of operations, cash flows and financial position of RAI.

Revenues from two distributors, McLane and Core-Mark, constituted approximately 28% and 14%, respectively, of RAI’s consolidated revenue in 2016. The loss of these customers, or a significant decline in their purchases, could have an adverse effect on the results of operations, cash flows and financial position of RAI.

Disruptions in information technology systems, including a security breach, or, more generally, the inability to effectively use digital technologies could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

RAI and its subsidiaries are dependent on information technology systems to operate and manage all aspects of their businesses, including, without limitation, to comply with regulatory, legal, financial reporting and tax requirements, and to collect and store confidential information. Such confidential information may include proprietary business information, and what is often referred to as “personally identifiable information,” or certain information about individuals (such as employees and, in the case of RAI’s subsidiaries, consumers). The use and handling of personally identifiable information is subject to developing regulations, which vary from jurisdiction to jurisdiction, and the cost of regulatory compliance may be significant.

RAI and its subsidiaries also rely on third party vendors to operate their information technology and to perform certain services for the companies. Certain of these vendors store, process or otherwise handle confidential information, including personally identifiable information. RAI’s and its subsidiaries’ information technology systems, and the systems of their vendors, may not function as intended, and may be vulnerable to damage, interruption, or shutdown from a variety of events, such as computer system and telecommunications failures, computer viruses, user errors and catastrophic events.

Cybersecurity threats, which are constantly evolving and becoming more prevalent, also pose a risk to the security and viability of RAI’s and its subsidiaries’ information technology systems, and the systems of their vendors. Security breaches could be committed by third parties intending to access, misappropriate or corrupt confidential information and personally identifiable information, or otherwise to disrupt the business of RAI and its subsidiaries. The techniques used in cybersecurity attacks change frequently, potentially delaying the detection of such an attack. Despite RAI’s investments to address cybersecurity threats, it may be difficult for RAI to anticipate and implement adequate preventative measures. Any interruptions, failures or breaches of RAI’s and its subsidiaries’ information technology systems, or the systems of their vendors, could result in: the loss of revenue and customers; transaction errors and processing inefficiencies; the loss or unauthorized disclosure of, or damage to, confidential and personally identifiable information and/or other assets; damage to the reputation of RAI and its subsidiaries and to the brands of those subsidiaries; litigation and regulatory enforcement actions; and increased costs. Any of these events could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

Competition in the tobacco industry is based, in part, on the effective use of digital technologies. In particular, the failure to (1) take advantage of opportunities, and respond to challenges, arising from the increasing digital influence on consumer purchasing decisions, (2) fully maximize evolving technology so as to (i) automate, or otherwise enhance the efficiencies of, business processes, (ii) support and accelerate product innovation and (iii) simplify regulatory compliance, and (3) adopt and implement effective e-

20


 

commerce strategies for the promotion of e-cigarettes and other vapor products, could lead to a competitive disadvantage, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

Difficulties attracting and retaining qualified employees, officers, and professionals due to the impact of health and social issues associated with the tobacco industry could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

Recruiting and retaining qualified employees, officers and professionals may be difficult given the health and social issues associated with the tobacco industry. If RAI and its subsidiaries are unable to recruit, retain and motivate key personnel to maintain the current businesses of these companies and support development of new products, it could have an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries.

RAI is obligated to indemnify ITG for specified matters and to retain certain liabilities related to the divested brands and other assets.

Under the asset purchase agreement related to the Divestiture, RAI will indemnify ITG against losses arising from, among other things, breaches of representations and warranties, breaches of covenants, assets excluded from the transaction, excluded liabilities, certain specific tobacco liabilities, certain assumed plaintiff fees, certain employment related obligations, and liabilities in connection with certain tobacco litigation, settlement and regulatory matters. The asset purchase agreement related to the Divestiture does not cap RAI’s indemnification obligations, except with respect to any indemnification arising from breaches of certain representations and warranties or pre-closing covenants. Accordingly, these indemnification obligations could be substantial and could have an adverse effect on RAI’s results of operations, cash flows and financial position.

SFNTC is obligated to indemnify JTI Holding for certain liabilities relating to specified pre-sale statements made by the disposed-of entities relating to NATURAL AMERICAN SPIRIT brand cigarettes consumed outside the United States.

Under the purchase agreement relating to the sale of the international rights to the NATURAL AMERICAN SPIRIT brand to JTI Holding, SFNTC and two other RAI subsidiaries will indemnify JTI Holding against liabilities resulting from breaches of representations, warranties, or covenants; certain pre-sale debts of the disposed-of entities; the operation of the NATURAL AMERICAN SPIRIT brand business in the United States; and liabilities arising from either personal injury actions commenced on or before January 13, 2019, or other actions commenced on or before January 13, 2021, where such actions are based on pre-sale statements by the disposed-of entities that NATURAL AMERICAN SPIRIT brand cigarettes intended to be consumed outside the United States were natural, organic, or additive free. Such purchase agreement does not cap these indemnification obligations, except with respect to breaches of representations or warranties. Accordingly, these indemnification obligations could be substantial and could have an adverse effect on RAI’s and SFNTC’s results of operations, cash flows and financial position.

The ability of RAI to access the debt capital markets could be impaired if the credit ratings of its debt securities fall. Borrowing costs under RAI’s revolving credit facility could increase as the credit ratings of RAI’s long-term debt falls.

RAI’s credit ratings impact the cost and availability of future borrowings and, accordingly, RAI’s cost of capital. As of December 31, 2016, the outstanding notes issued by RAI were rated investment grade. During 2016, Standard & Poor’s Ratings Services upgraded all of its BBB- ratings on RAI one notch, to BBB, Moody’s Investor Service reaffirmed RAI’s Baa3 senior unsecured debt rating and Fitch Ratings assigned a Long-Term Issuer Default Rating on RAI of BBB. If RAI’s credit ratings were to fall, RAI may not be able to sell additional debt securities or borrow money in such amounts, at the times, at the lower interest rates or upon the more favorable terms and conditions that might be available if its debt maintained its current or higher ratings. In addition, future debt security issuances or other borrowings may be subject to further negative terms, including provisions for collateral or limitations on indebtedness or more restrictive covenants, if RAI’s credit ratings decline.

RAI’s credit ratings are influenced by some important factors not entirely within the control of RAI or its affiliates, such as tobacco litigation, the regulatory environment and the performance of suppliers to RAI’s operating subsidiaries. Moreover, because the kinds of events and contingencies that may impair RAI’s credit ratings and the ability of RAI and its affiliates to access the debt capital markets are often the same kinds of events and contingencies that could cause RAI and its affiliates to seek to raise additional capital on an urgent basis, RAI and its affiliates may not be able to issue debt securities or borrow money with acceptable terms, or at all, at the times at which they may most need additional capital.

In addition, the interest rate RAI pays on borrowings under its revolving credit facility is equal to an underlying interest rate plus an applicable margin, which margin is based on the ratings of RAI’s senior, unsecured, long-term indebtedness. If these ratings decline, the applicable margin RAI is required to pay would increase. RAI pays a fee on commitments under its revolving credit facility based on the ratings of RAI’s senior, unsecured, long-term indebtedness. As a result, although the revolving credit facility

21


 

provides RAI with a source of liquidity, the cost of borrowing under, and of maintaining, that facility could be at a higher rate at a time when RAI most needs to utilize that facility.

For more complete information on RAI’s credit agreement and long-term debt, see Item 8, notes 11 and 12 to consolidated financial statements.

An adverse effect on the results of operations, cash flows and financial position of RAI or its operating subsidiaries could cause RAI’s Board to depart from or change its historical dividend policy.

RAI’s Board could, at its discretion, depart from or change its dividend policy at any time. RAI is not required to pay dividends and its shareholders do not have contractual or other legal rights to receive them. RAI’s ability to pay dividends is dependent on its earnings, capital requirements, financial condition, expected cash needs, debt covenant compliance and other factors considered relevant by RAI’s Board. To the extent that RAI or its operating subsidiaries experience an adverse effect on their results of operations, cash flows or financial position or such other relevant factors, as noted above, RAI’s Board may decide, at its discretion, to decrease the amount of dividends, change or revoke the dividend policy or discontinue paying dividends entirely. In addition, if RAI does not pay or reduces its historical dividend rate, the market price of its common stock could decline.

There are a variety of risks, contingencies and other uncertainties associated with the BAT Merger that could result in the failure of the BAT Merger to be completed or, if completed, to have an adverse effect on the results of operations, cash flows and financial position of RAI or the combined company, respectively, or on shareholders generally.

RAI’s ability to complete the BAT Merger is subject to risks and uncertainties, including, but not limited to, failure to satisfy required closing conditions to the BAT Merger, including the failure to obtain necessary shareholder, regulatory or other approvals, or complete the BAT Merger in a timely manner or at all; if necessary approvals are obtained, the possibility of being subjected to conditions that could reduce the expected synergies and other benefits of the BAT Merger, result in a material delay in, or the abandonment of, the BAT Merger or otherwise have an adverse effect on RAI or the combined company; and the occurrence of any event, change or other circumstances that could give rise to the right of a party to terminate the Merger Agreement, including such a circumstance where RAI would be required to pay BAT a termination fee of $1 billion. As a result, one or more conditions to closing of the BAT Merger may not be satisfied and the BAT Merger may not be completed. Any delay in completing the BAT Merger may adversely affect the synergies and other benefits that RAI and BAT expect to achieve assuming the BAT Merger and the integration of the companies’ respective businesses are completed within the expected timeframe.

During the pendency of the BAT Merger, RAI and its subsidiaries will be subject to business uncertainties, certain operating restrictions and merger-related costs. Further, the Merger Agreement contains restrictions on RAI’s ability to pursue other alternatives to the BAT Merger. The ability of RAI or its subsidiaries to retain customers, retain and hire key personnel and maintain relationships with suppliers may be subject to disruption due to uncertainty associated with the BAT Merger, which could have an adverse effect on the results of operations, cash flows and financial position of RAI and its operating subsidiaries. RAI’s management may be distracted from ongoing business operations due to the BAT Merger. Further, RAI’s directors and executive officers have interests in the BAT Merger that are different from, or in addition to, the interests of RAI shareholders generally. These interests may cause RAI’s directors and executive officers to view the BAT Merger differently and more favorably than RAI shareholders may view it.

Even if the BAT Merger is completed, there can be no assurance that the expected benefits of the merger will occur or be fully or timely realized. Further, there can be no assurance of the value of the merger consideration that RAI shareholders will receive; the BAT ADS exchange ratio for the non-cash portion of the merger consideration is fixed and will not be adjusted in the event of any change in either RAI’s or BAT’s stock price. Following the completion of the BAT Merger, RAI’s former shareholders will be subject to different rights as BAT shareholders. If the combined company is not able to successfully combine the businesses of RAI and BAT in an efficient and effective manner, the anticipated benefits and cost savings may not be realized fully, or at all, or may take longer to realize than expected, and the value of common stock of the combined company may be affected adversely.  The value to former RAI shareholders of such common stock may be further adversely affected post-closing, as former RAI shareholders will be subject to exchange rate risk with respect to BAT ADSs, a risk not associated with RAI common stock prior to the BAT Merger. An inability to realize the full extent of the anticipated benefits of the BAT Merger, as well as any delays encountered in the integration process, could have an adverse effect upon the results of operations, cash flows and financial position of the combined company, which may adversely affect the value of its common stock following the BAT Merger. In addition, the actual integration may result in additional and unforeseen expenses, and the anticipated benefits of the integration plan may not be realized. Actual growth and cost savings, if achieved, may be lower than what the combined company expects and may take longer to achieve than anticipated. If the combined company is not able to adequately address integration challenges, the combined company may be unable to integrate successfully BAT’s and RAI’s operations or to realize the anticipated benefits of the integration of the two companies.

22


 

During the pendency of the BAT Merger, or in the event the BAT Merger is not completed, BAT’s significant beneficial equity interest in RAI could be determinative in matters submitted to a vote by RAI shareholders, resulting in RAI taking actions that RAI’s other shareholders do not support. BAT and B&W also have influence over RAI by virtue of the Governance Agreement, which requires B&W’s approval before RAI takes certain actions.

BAT, through its subsidiaries, beneficially owns approximately 42% of the outstanding shares of RAI common stock. No other shareholder owns more than 10% of the outstanding shares of RAI common stock. Unless substantially all of RAI’s public shareholders vote together on matters presented to RAI shareholders, BAT, through its subsidiaries, would have the power to determine the outcome of matters submitted to a shareholder vote, subject to the Governance Agreement described below.

Moreover, in connection with the B&W business combination, RAI, B&W and BAT entered into an agreement, referred to as the Governance Agreement, relating to various aspects of RAI’s corporate governance. RAI is currently subject to, and throughout the pendency of the BAT Merger will be subject to, the provisions of the Governance Agreement. Under the Governance Agreement, the approval of B&W, as a RAI shareholder, is required in connection with, among other things, the following matters:

 

the sale or transfer of certain RAI intellectual property associated with B&W brands having an international presence, other than in connection with a sale of RAI; and

 

RAI’s adoption of any takeover defense measures that would apply to the acquisition of equity securities of RAI by BAT or its affiliates, other than a re-adoption of the RAI rights plan in the form permitted by the Governance Agreement.

Such influence could result in RAI taking actions that RAI’s other shareholders do not support. The Governance Agreement and amendments thereto are filed as Exhibits 10.9 to 10.12 to this Annual Report on Form 10-K.

Under the Governance Agreement, B&W is entitled to nominate individuals to RAI’s Board, and the approvals of the majority of those individuals is required before certain actions may be taken, even though those individuals represent less than a majority of the entire Board.

Under the Governance Agreement, B&W, based upon the current beneficial ownership of BAT through its subsidiaries, is entitled to nominate five directors to RAI’s Board, at least three of whom are required to be independent directors and two of whom may be executive officers of BAT or any of its subsidiaries. RAI’s Board currently is composed of 14 persons, including five designees of B&W, the maximum number of designees that B&W is entitled to nominate under the Governance Agreement. Matters requiring the approval of RAI’s Board generally require the affirmative vote of a majority of the directors present at a meeting. Under the Governance Agreement, however, the approval of a majority of B&W’s designees on RAI’s Board is required in connection with the following matters:

 

any issuance of RAI equity securities in excess of 5% of its outstanding voting stock, unless at such time BAT and its subsidiaries’ ownership interest in RAI is less than 32%; and

 

any repurchase of RAI common stock, subject to a number of exceptions, unless at such time BAT and its subsidiaries’ ownership interest in RAI is less than 25%.

As a result, B&W’s designees on RAI’s Board may prevent the foregoing transactions from being effected, notwithstanding a majority of the entire Board may have voted to approve such transactions. Though such transactions are nonetheless restricted by the provisions of the Merger Agreement, should the BAT Merger not be completed, the Governance Agreement restrictions will remain in place.

Under the RAI articles of incorporation, neither BAT nor any director of RAI who is affiliated with, or employed by, BAT is required to present a business opportunity to RAI if the business opportunity does not primarily relate to the United States. The loss of favorable business opportunities could have an adverse effect on the results of operations, cash flows and financial position of RAI.

Unless otherwise agreed by the parties, under the RAI articles of incorporation, neither BAT or any of its subsidiaries or affiliates nor any director of RAI who is affiliated with, or employed by, BAT or its subsidiaries and affiliates, including any B&W designated director, is required to present a transaction, relationship, arrangement or other opportunity, all of which are collectively referred to as a business opportunity to RAI, RAI’s Board or any RAI officer or employee if the business opportunity does not relate primarily to the United States. RAI has renounced any expectancy or interest in, or in being offered an opportunity to participate in, any such business opportunity, and BAT and its subsidiaries and affiliates are entitled to act upon any such business opportunity and will not be liable to RAI or any RAI shareholders for taking any such action or not presenting such business opportunity to RAI. As a result, RAI may not be presented with certain favorable business opportunities that are known to BAT or a BAT affiliated director of

23


 

RAI, and BAT may take advantage and receive the benefits of those business opportunities. Because of this provision, if the BAT Merger is not completed, the loss of favorable business opportunities could have an adverse effect on the results of operations, cash flows and financial position of RAI.

Under the Merger Agreement, RAI is restricted from pursuing alternative takeover proposals. If the BAT Merger is not completed, BAT’s significant beneficial ownership interest in RAI could deter future acquisition proposals and make it difficult for a third party to acquire control of RAI without the cooperation of BAT. This could have a negative effect on the price of RAI common stock.

Pursuant to the terms of the Merger Agreement, RAI is restricted from pursuing alternative takeover proposals to the BAT Merger. Should RAI pursue an alternative takeover proposal instead of the BAT Merger, in certain instances, RAI would be required to pay a termination fee to BAT of $1 billion. Further, if the BAT Merger is not completed, BAT, through its subsidiaries, could vote its shares of RAI common stock against any future takeover proposal submitted for shareholder approval or refuse to accept any tender offer for shares of RAI common stock. As a result, it would make it very difficult for a third party to acquire RAI without BAT consent. BAT’s beneficial ownership interest in RAI and these defenses could discourage potential acquisition proposals and could delay or prevent a change in control of RAI. These deterrents could adversely affect the price of RAI common stock and make it very difficult to remove or replace members of the board of directors or management of RAI without cooperation of BAT.

In the event that the BAT Merger is not completed, RAI shareholders may be adversely affected if all or part of the Governance Agreement were to be terminated because in some circumstances the board composition and share transfer restrictions on BAT and its subsidiaries would no longer apply. These developments could enable BAT and its subsidiaries to, among other things, acquire some or all of the shares of RAI common stock not held by BAT and its subsidiaries, seek additional representation on RAI’s Board, replace existing RAI directors, solicit proxies, otherwise influence or gain control of RAI or transfer all or a significant percentage of their shares of RAI common stock to a third party.

The Governance Agreement provides that it will terminate automatically in its entirety if BAT and its subsidiaries own either 100% or less than 15% or if any third party or group controls more than 50% of the voting power of all RAI shares. In addition, BAT and B&W may terminate the Governance Agreement in its entirety if B&W nominees proposed in accordance with the Governance Agreement are not elected to serve on RAI’s Board or its committees or if RAI has deprived B&W nominees of such representation for “fiduciary” reasons or has willfully deprived B&W or its board nominees of any veto rights.

BAT and B&W also may terminate the obligation to vote their shares of RAI common stock for Board-proposed director nominees, the restriction on Board representation in excess of proportionate representation and the RAI share transfer restrictions of the Governance Agreement if RAI willfully and deliberately breaches the provisions regarding B&W’s Board and Board committee representation.

In the event that the BAT Merger is not completed and the share transfer restrictions in the Governance Agreement are terminated, there will be no contractual restrictions on the ability of BAT and its subsidiaries to sell or transfer their shares of RAI common stock on the open market, in privately negotiated transactions or otherwise. These sales or transfers could create a substantial decline in the price of shares of RAI common stock or, if these sales or transfers were made to a single buyer or group of buyers that own shares of RAI common stock, could result in a third party acquiring control of or influence over RAI.

The bylaws of RAI designate the state courts of North Carolina or the U.S. District Court for the Middle District of North Carolina as the sole and exclusive forum for certain legal actions, which could limit the ability of RAI shareholders to obtain a favorable judicial forum for disputes with RAI.

RAI’s bylaws provide that, unless RAI consents in writing to the selection of an alternative forum, the state courts of North Carolina or the U.S. District Court for the Middle District of North Carolina will be the sole and exclusive forum for:

 

any derivative action or proceeding brought on behalf of RAI;

 

any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of RAI to RAI or its shareholders;

 

any action asserting a claim arising pursuant to any provision of the North Carolina Business Corporation Act, the bylaws or the articles of incorporation of RAI (as each may be amended from time to time); or

 

any action asserting a claim governed by the internal affairs doctrine.

24


 

Any person or entity purchasing or otherwise acquiring any interest in shares of RAI’s capital stock may be deemed to have notice of and to have consented to the provisions described above. This forum selection provision may limit RAI shareholders’ ability to obtain a judicial forum that they find favorable for certain disputes with RAI or its directors, officers or other employees or shareholders.

 

 

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The executive offices of RAI and its material subsidiaries, other than SFNTC, are located in Winston-Salem, North Carolina. RJR Tobacco’s manufacturing facilities are located in the Winston-Salem, North Carolina area, and American Snuff Co.’s manufacturing facilities are located in Memphis, Tennessee; Clarksville, Tennessee; and Winston-Salem, North Carolina. SFNTC’s manufacturing facility is located in Oxford, North Carolina, and its executive offices are located in Santa Fe, New Mexico. All of RAI’s material operating subsidiaries’ executive offices and manufacturing facilities are owned.

Item 3. Legal Proceedings

See Item 8, note 13 to consolidated financial statements for disclosure of legal proceedings involving RAI and its operating subsidiaries.

Item 4. Mine Safety Disclosures

Not applicable.

 

 

25


 

PART  II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

RAI common stock, par value $.0001 per share, is listed on the NYSE under the trading symbol “RAI.” On January 23, 2017, there were approximately 11,830 holders of record of RAI common stock. Shareholders whose shares are held of record by a broker or clearing agency are not included in this amount; however, each of those brokers or clearing agencies is included as one holder of record. The closing price of RAI common stock on January 23, 2017, was $58.88 per share.

The cash dividends declared, and high and low sales prices per share for RAI common stock on the NYSE Composite Tape, as reported by the NYSE, were as follows:

 

 

 

Price Per Share

 

 

Cash

Dividends

Declared Per

 

 

 

High

 

 

Low

 

 

Share

 

2016:

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

52.54

 

 

$

44.58

 

 

$

0.42

 

Second Quarter

 

 

53.99

 

 

 

46.85

 

 

 

0.42

 

Third Quarter

 

 

54.48

 

 

 

46.69

 

 

 

0.46

 

Fourth Quarter

 

 

56.65

 

 

 

43.38

 

 

 

0.46

 

2015:

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

38.12

 

 

$

31.35

 

 

$

0.335

 

Second Quarter

 

 

38.98

 

 

 

34.33

 

 

 

0.335

 

Third Quarter

 

 

44.44

 

 

 

35.70

 

 

 

0.360

 

Fourth Quarter

 

 

49.56

 

 

 

43.02

 

 

 

0.360

 

 

On February 8, 2017, the board of directors of RAI declared a quarterly cash dividend of $0.51 per common share. The dividends will be paid on April 3, 2017, to shareholders of record as of March 10, 2017.

On July 25, 2016, the board of directors of RAI authorized the repurchase, from time to time, on or before December 31, 2018, of up to $2 billion of outstanding shares of RAI common stock in open-market or privately negotiated transactions, referred to as the Share Repurchase Program. The purchases are subject to prevailing market and business conditions, and the program may be terminated or suspended at any time. In connection with the Share Repurchase Program, B&W and Louisville Securities Limited, referred to as LSL, wholly owned subsidiaries of BAT, entered into an agreement, referred to as the Share Repurchase Agreement, with RAI, pursuant to which BAT and its subsidiaries will participate in the Share Repurchase Program on a basis approximately proportionate with BAT and its subsidiaries’ beneficial ownership of RAI’s common stock. During 2016, RAI repurchased 1,565,698 shares of RAI common stock for $75 million in accordance with the Share Repurchase Program. The Merger Agreement places restrictions on RAI’s ability to repurchase its common stock. As a result, RAI does not expect to make repurchases under the Share Repurchase Program while the Merger Agreement is in effect.

RAI, B&W and BAT entered into Amendment No. 3, dated November 11, 2011, to the Governance Agreement, pursuant to which RAI has agreed that, so long as the beneficial ownership interest of BAT and its subsidiaries in RAI has not dropped below 25%, if RAI issues shares of its common stock or any other RAI equity security to certain designated persons, including its directors, officers or employees, then RAI will repurchase a number of shares of outstanding RAI common stock so that the number of outstanding shares of RAI common stock are not increased, and the beneficial ownership interest of BAT and its subsidiaries in RAI is not decreased, by such issuance after taking into account such repurchase. During 2016, in accordance with the Governance Agreement, at a cost of $93 million, RAI repurchased 1,817,846 shares of RAI common stock in open-market transactions.

During 2016, RAI repurchased 1,146,978 shares of RAI common stock at a cost of $58 million that were forfeited and cancelled with respect to tax liabilities associated with vesting of restricted stock units granted under the Reynolds American Inc. 2009 Omnibus Incentive Compensation Plan, referred to as the Omnibus Plan. The Amended and Restated Omnibus Plan was approved by shareholders in 2014.

Due to RAI’s incorporation in North Carolina, which does not recognize treasury shares, the shares repurchased were cancelled at the time of repurchase.

26


 

The following table summarizes RAI’s purchases of its common stock during the fourth quarter of 2016:

 

 

 

Total

Number of

Shares

Purchased (1)

 

 

Average

Price Paid

per Share

 

 

Total Number of

Shares Purchased

as Part of Publicly

Announced Plans

or Programs (2)

 

 

Approximate

Dollar Value of Shares that May

Yet be Purchased Under the Plans

or Programs (2)

 

October 1, 2016 to October 31, 2016

 

 

19,814

 

 

$

47.15

 

 

 

 

 

$

1,925

 

November 1, 2016 to November 30, 2016

 

 

 

 

 

 

 

 

 

 

 

1,925

 

December 1, 2016 to December 31, 2016

 

 

8,655

 

 

 

55.65

 

 

 

 

 

 

1,925

 

Total

 

 

28,469

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

During the fourth quarter of 2016, RAI repurchased and cancelled the following shares of its common stock with respect to the tax liability associated with the vesting of restricted stock grants under the Omnibus Plan. For equity-based benefit plan information, see Item 8, note 15 to consolidated financial statements.

( 2 )

During the fourth quarter of 2016, RAI did not repurchase any shares of its common stock under the Share Repurchase Program. For additional information, see Item 8, note 14 to consolidated financial statements.

Performance Graph

Set forth below is a line graph comparing, for the period which commenced on December 31, 2011, and ended on December 31, 2016, the cumulative shareholder return of $100 invested in RAI common stock with the cumulative return of $100 invested in the Standard & Poor’s 500 Index and the Standard & Poor’s Tobacco Index.

 

 

 

 

12/31/11

 

 

12/31/12

 

 

12/31/13

 

 

12/31/14

 

 

12/31/15

 

 

12/31/16

 

Reynolds American Inc .(1)

 

$

100.00

 

 

$

105.59

 

 

$

134.29

 

 

$

180.68

 

 

$

268.79

 

 

$

337.67

 

S&P 500

 

 

100.00

 

 

 

116.00

 

 

 

153.58

 

 

 

174.60

 

 

 

177.01

 

 

 

198.18

 

S&P Tobacco (2)

 

 

100.00

 

 

 

110.42

 

 

 

129.15

 

 

 

146.98

 

 

 

179.12

 

 

 

206.98

 

 

(1)

Assumes that $100 was invested in RAI common stock and indexes on December 31, 2011, and that in each case all dividends were reinvested.

(2)

The S&P Tobacco Index includes as of December 31, 2016, the following companies: Altria Group, Inc., Philip Morris International Inc. and Reynolds American Inc.

 

 

27


 

Item 6. Selected Financial Data

The selected historical consolidated financial data as of December 31, 2016 and 2015, and for each of the years in the three-year period ended December 31, 2016, are derived from the consolidated financial statements and accompanying notes, which have been audited by RAI’s independent registered public accounting firm. The selected historical consolidated financial data as of December 31, 2014, 2013 and 2012, and for the years ended December 31, 2013 and 2012, are derived from audited consolidated financial statements not presented or incorporated by reference. For further information, you should read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and the consolidated financial statements in Item 8.

 

 

 

For the Years Ended December 31,

 

 

 

2016 (7)

 

 

2015 (8)

 

 

2014

 

 

2013

 

 

2012

 

 

 

(Dollars in Millions, Except Per Share Amounts)

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales (1)

 

$

12,503

 

 

$

10,675

 

 

$

8,471

 

 

$

8,236

 

 

$

8,304

 

Income from continuing operations (1)(2)(3)(4)(5)(6)

 

 

6,073

 

 

 

3,253

 

 

 

1,445

 

 

 

1,718

 

 

 

1,272

 

Income from discontinued operations

 

 

 

 

 

 

 

 

25

 

 

 

 

 

 

 

Net income

 

 

6,073

 

 

 

3,253

 

 

 

1,470

 

 

 

1,718

 

 

 

1,272

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic income from continuing operations

 

 

4.26

 

 

 

2.57

 

 

 

1.36

 

 

 

1.58

 

 

 

1.12

 

Diluted income from continuing operations

 

 

4.25

 

 

 

2.57

 

 

 

1.35

 

 

 

1.57

 

 

 

1.12

 

Basic income from discontinued operations

 

 

 

 

 

 

 

 

0.02

 

 

 

 

 

 

 

Diluted income from discontinued operations

 

 

 

 

 

 

 

 

0.02

 

 

 

 

 

 

 

Basic net income

 

 

4.26

 

 

 

2.57

 

 

 

1.38

 

 

 

1.58

 

 

 

1.12

 

Diluted net income

 

 

4.25

 

 

 

2.57

 

 

 

1.37

 

 

 

1.57

 

 

 

1.12

 

Basic weighted average shares, in thousands

 

 

1,426,987

 

 

 

1,264,182

 

 

 

1,066,320

 

 

 

1,089,849

 

 

 

1,131,139

 

Diluted weighted average shares, in thousands

 

 

1,429,933

 

 

 

1,267,715

 

 

 

1,069,940

 

 

 

1,093,899

 

 

 

1,135,746

 

Cash dividends declared per share of common stock

 

$

1.760

 

 

$

1.390

 

 

$

1.340

 

 

$

1.240

 

 

$

1.165

 

Balance Sheet Data (at end of periods):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets (9)

 

 

51,095

 

 

 

52,100

 

 

 

14,781

 

 

 

14,790

 

 

 

16,063

 

Long-term debt (less current maturities) (10)

 

 

12,664

 

 

 

16,849

 

 

 

4,602

 

 

 

5,065

 

 

 

5,003

 

Shareholders’ equity

 

 

21,711

 

 

 

18,252

 

 

 

4,522

 

 

 

5,167

 

 

 

5,257

 

Cash Flow Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash from operating activities

 

 

1,280

 

 

 

196

 

 

 

1,623

 

 

 

1,308

 

 

 

1,568

 

Net cash from (used in) investing activities

 

 

5,078

 

 

 

(10,005

)

 

 

(205

)

 

 

(113

)

 

 

(54

)

Net cash from (used in) financing activities

 

 

(6,866

)

 

 

11,438

 

 

 

(1,918

)

 

 

(2,207

)

 

 

(971

)

Net cash related to discontinued operations, net of tax

   benefit

 

 

 

 

 

 

 

 

25

 

 

 

 

 

 

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of earnings to fixed charges (11)

 

 

16.3

 

 

 

12.0

 

 

 

8.7

 

 

 

11.3

 

 

 

9.1

 

 

(1)

Net sales and cost of products sold exclude excise taxes of $4,343 million, $4,209 million, $3,625 million, $3,730 million and $3,923 million for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively.

(2)

Includes restructuring and/or asset impairment charges of $99 million and $149 million for the years ended December 31, 2015 and 2012, respectively.

(3)

Includes trademark, goodwill and/or other intangible asset impairment charges of $32 million and $129 million for the years ended December 31, 2013 and 2012, respectively.

(4)

Includes NPM Adjustment credits of $390 million, $297 million, $345 million and $483 million for the years ended December 31, 2016, 2015, 2014 and 2013, respectively.

(5)

Includes a mark-to-market adjustment of $45 million, $246 million, $452 million and $329 million for the years ended December 31, 2016, 2015, 2014 and 2012, respectively.

(6)

Includes gain on divestitures of $4,861 million and $3,181 million for the years ended December 31, 2016 and 2015, respectively.

(7)

Reflects impact of the sale of the international rights to the NATURAL AMERICAN SPIRIT brand. See Item 8, note 3 to consolidated financial statements.

(8)

Reflects impact of the Lorillard Merger and Divestiture. See Item 8, note 2 to consolidated financial statements.

(9)

Includes a reclassification due to the adoption of Accounting Standards Updates 2015-17 and 2015-03 and was reduced by $968 million, $1.1 billion, $415 million, $612 million and $494 million for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively. See Item 8, note 1 to consolidated financial statements.

28


 

(10)

Includes a reclassification due to the adoption of Accounting Standards Update 2015-03 and was reduced by $68 million, $92 million, $31 million, $34 million and $32 million for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively.  See Item 8, note 1 to consolidated financial statements.

(11)

Earnings consist of income from continuing operations before equity earnings, income taxes and fixed charges. Fixed charges consist of interest on indebtedness, amortization of debt issuance costs and the interest portion of rental expense.

 

 

29


 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion and analysis of RAI’s business initiatives, critical accounting estimates and its consolidated results of operations and financial position. Following the overview and discussion of business initiatives, the critical accounting estimates disclose certain accounting estimates that are material to RAI’s results of operations and financial position for the periods presented in this report. The discussion and analysis of RAI’s results of operations is presented in two comparative sections, 2016 compared with 2015, and 2015 compared with 2014. The statements of financial position and results of operations contained in the consolidated financial statements reflect the results of the Lorillard Merger, Divestiture and related transactions. Disclosures related to liquidity and financial position as well as governmental activity complete management’s discussion and analysis. You should read this discussion and analysis of RAI’s consolidated financial position and results of operations in conjunction with the consolidated financial statements and the related notes in Item 8, as of December 31, 2016 and 2015, and for each of the years in the three-year period ended December 31, 2016.

Proposed Merger with BAT

On January 16, 2017, RAI, BAT, a subsidiary of BAT, and Merger Sub entered into the Merger Agreement, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will merge with and into RAI, with RAI surviving as a wholly owned subsidiary of BAT.

The BAT Merger has been approved by the independent directors of RAI who formed the Transaction Committee to negotiate with BAT, given BAT’s existing ownership stake in RAI and representation on RAI’s Board, and by the Boards of Directors of both companies.

At the effective time of the BAT Merger, each share of RAI common stock (other than any shares of RAI common stock owned by BAT or any of its subsidiaries and by shareholders of RAI who have properly asserted and not lost or effectively withdrawn appraisal rights) will be converted into the right to receive 0.5260 of a BAT ADS and $29.44 in cash, without interest, and subject to adjustment to prevent dilution.

The BAT Merger is subject to customary closing conditions, including RAI and BAT shareholder approvals, including the approval of the BAT Merger by a majority of the shares of RAI common stock not owned, directly or indirectly, by BAT or its subsidiaries or any of RAI’s subsidiaries, and regulatory approvals. The Merger Agreement contains certain other termination rights for each of RAI and BAT, including the right of each party to terminate the Merger Agreement if the BAT Merger has not been completed on or before December 31, 2017, subject to an extension of five business days if, on December 31, 2017, BAT has not completed all or any portion of the financing it needs to fund the BAT Merger and the transactions contemplated by the Merger Agreement. Financing, however, is not a condition to the closing of the BAT Merger. Under certain circumstances, if the Merger Agreement is terminated, the terminating party must pay the non-terminating party a termination fee of $1 billion. In the event that the Merger Agreement is terminated due to an inability to obtain unconditional approval under the HSR Act or any other antitrust laws, RAI will be entitled to receive a termination fee of $500 million from BAT. The BAT Merger is currently expected to close in the third quarter of 2017.

Each of RAI and BAT has made representations and warranties in the Merger Agreement. RAI and BAT each also have agreed to various covenants and agreements, including, among other things, to conduct their respective businesses in the ordinary course in all material respects during the period between the execution of the Merger Agreement and completion of the BAT Merger and not to engage in certain transactions during this period.

The foregoing description of the BAT Merger and the Merger Agreement is qualified in its entirety by reference to the Merger Agreement, a copy of which is attached as Exhibit 2.1 to RAI’s Current Report on Form 8-K filed with the SEC on January 17, 2017, which is incorporated by reference herein.

There are a number of risks and uncertainties associated with the BAT Merger. For more information, see Item 1A. Risk Factors and “— Cautionary Information Regarding Forward-Looking Statements” in this Item 7. In connection with the BAT Merger, BAT will file with the SEC a registration statement on Form F-4 that will include the proxy statement of RAI that also constitutes a prospectus of BAT. Shareholders are urged to read the proxy statement/prospectus on Form F-4 once it becomes available because it will contain important information about the BAT Merger, including relevant risk factors.

Overview and Business Initiatives

RAI’s reportable operating segments are RJR Tobacco, Santa Fe and American Snuff. The RJR Tobacco segment consists of the primary operations of R. J. Reynolds Tobacco Company. The Santa Fe segment consists of the primary operations of SFNTC. The

30


 

American Snuff segment consists of the primary operations of American Snuff Co. Included in All Other, among other RAI subsidiaries, are RJR Vapor, Niconovum USA, Inc., Niconovum AB, and until th eir sale on January 13, 2016, SFRTI and various foreign subsidiaries affiliated with SFRTI. The segments were identified based on how RAI’s chief operating decision maker allocates resources and assesses performance. Certain of RAI’s operating subsidiaries have entered into intercompany agreements for products or services with other subsidiaries. As a result, certain activities of an operating subsidiary may be included in a different segment of RAI.

On January 13, 2016, RAI, through the Sellers, completed the sale of the international rights to the NATURAL AMERICAN SPIRIT brand name and associated trademarks, along with SFRTI and other international companies that distributed and marketed the brand outside the United States, to JTI Holding, in an all-cash transaction of approximately $5 billion and recognized a pre-tax gain of approximately $4.9 billion. For additional information on the transaction, see Item 8, notes 3 and 13 to consolidated financial statements.

In June 2015, RAI completed the Lorillard Merger and Divestiture, which resulted in the acquisition of the premium cigarette brand, NEWPORT, which is the top selling menthol and second largest selling cigarette brand in the United States, and the divestiture of the WINSTON, KOOL and SALEM cigarette brands. The brands acquired and divested are included in the RJR Tobacco segment. For additional information on these transactions, see Item 8, notes 2 and 13 to consolidated financial statements.

RAI’s strategy continues to focus on transforming tobacco to deliver sustainable earnings growth, strong cash flow and enhanced long-term shareholder value. This transformation strategy includes growing the core cigarette and moist-snuff businesses, focusing on innovation and engaging with adult tobacco consumers, while maintaining efficient and effective operations.

To achieve its strategy, RAI encourages the migration of adult smokers to smoke-free tobacco products and other non-combustible nicotine-containing products, which it believes aligns consumer preferences for new alternatives to traditional tobacco products in view of societal pressure to reduce smoking. RAI’s operating companies facilitate this migration through innovation, including the development of digital vapor cigarettes, CAMEL Snus, heat-not-burn cigarettes and nicotine replacement therapy technologies. RAI remains committed to maintaining high standards of corporate governance and business conduct in a high-performing culture.

RAI’s largest reportable operating segment, RJR Tobacco, is the second largest tobacco company in the United States. RJR Tobacco’s brands include three of the top four best-selling cigarettes in the United States: NEWPORT, CAMEL and PALL MALL. These brands, and its other brands, including DORAL, MISTY and CAPRI, are manufactured in a variety of styles and marketed in the United States. As part of its total tobacco strategy, RJR Tobacco offers a smoke-free tobacco product, CAMEL Snus. RJR Tobacco manages contract manufacturing of cigarette and tobacco products through arrangements with BAT affiliates, and manages the export of tobacco products to U.S. territories, U.S. duty-free shops and U.S. overseas military bases. RJR Tobacco also manages the super-premium cigarette brands, DUNHILL and STATE EXPRESS 555, which are licensed from BAT.

Santa Fe manufactures and markets super-premium cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand in the United States.

American Snuff is the second largest smokeless tobacco products manufacturer in the United States. American Snuff’s primary brands include its largest selling moist snuff brands, GRIZZLY and KODIAK.

RJR Tobacco

RJR Tobacco primarily conducts business in the highly competitive U.S. cigarette market, which has a few large manufacturers and many smaller participants. The international rights to substantially all of RJR Tobacco’s brands were sold in 1999 to JTI, and no international rights were acquired in connection with the B&W business combination in 2004 or the Lorillard Merger in 2015. The U.S. cigarette market is a mature market in which overall adult consumer demand has declined since 1981, and is expected to continue to decline. Profitability of the U.S. cigarette industry and RJR Tobacco continues to be adversely impacted by decreases in consumption, increases in state excise taxes and governmental regulations and restrictions, such as marketing limitations, product standards and ingredients legislation.

RJR Tobacco’s cigarette brand portfolio strategy is based upon two brand categories: drive and other. The drive brands consist of two premium brands, NEWPORT and CAMEL, and the largest traditional value brand, PALL MALL. These three brands are managed for long-term market share and profit growth, and receive the vast majority of RJR Tobacco’s equity support with an emphasis on the NEWPORT and CAMEL brands. The other brand category includes the premium brand, CAPRI, and the value brands, DORAL and MISTY, along with other smaller brands. All of the other brands receive limited marketing support and are managed to maximize profitability.

31


 

The key objectives of the portfolio strategy are designed to balance the long-term market share growth and profitability of the drive brands while managing the other brands for long-term sustainability and profitability. Consistent with that strategy, RJR Tobacco continues to evaluate some of its non-core cigarette styles for potential elimination.

RJR Tobacco’s portfolio also includes CAMEL Snus, a smoke-free, heat-treated tobacco product sold in individual pouches that provide convenient tobacco consumption.

Competition is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence as well as finding efficient and effective means of balancing market share and profit growth. Cigarette brands produced by the major manufacturers generally require competitive pricing, substantial marketing support, retail programs and other incentives to maintain or improve market position or to introduce a new brand or brand style. Competition among the major cigarette manufacturers continues to be highly competitive and includes product innovation and expansion into smoke-free tobacco categories.

RJR Tobacco is committed to building and maintaining a portfolio of profitable brands. RJR Tobacco’s marketing programs are designed to strengthen brand image, build brand awareness and loyalty, and switch adult smokers of competing brands to RJR Tobacco brands. In addition to building strong brand equity, RJR Tobacco’s marketing approach utilizes a retail pricing strategy, including discounting at retail, to defend certain brands’ shares of market against competitive pricing pressure. RJR Tobacco’s competitive pricing methods may include list price changes, discounting programs, such as retail and wholesale buydowns, periodic price reductions, off-invoice price reductions, dollar-off promotions and consumer coupons. Retail buydowns refer to payments made to the retailer to reduce the price that consumers pay at retail. Consumer coupons are distributed by a variety of methods.

Santa Fe

Santa Fe competes in the U.S. cigarette market with its Natural American Spirit brand, which is the fastest growing super-premium cigarette brand and is a top 10 best-selling cigarette brand. It is priced higher than most other competitive brands. Competition in the cigarette category is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence.

American Snuff

American Snuff offers adult tobacco consumers a range of differentiated smokeless tobacco products, primarily moist snuff, with its GRIZZLY and KODIAK brands. The moist snuff category is divided into premium, price-value and popular-price brands. The highly competitive moist snuff category has developed many of the characteristics of the larger, cigarette market, including multiple pricing tiers, focused marketing programs and significant product innovation.

In contrast to the declining U.S. cigarette market, U.S. moist snuff retail volumes grew approximately 3.6% in 2016. Profit margins on moist snuff products are generally higher than on cigarette products. Moist snuff’s growth is partially attributable to cigarette smokers switching from cigarettes to smokeless tobacco products or using both.

American Snuff faces significant competition in the smokeless tobacco category. Similar to the cigarette market, competition is based primarily on brand positioning and price, as well as product attributes and packaging, consumer loyalty, promotions, advertising and retail presence.

All Other

RJR Vapor is a marketer of VUSE Digital Vapor Cigarette products, which include VUSE Solo, VUSE Fob and VUSE Vibe. The national expansion of VUSE was completed in early 2015, and it is available in more than 110,000 retail outlets across the United States. VUSE is the top-selling vapor product in convenience/gas stores, and its innovative digital technology is designed to deliver a consistent flavor and vapor experience. In March 2016, RJR Vapor introduced its VUSE Fob power unit. This next-level VUSE Fob, which integrates Bluetooth® technology, offers an on-device display with information about battery and cartridge levels. When paired with the VUSE App, the device can be locked, preventing use by minors and others. VUSE Fob is available online to adult tobacco consumers. RJR Vapor began national distribution, in November 2016, of its VUSE Vibe high-volume cartridge and closed-tank system with a rechargeable battery. VUSE Vibe offers more liquid than previous VUSE products, as well as a stronger and longer-lasting battery.

Since the fourth quarter of 2015, all production of VUSE Solo cartridges is performed at RJR Tobacco’s manufacturing facility, pursuant to a services agreement between RJR Tobacco and RJR Vapor. For additional information, see Item 8, note 6 to consolidated financial statements.

32


 

Niconovum USA, Inc. is a marketer of a nicotine replacement therapy gum, Z ONNIC , which is available in about 35,000 retail outlets across the United States. Niconovum AB is a marketer of nicotine replacement therapy products in Sweden under the ZONNIC brand name.

Critical Accounting Estimates

Accounting principles generally accepted in the United States of America, referred to as GAAP, require estimates and assumptions to be made that affect the reported amounts in RAI’s consolidated financial statements and accompanying notes. Some of these estimates require difficult, subjective and/or complex judgments about matters that are inherently uncertain, and as a result, actual results could differ from those estimates. Due to the estimation processes involved, the following summarized accounting policies and their application are considered to be critical to understanding the business operations, financial position and results of operations of RAI and its subsidiaries. For information related to these and other significant accounting policies, see Item 8, note 1 to consolidated financial statements.

Litigation

RAI discloses information concerning litigation for which an unfavorable outcome is more than remote. RAI and its subsidiaries record their legal expenses and other litigation costs and related administrative costs as selling, general and administrative expenses as those costs are incurred. RAI and its subsidiaries will record any loss related to litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated on an individual case-by-case basis. When the reasonable estimate is a range, the recorded loss will be the best estimate within the range. If no amount in the range is a better estimate than any other amount, the minimum amount of the range will be recorded.

Reynolds Defendants have been named in a number of tobacco-related legal actions, proceedings or claims seeking damages in amounts ranging into the hundreds of millions or even billions of dollars. Unfavorable judgments have been returned in a number of tobacco-related cases and state enforcement actions. For further discussion of the litigation and legal proceedings pending against RAI or its affiliates or indemnitees, see Item 8, note 13 to consolidated financial statements.

State Settlement Agreements

RJR Tobacco (itself, and as successor by merger to Lorillard Tobacco) and SFNTC are participants in the MSA, and RJR Tobacco (itself, and as successor by merger to Lorillard Tobacco) is a participant in the other state settlement agreements. Their obligations and the related expense charges under these agreements are subject to adjustments based upon, among other things, the volume of cigarettes sold by the operating subsidiaries, their relative market share, their operating profits and inflation. Since relative market share is based on cigarette shipments, the best estimate of the allocation of charges to RJR Tobacco and SFNTC under these agreements is recorded in cost of products sold as the products are shipped. Adjustments to these estimates are recorded in the period that the change becomes probable and the amount can be reasonably estimated. American Snuff Co. is not a participant in the State Settlement Agreements. For additional information related to the State Settlement Agreements, see “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases — State Settlement Agreements” and “— State Settlement Agreements — Enforcement and Validity; Adjustments” in Item 8, note 13 to consolidated financial statements.

Pension and Postretirement Benefits

RAI sponsors a number of non-contributory defined benefit pension plans covering certain employees of RAI and its subsidiaries. RAI and a subsidiary provide health and life insurance benefits for certain retired employees, of RAI and its subsidiaries, and their dependents. These benefits are generally no longer provided to employees hired on or after January 1, 2004.

Because pension and postretirement obligations ultimately will be settled in future periods, the determination of annual benefit cost (income) and liabilities is subject to estimates and assumptions. RAI reviews these assumptions annually or coincidental with a major event based on historical experience and expected future trends and modifies them as needed. Demographic assumptions such as termination of employment, mortality and retirement date are reviewed periodically as expectations change.

Actuarial (gains) losses are changes in the amount of either the benefit obligation or the fair value of plan assets resulting from experience different from that assumed or from changes in assumptions. Actuarial (gains) losses are immediately recognized in the operating results in the year in which they occur, to the extent the net (gains) losses are in excess of 10% of the greater of the fair value of plan assets or benefit obligations, referred to as the corridor. Net (gains) losses outside the corridor are recognized annually as of December 31, or when a plan is remeasured during an interim period, and are recorded as a mark-to-market adjustment, referred to as an MTM adjustment. Additionally, for the purpose of calculating the expected return on plan assets, RAI uses the actual fair value of plan assets.

33


 

Prior service costs (credits) of pension benefits, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the average remaining service period for active employees, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees. Prior service costs (credits) of postretirement benefits, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the expected service period to full eligibility age for active employees, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees.

Assumed discount rate and asset return are the most critical assumptions, and their respective sensitivity to change can have a significant effect on the amounts reported for the benefit plans. A one-percentage point change in the assumed discount rate for the pension plans and postretirement plans would have had the following effects, excluding any potential MTM adjustments:

 

 

 

1-Percentage Point

Increase

 

 

1-Percentage Point

Decrease

 

 

 

Pension

Plans

 

 

Postretirement

Plans

 

 

Pension

Plans

 

 

Postretirement

Plans

 

Effect on 2016 net periodic benefit cost

 

$

23

 

 

$

5

 

 

$

(34

)

 

$

(7

)

Effect on December 31, 2016, projected benefit obligation

   and accumulated postretirement benefit obligation

 

 

(665

)

 

 

(103

)

 

 

812

 

 

 

123

 

 

A one-percentage point change in assumed asset return would have had the following effects:

 

 

 

1-Percentage Point

Increase

 

 

1-Percentage Point

Decrease

 

 

 

Pension

Plans

 

 

Postretirement

Plans

 

 

Pension

Plans

 

 

Postretirement

Plans

 

Effect on 2016 net periodic benefit cost

 

$

(55

)

 

$

(2

)

 

$

55

 

 

$

2

 

 

For additional information relating to pension and postretirement benefits, see Item 8, note 16 to consolidated financial statements.

Intangible Assets

Intangible assets include goodwill, trademarks and other intangible assets. The determination of fair value involves considerable estimates and judgment. Intangible assets with indefinite lives are tested annually for impairment in the fourth quarter or more frequently if events and circumstances indicate that an impairment may have occurred.

For goodwill, the determination of fair value of a reporting unit involves, among other things, RAI’s market capitalization, and application of the income approach, which includes developing forecasts of future cash flows and determining an appropriate discount rate. If goodwill impairment is implied, the fair values of individual assets and liabilities, including unrecorded intangibles, must be determined. RAI believes it has based its goodwill impairment testing on reasonable estimates and assumptions, and during the annual testing, the estimated fair value of each of RAI’s reporting units was substantially in excess of its respective carrying value.

The methodology used to determine the fair value of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate. The carrying value of intangible assets is at risk of impairment if future projected revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate. The aggregate fair value of RAI’s operating units’ trademarks and other intangible assets at December 31, 2016, was substantially in excess of their aggregate carrying value. However, at December 31, 2016, the individual fair values of five trademarks were less than 15% in excess of their respective carrying values. The aggregate carrying value of these five trademarks was $27.3 billion at December 31, 2016.

Goodwill, trademarks and other intangible assets are tested more frequently if events and circumstances indicate that the asset might be impaired. The carrying value of these intangible assets could be impaired if a significant adverse change in the use, life, or brand strategy of the asset is determined, or if a significant adverse change in the legal and regulatory environment, business or competitive climate occurs that would adversely impact the asset. For information related to intangible assets, see Item 8, note 5 to consolidated financial statements.

34


 

Fair Value Measurement

RAI determines fair value of assets and liabilities using a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price.

For information on assets and liabilities recorded at fair value, see Item 8, notes 4, 12 and 16 to consolidated financial statements.

Income Taxes

Tax law requires certain items to be excluded or included in taxable income at different times than is required for book reporting purposes. These differences may be permanent or temporary in nature.

RAI determines its annual effective income tax rate based on forecasted pre-tax book income and forecasted permanent book and tax differences. The rate is established at the beginning of the year and is evaluated on a quarterly basis. Any changes to the forecasted information may cause the effective rate to be adjusted. Additional tax, interest and penalties associated with uncertain tax positions are recognized in tax expense on a quarterly basis.

To the extent that any book and tax differences are temporary in nature, that is, the recognition and measurement of assets and liabilities under the tax law may differ from recognition and measurement under GAAP, a deferred tax asset or liability is recorded. To the extent that a deferred tax asset is recorded, management evaluates RAI’s ability to realize this asset. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the assets will not be realized.

The financial statements reflect management’s best estimate of RAI’s current and deferred tax liabilities and assets. Future events, including, but not limited to, additional resolutions with taxing authorities, could have an impact on RAI’s current estimate of tax liabilities, realization of tax assets and effective income tax rate. For additional information on income taxes, see Item 8, note 10 to consolidated financial statements.

Business Combination

RAI accounts for business combination transactions in accordance with the Financial Accounting Standards Board, referred to as FASB, Accounting Standards Codification 805, Business Combinations , referred to as ASC 805. RAI allocates the cost of an acquisition to the assets acquired and liabilities assumed based on their fair values as of the acquisition date. Any excess of the purchase price over the estimated fair value of net assets acquired is recorded as goodwill. Determining the fair value of these items requires management’s judgment and may require utilization of independent valuation experts to assist such valuations. These valuations involve the use of significant estimates and assumptions with respect to the timing and amounts of future cash flows, discount rates, market prices and asset lives, among other items. The judgments made in the determination of the estimated fair value of the assets acquired and the liabilities assumed as well as the estimated useful life of each asset and the duration of each liability can materially impact the financial statements in periods after the acquisition, such as depreciation, amortization, or in certain situations, impairment charges. For further information related to accounting for the Lorillard Merger and Divestiture, see Item 8, notes 1 and 2 to consolidated financial statements.

Recently Adopted and Issued Accounting Pronouncements

For information relating to recently adopted and issued accounting guidance, see Item 8, note 1 to consolidated financial statements.

 

 

35


 

Results of Operations

RJR Tobacco’s net sales and operating income include the WINSTON, KOOL and SALEM brands until the date of their sale on June 12, 2015, and the NEWPORT, KENT, OLD GOLD and TRUE brands after June 12, 2015. All Other net sales and operating income include SFRTI and the various foreign subsidiaries affiliated with SFRTI, until the date of their sale on January 13, 2016.

 

 

 

For the Twelve Months Ended December 31,

 

 

 

2016

 

 

2015

 

 

% Change

 

 

2014

 

 

% Change

 

Net sales: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RJR Tobacco

 

$

10,314

 

 

$

8,634

 

 

 

19.5

%

 

$

6,767

 

 

 

27.6

%

Santa Fe

 

 

973

 

 

 

818

 

 

 

18.9

%

 

 

658

 

 

 

24.3

%

American Snuff

 

 

914

 

 

 

855

 

 

 

6.9

%

 

 

783

 

 

 

9.2

%

All Other

 

 

302

 

 

 

368

 

 

 

(17.9

)%

 

 

263

 

 

 

39.9

%

Net sales

 

 

12,503

 

 

 

10,675

 

 

 

17.1

%

 

 

8,471

 

 

 

26.0

%

Cost of products sold (1)(2)

 

 

4,841

 

 

 

4,688

 

 

 

3.3

%

 

 

4,058

 

 

 

15.5

%

Selling, general and administrative expenses

 

 

1,931

 

 

 

2,098

 

 

 

(8.0

)%

 

 

1,871

 

 

 

12.1

%

Gain on divestitures

 

 

(4,861

)

 

 

(3,181

)

 

 

52.8

%

 

 

 

 

NM (3)

 

Amortization expense

 

 

23

 

 

 

18

 

 

 

27.8

%

 

 

11

 

 

 

63.6

%

Asset impairment and exit charges

 

 

 

 

 

99

 

 

NM (3)

 

 

 

 

 

NM (3)

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RJR Tobacco

 

 

4,922

 

 

 

3,359

 

 

 

46.5

%

 

 

2,173

 

 

 

54.6

%

Santa Fe

 

 

546

 

 

 

449

 

 

 

21.6

%

 

 

337

 

 

 

33.2

%

American Snuff

 

 

541

 

 

 

502

 

 

 

7.8

%

 

 

438

 

 

 

14.6

%

All Other

 

 

(145

)

 

 

(265

)

 

 

(45.3

)%

 

 

(234

)

 

 

13.2

%

Gain on divestitures

 

 

4,861

 

 

 

3,181

 

 

 

52.8

%

 

 

 

 

NM (3)

 

Corporate expense

 

 

(156

)

 

 

(273

)

 

 

(42.9

)%

 

 

(183

)

 

 

49.2

%

Operating income

 

$

10,569

 

 

$

6,953

 

 

 

52.0

%

 

$

2,531

 

 

NM (3)

 

 

(1)

Excludes excise taxes of:

 

 

 

2016

 

 

2015

 

 

2014

 

RJR Tobacco

 

$

3,997

 

 

$

3,590

 

 

$

3,068

 

Santa Fe

 

 

287

 

 

 

254

 

 

 

211

 

American Snuff

 

 

54

 

 

 

54

 

 

 

53

 

All Other

 

 

5

 

 

 

311

 

 

 

293

 

 

 

$

4,343

 

 

$

4,209

 

 

$

3,625

 

 

(2)

See below for further information related to State Settlement Agreements, FDA user fees and federal tobacco buyout included in cost of products sold.

(3)

Percentage change not meaningful.

In the following discussion, the amounts presented in the operating companies’ shipment volume and share tables are rounded on an individual basis and, accordingly, may not sum in the aggregate. Percentages are calculated on unrounded numbers.

 

 

36


 

2016 Compared with 2015

RJR Tobacco

Net Sales

Domestic cigarette shipment volume, in billions of units, for RJR Tobacco and the industry, was as follows:

 

 

 

For the Twelve Months Ended

December 31,

 

 

 

2016

 

 

2015

 

 

% Change

 

RJR Tobacco:

 

 

 

 

 

 

 

 

 

 

 

 

Drive brands:

 

 

 

 

 

 

 

 

 

 

 

 

NEWPORT

 

 

34.4

 

 

 

18.9

 

 

NM (2)

 

CAMEL

 

 

20.3

 

 

 

20.8

 

 

 

(2.2

)%

PALL MALL

 

 

18.9

 

 

 

19.9

 

 

 

(5.2

)%

Total RJR Tobacco drive brands

 

 

73.5

 

 

 

59.5

 

 

 

23.5

%

Other brands

 

 

5.9

 

 

 

11.8

 

 

 

(50.0

)%

Total RJR Tobacco domestic cigarette shipment volume

 

 

79.4

 

 

 

71.3

 

 

 

11.3

%

Total premium

 

 

56.5

 

 

 

47.0

 

 

 

20.1

%

Total value

 

 

23.0

 

 

 

24.3

 

 

 

(5.6

)%

Premium/total mix

 

 

71.1

%

 

 

65.9

%

 

 

 

 

Industry (1) :