XNYS:LO Lorillard Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2012

OR

 

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

For the Transition Period From                      to                     

Commission File Number: 001-34097

 

 

Lorillard, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   13-1911176
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

714 Green Valley Road, Greensboro, North Carolina 27408-7018

(Address of principal executive offices) (Zip Code)

(336) 335-7000

(Registrant’s telephone number, including area code)

NOT APPLICABLE

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark 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  x    No  ¨

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   x    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  x

 

Class

 

Outstanding at July 25, 2012

Common stock, $0.01 par value   130,614,265 shares

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page No.  

PART I. FINANCIAL INFORMATION

     1   

Item 1.

   Financial Statements      1   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      37   

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk      47   

Item 4.

   Controls and Procedures      47   
PART II. OTHER INFORMATION      48   

Item 1.

   Legal Proceedings      48   

Item 1A.

   Risk Factors      48   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      52   

Item 3.

   Defaults Upon Senior Securities      52   

Item 4.

   Mine Safety Disclosures      52   

Item 5.

   Other Information      52   

Item 6.

   Exhibits      53   

SIGNATURES

     S-1   


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

LORILLARD, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

 

(In millions, except share and per share data)    June 30,
2012
    December 31,
2011
 
     (Unaudited)        

Assets:

  

Cash and cash equivalents

   $ 946      $ 1,634   

Accounts receivable, less allowances of $2 and $2

     14        10   

Other receivables

     14        83   

Inventories

     365        277   

Deferred income taxes

     535        535   

Other current assets

     108        25   
  

 

 

   

 

 

 

Total current assets

     1,982        2,564   

Plant and equipment, net

     278        262   

Goodwill

     64        —     

Intangible assets

     58        —     

Deferred income taxes

     50        54   

Other assets

     144        128   
  

 

 

   

 

 

 

Total assets

   $ 2,576      $ 3,008   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Deficit:

    

Accounts and drafts payable

   $ 31      $ 32   

Accrued liabilities

     321        296   

Settlement costs

     747        1,151   

Income taxes

     2        6   
  

 

 

   

 

 

 

Total current liabilities

     1,101        1,485   

Long-term debt

     2,610        2,595   

Postretirement pension, medical and life insurance benefits

     375        388   

Other liabilities

     58        53   
  

 

 

   

 

 

 

Total liabilities

     4,144        4,521   
  

 

 

   

 

 

 

Commitments and Contingent Liabilities

    

Shareholders’ Deficit:

    

Preferred stock, $0.01 par value, authorized 10 million shares

     —          —     

Common stock:

    

Authorized — 600 million shares; par value $0.01 per share

    

Issued — 175 million and 175 million shares (outstanding 131 million and 132 million shares)

     2        2   

Additional paid-in capital

     288        266   

Retained earnings

     2,161        2,059   

Accumulated other comprehensive loss

     (219     (228

Treasury stock at cost, 44 million and 43 million shares

     (3,800     (3,612
  

 

 

   

 

 

 

Total shareholders’ deficit

     (1,568     (1,513
  

 

 

   

 

 

 

Total liabilities and shareholders’ deficit

   $ 2,576      $ 3,008   
  

 

 

   

 

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

LORILLARD, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(UNAUDITED)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
(In millions, except per share data)    2012     2011     2012     2011  

Net sales (including excise taxes of $526, $533, $993 and $1,012, respectively)

   $ 1,731      $ 1,692      $ 3,257      $ 3,227   

Cost of sales

     1,119        1,093        2,122        2,085   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     612        599        1,135        1,142   

Selling, general and administrative

     128        112        260        234   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     484        487        875        908   

Investment income

     —          1        2        2   

Interest expense

     (37     (28     (76     (56
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     447        460        801        854   

Income taxes

     163        169        294        315   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 284      $ 291      $ 507      $ 539   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 2.17      $ 2.05      $ 3.88      $ 3.75   

Diluted

   $ 2.17      $ 2.05      $ 3.87      $ 3.75   

Weighted average number of shares outstanding:

        

Basic

     130.18        141.79        130.34        143.28   

Diluted

     130.49        141.96        130.66        143.57   

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

LORILLARD, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
(In millions, except per share data)        2012              2011             2012              2011      

Net income

   $ 284       $ 291      $ 507       $ 539   

Other comprehensive income, net of tax:

          

Defined benefit retirement plan gains (loss), net of tax expense (benefit) of $3, $(3), $5, and $(2)

     5         (4     9         (3
  

 

 

    

 

 

   

 

 

    

 

 

 

Other comprehensive income

     5         (4     9         (3
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 289       $ 287      $ 516       $ 536   
  

 

 

    

 

 

   

 

 

    

 

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

LORILLARD, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS’ DEFICIT

(UNAUDITED)

 

(In millions, except per share data)    Common
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Treasury
Shares
    Total
Shareholders’
Deficit
 

Balance, January 1, 2011

   $ 2       $ 242       $ 1,666      $ (109   $ (2,026   $ (225

Net income

           539            539   

Other comprehensive loss, net of tax benefit of $(2)

             (3       (3

Dividends paid ($2.60 per share)

           (373         (373

Shares repurchased

               (783     (783

Share-based compensation

        14               14   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 2       $ 256       $ 1,832      $ (112   $ (2,809   $ (831
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 1, 2012

   $ 2       $ 266       $ 2,059      $ (228   $ (3,612   $ (1,513

Net income

           507            507   

Other comprehensive income, net of tax expense of $5

             9          9   

Dividends paid ($3.10 per share)

           (405         (405

Shares repurchased

               (188     (188

Share-based compensation

        22               22   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

   $ 2       $ 288       $ 2,161      $ (219   $ (3,800   $ (1,568
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

LORILLARD, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     Six Months Ended
June 30,
 
(In millions)    2012     2011  

Cash flows from operating activities:

    

Net income

   $ 507      $ 539   

Adjustments to reconcile net cash provided by operating activities:

    

Depreciation and amortization

     20        19   

Pension, health and life insurance contributions

     (20     (18

Pension, health and life insurance benefits expense

     22        15   

Deferred income taxes

     (1     (5

Share-based compensation

     9        7   

Excess tax benefits from share-based payment arrangements

     (8     (3

Changes in operating assets and liabilities, net of amounts from acquired business:

    

Accounts and other receivables

     3        (2

Inventories

     (73     (42

Accounts payable and accrued liabilities

     19        113   

Settlement costs

     (404     (326

Income taxes

     (19     (35

Other current assets

     9        —     

Other assets

     (1     1   
  

 

 

   

 

 

 

Net cash provided by operating activities

     63        263   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Business acquisition

     (135     —     

Additions to plant and equipment

     (36     (26
  

 

 

   

 

 

 

Net cash used in investing activities

     (171     (26
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Shares repurchased

     (188     (783

Dividends paid

     (405     (373

Proceeds from exercise of stock options

     5        7   

Excess tax benefits from share-based payment arrangements

     8        3   
  

 

 

   

 

 

 

Net cash used in financing activities

     (580     (1,146
  

 

 

   

 

 

 

Change in cash and cash equivalents

     (688     (909

Cash and cash equivalents, beginning of year

     1,634        2,063   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 946      $ 1,154   
  

 

 

   

 

 

 

Cash paid for income taxes

   $ 315      $ 352   

Cash paid for interest, net of cash received from interest rate swaps of $12 and $12

   $ 72      $ 54   

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

LORILLARD, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

Overview. Lorillard, Inc., through its subsidiaries, is engaged in the manufacture and sale of cigarettes. Its principal products are marketed under the brand names of Newport, Kent, True, Maverick and Old Gold with substantially all of its sales in the United States of America. Lorillard recently acquired blu ecigs, the leading electronic cigarette company in the U.S.

The consolidated condensed financial statements of Lorillard, Inc. (the “Company”), together with its subsidiaries (“Lorillard”), include the accounts of the Company and its subsidiaries after the elimination of intercompany accounts and transactions. The Company’s tobacco operations represent a single operating and reporting segment. Non-tobacco operations are not significant for any of the periods presented.

Basis of Presentation. The accompanying unaudited consolidated condensed financial statements reflect all adjustments necessary to present fairly the financial position as of June 30, 2012 and December 31, 2011 and the consolidated income, shareholders’ deficit and cash flows for the three and six months ended June 30, 2012 and 2011.

Results of operations for the three and six months for each of the years reported herein are not necessarily indicative of results of operations of the entire year.

These consolidated condensed financial statements should be read in conjunction with the Consolidated Financial Statements and related Notes to Consolidated Financial Statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on February 21, 2012.

Business Combinations. Lorillard utilizes the acquisition method in accounting for business combinations whereby the amount of purchase price that exceeds the fair value of the acquired assets and assumed liabilities is allocated to goodwill. Lorillard recognizes intangible assets apart from goodwill if they arise from contractual or other legal rights, or if they are capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. Assumptions and estimates are used in determining the fair value of assets acquired and liabilities assumed in a business combination. Valuation of intangible assets acquired requires that we use significant judgment in determining fair value, whether such intangibles are amortizable and, if the asset is amortizable, the period and the method by which the intangible asset will be amortized. Changes in the initial assumptions could lead to changes in amortization or impairment charges recorded in our consolidated financial statements. Additionally, estimates for the preliminary purchase allocation may change as subsequent information becomes available. In April 2012, Lorillard, Inc., through its wholly owned subsidiary, Lorillard Holdings Company, Inc., formerly known as LRDHC, Inc., and its subsidiaries acquired blu ecigs and other assets used in the manufacture, distribution, development, research, marketing, advertising, sale and service of electronic cigarettes. See Notes 2 and 6 to the Consolidated Condensed Financial Statements for additional disclosure about the acquisition and preliminary purchase price allocation.

Recently adopted accounting pronouncements. Lorillard adopted FASB ASU 2010-09 “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-09 amends Topic 855 for SEC filers to eliminate the disclosure of the date through which subsequent events have been reviewed. The effective date was February 24, 2010. ASU 2010-09 did not have a material impact on Lorillard’s financial position or results of operations.

Lorillard adopted FASB ASU 2010-06 “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 establishes additional disclosures related to fair value. Transfers in and out of Level 1 and Level 2 and the reasons for the transfers must be disclosed. Level 3 purchases, sales, issuances and settlements should be presented separately rather than net. In addition, the level of disaggregation and input and valuation techniques need to be disclosed. The effective dates are periods beginning after December 15, 2010 for the Level 3 purchases, sales, issuances and settlements disclosure, and periods beginning after December 15, 2009 for all other provisions. ASU 2010-06 did not have a material impact on Lorillard’s financial position or results of operations.

 

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In May 2011, the FASB issued ASU 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” ASU 2011-04 clarifies certain areas of the fair value guidance, including application of the highest and best use and valuation premise concepts, measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity, and quantitative information about unobservable inputs used in a Level 3 fair value measurement. Additionally, ASU 2011-04 contains guidance on measuring the fair value of instruments that are managed within a portfolio, application of premiums and discounts in a fair value measurement, and requires additional disclosures about fair value measurements. The amendments contained in ASU 2011-04 are to be applied prospectively, and ASU 2011-04 is effective for public companies for interim and annual periods beginning after December 15, 2011. ASU 2011-04 did not have a material impact on Lorillard’s financial position or results of operations.

In June 2011, the FASB issued ASU 2011-05 “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 requires presentation of comprehensive income in either a single statement of comprehensive income or two separate but consecutive statements. ASU 2011-05 does not change the definitions or the components of net income and other comprehensive income (OCI), when an item must be reclassified from OCI to net income, or the calculation or presentation of earnings per share. The entity still has the choice to either present OCI components before tax with one line amount for tax, or net of taxes. Disclosure of the tax impact for each OCI component is still required. ASU 2011-05 is effective for public companies for reporting periods beginning after December 15, 2011 and must be applied retrospectively. ASU 2011-05 did not have any impact on Lorillard’s financial position or results of operations, but resulted in the presentation of a separate statement of other comprehensive income.

In September 2011, the FASB issued ASU 2011-08 “Intangibles — Goodwill and Other (Topic 220): Testing Goodwill for Impairment.” ASU 2011-08 gives an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value in a reporting unit is less than its carrying amount. If an entity determines that it is not more likely than not, then performing a two-step impairment test of goodwill is not necessary. ASU 2011-08 is effective for public companies for reporting periods beginning after December 15, 2011. The adoption of ASU 2011-08 did not have a material impact on Lorillard’s financial position or results of operations, but may impact the manner in which Lorillard assesses goodwill for impairment.

 

2. Acquisition

On April 24, 2012, Lorillard, Inc., through its wholly owned subsidiary, Lorillard Holdings Company, Inc. (“LHCI”), and its subsidiaries acquired blu ecigs® and other assets used in the manufacture, distribution, development, research, marketing, advertising, sale and service of electronic cigarettes (the “Acquisition”) for $135 million in cash. The Acquisition was made pursuant to an asset purchase agreement (the “Agreement”) with BLEC, LLC, Intermark Brands, LLC and QSN Technologies, LLC (the “Sellers”). The Agreement contains customary representations, warranties, covenants and indemnities by the Sellers and LHCI. The Acquisition provides Lorillard with the blu ecigs brand and e-cigarette products in a rapidly growing category.

The financial statements of blu ecigs are included in our consolidated financial statements beginning as of April 24, 2012. Lorillard’s consolidated revenues include $8 million of sales of blu ecigs and Lorillard incurred $5 million of acquisition-related expenses during the second quarter of 2012. Operating income of blu ecigs in the second quarter of 2012 was immaterial.

 

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Lorillard is still in the process of valuing the assets acquired and the liabilities assumed in the Acquisition. The allocation of the purchase price is preliminary and subject to change. The preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition are summarized below (in millions):

 

Assets acquired:

  

Current assets:

  

Accounts receivable

   $ 2   

Inventories

     15   
  

 

 

 

Total current assets

     17   
  

 

 

 

Goodwill

     64   

Intangible assets

     58   
  

 

 

 

Total assets

   $ 139   
  

 

 

 

Liabilities assumed:

  

Current liabilities:

  

Accounts and drafts payable

     4   
  

 

 

 

Purchase price

   $ 135   
  

 

 

 

 

3. Inventories

Inventories are valued at the lower of cost, determined on a last-in, first-out (“LIFO”) basis, or market and consisted of the following:

 

     June 30,
2012
     December 31,
2011
 
     (In millions)  

Leaf tobacco

   $ 251       $ 230   

Manufactured stock

     109         43   

Material and supplies

     5         4   
  

 

 

    

 

 

 
   $ 365       $ 277   
  

 

 

    

 

 

 

If the average cost method of accounting was used, inventories would be greater by approximately $234 and $223 million at June 30, 2012 and December 31, 2011, respectively.

 

4. Other Current Assets

Other current assets were as follows:

 

     June 30,
2012
     December 31,
2011
 
     (In millions)  

Prepaid income taxes

   $ 92       $ —     

Restricted cash

     —           13   

Appeal bonds

     7         7   

Other current assets

     9         5   
  

 

 

    

 

 

 

Total

   $ 108       $ 25   
  

 

 

    

 

 

 

 

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5. Plant and Equipment, Net

Plant and equipment is stated at cost and consisted of the following:

 

     June 30,
2012
    December 31,
2011
 
     (In millions)  

Land

   $ 3      $ 3   

Buildings

     90        90   

Equipment

     626        597   
  

 

 

   

 

 

 

Total

     719        690   

Accumulated depreciation

     (441     (428
  

 

 

   

 

 

 

Plant and equipment, net

   $ 278      $ 262   
  

 

 

   

 

 

 

 

6. Intangible Assets and Goodwill

On April 24, 2012, Lorillard completed the Acquisition of the net assets of blu ecigs from BLEC, LLC, Intermark Brands, LLC and QSN Technologies, LLC. The preliminary purchase price allocation includes $64 million of goodwill and $58 million of intangible assets, which consisted primarily of trademarks.

Goodwill

Goodwill and the changes in goodwill during the period are as follows:

 

In millions    Total  

Balance, December 2011

   $ —     

Purchase of blu ecigs net assets

     64   
  

 

 

 

Balance, June 2012

   $ 64   
  

 

 

 

Intangible Assets

 

            June 2012  
Dollars in millions    Weighted
Average
Amortization
Period
     Cost      Accumulated
Amortization
     Net
Carrying
Amount
 

Amortizable intangible assets:

           

Non-compete Agreement and Technology

     5 years       $ 1       $ —         $ 1   
           

 

 

 

Amortizable intangible assets, net

              1   

Indefinite-lived intangible assets:

           

Trademarks and trade names

              57   
           

 

 

 

Intangible assets, net

            $ 58   
           

 

 

 

Intangible assets are amortized using the straight-line method.

 

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7. Other Assets

Other assets were as follows:

 

     June 30,
2012
     December 31,
2011
 
     (In millions)  

Debt issuance costs

   $ 22       $ 24   

Interest rate swap

     110         95   

Other prepaid assets

     12         9   
  

 

 

    

 

 

 

Total

   $ 144       $ 128   
  

 

 

    

 

 

 

 

8. Accrued Liabilities

Accrued liabilities were as follows:

 

     June 30,
2012
     December 31,
2011
 
     (In millions)  

Legal fees

   $ 39       $ 28   

Salaries and other compensation

     20         20   

Medical and other employee benefit plans

     27         31   

Consumer rebates

     71         60   

Sales promotion

     21         23   

Accrued vendor charges

     8         7   

Excise and other taxes

     76         52   

Accrued bond interest

     27         27   

Other accrued liabilities

     32         48   
  

 

 

    

 

 

 

Total

   $ 321       $ 296   
  

 

 

    

 

 

 

 

9. Fair Value

Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable:

 

   

Level 1 — Quoted prices for identical instruments in active markets.

 

   

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable directly or indirectly.

 

   

Level 3 — Valuations derived from valuation techniques in which one or more significant inputs are unobservable.

Lorillard is responsible for the valuation process and as part of this process may use data from outside sources in estimating fair value. Lorillard performs due diligence to understand the inputs used or how the data was calculated or derived, and corroborates the reasonableness of external inputs in the valuation process.

 

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Assets and liabilities measured at fair value on a recurring basis as of June 30, 2012, were as follows:

 

     Level 1      Level 2      Level 3      Total  
     (In millions)  

Cash and Cash Equivalents:

           

Prime money market funds

   $ 946       $ —         $ —         $ 946   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents

   $ 946       $ —         $ —         $ 946   
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative Asset:

           

Interest rate swaps — fixed to floating rate

   $ —         $ 110       $ —         $ 110   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total derivative asset

   $ —         $ 110       $ —         $ 110   
  

 

 

    

 

 

    

 

 

    

 

 

 

Assets and liabilities measured at fair value on a recurring basis at December 31, 2011 were as follows:

 

     Level 1      Level 2      Level 3      Total  
     (In millions)  

Cash and Cash Equivalents:

           

Prime money market funds

   $ 1,634       $ —         $ —         $ 1,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents

   $ 1,634       $ —         $ —         $ 1,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative Asset:

           

Interest rate swaps — fixed to floating rate

   $ —         $ 95       $ —         $ 95   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total derivative asset

   $ —         $ 95       $ —         $ 95   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between levels within the fair value hierarchy or Level 3 purchases, sales, issuances or settlements for the six months ended June 30, 2012 or the twelve months ended December 31, 2011.

The fair value of the money market funds, classified as Level 1, utilized quoted prices in active markets.

The fair value of the interest rate swaps, classified as Level 2, utilized a market approach model using the notional amount of the interest rate swap and observable inputs of time to maturity and market interest rates. See Note 12 for additional information on the interest rate swaps.

 

10. Credit Agreement

On July 10, 2012, Lorillard Tobacco, the principal, wholly owned operating subsidiary of the Company, terminated its three-year $185 million credit agreement (the “Old Revolver”), dated as of March 26, 2010, and entered into a $200 million revolving credit facility that expires on July 10, 2017 (the “Revolver”) and is guaranteed by the Company. The Revolver may be increased to $300 million upon request for commitment increases. Proceeds from the Revolver may be used for general corporate and working capital purposes. The interest rates on borrowings under the Revolver are based on prevailing interest rates and, in part, upon the credit rating applicable to the Company’s senior unsecured long-term debt.

The Revolver requires that Lorillard maintain a (i) ratio of debt to net income plus income taxes, interest expense, depreciation and amortization expense, any extraordinary losses, any non-cash expenses or losses and any losses on sales of assets outside of the ordinary course of business (“EBITDA”) of not more than 2.25 to 1 and (ii) ratio of EBITDA to interest expense of not less than 3.0 to 1. In addition, the Revolver contains other affirmative and negative covenants customary for facilities of this type. The Revolver contains customary events of default, including upon a change in control (as defined therein), that could result in the acceleration of all amounts and cancellation of all commitments outstanding under the Revolver.

 

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As of June 30, 2012, Lorillard was in compliance with all financial covenants and there were no borrowings under the Old Revolver.

 

11. Long-Term Debt

Long-term debt, net of interest rate swaps, consisted of the following:

 

     June 30,
2012
     December 31,
2011
 
     (In millions)  

2016 Notes — 3.500% Notes due 2016

   $ 500       $ 500   

2019 Notes — 8.125% Notes due 2019

     860         845   

2020 Notes — 6.875% Notes due 2020

     750         750   

2040 Notes — 8.125% Notes due 2040

     250         250   

2041 Notes — 7.000% Notes due 2041

     250         250   
  

 

 

    

 

 

 

Total long-term debt

   $ 2,610       $ 2,595   
  

 

 

    

 

 

 

In June 2009, Lorillard Tobacco issued $750 million aggregate principal amount of 8.125% unsecured senior notes due June 23, 2019 (the “2019 Notes”) pursuant to an Indenture, dated June 23, 2009 (the “Indenture”), and First Supplemental Indenture, dated June 23, 2009 (the “First Supplemental Indenture”).

In April 2010, Lorillard Tobacco issued $1 billion of unsecured senior notes in two tranches pursuant to the Indenture and the Second Supplemental Indenture, dated April 12, 2010 (the “Second Supplemental Indenture”). The first tranche was $750 million aggregate principal amount of 6.875% Notes due May 1, 2020 (the “2020 Notes”), and the second tranche was $250 million aggregate principal amount of 8.125% Notes due May 1, 2040 (the “2040 Notes”).

In August 2011, Lorillard Tobacco issued $750 million of unsecured senior notes in two tranches pursuant to the Indenture and the Third Supplemental Indenture, dated August 4, 2011 (the “Third Supplemental Indenture”). The first tranche was $500 million aggregate principal amount of 3.500% Notes due August 4, 2016 (the “2016 Notes”) and the second tranche was $250 million aggregate principal amount of 7.000% Notes due August 4, 2041 (the “2041 Notes”). The net proceeds from the issuance were used for the repurchase of the Company’s common stock.

Lorillard Tobacco is the principal, wholly owned operating subsidiary of the Company, and the 2016 Notes, 2019 Notes, 2020 Notes, 2040 Notes and 2041 Notes (together, the “Notes”) are unconditionally guaranteed on a senior unsecured basis by the Company.

The interest rate payable on the 2019 Notes is subject to incremental increases from 0.25% to 2.00% in the event either Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s Ratings Services (“S&P”) or both Moody’s and S&P downgrade the 2019 Notes below investment grade (Baa3 and BBB- for Moody’s and S&P, respectively). As of June 30, 2012, our debt ratings were Baa2 and BBB- with Moody’s and S&P, respectively, both of which are investment grade.

Upon the occurrence of a change of control triggering event, Lorillard Tobacco would be required to make an offer to repurchase the Notes at a price equal to 101% of the aggregate principal amount of the Notes, plus accrued interest. A “change of control triggering event” occurs when there is both a “change of control” (as defined in the Supplemental Indentures) and the Notes cease to be rated investment grade by both Moody’s and S&P within 60 days of the occurrence of a change of control or public announcement of the intention to effect a change of control. The Notes are not entitled to any sinking fund and are not redeemable prior to maturity. The Notes contain covenants that restrict liens and sale and leaseback transactions, subject to a limited exception. At June 30, 2012 and December 31, 2011, the carrying value of the Notes was $2.610 billion and $2.595 billion, respectively, and the estimated fair value was $2.964 billion and $2.801 billion, respectively. The fair value of the Notes is based on market pricing. The fair value of the Notes, classified as Level 1, utilized quoted prices in active markets.

 

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12. Derivative Instruments

In September 2009, Lorillard Tobacco entered into interest rate swap agreements, which the Company guaranteed, with a total notional amount of $750 million to modify its exposure to interest rate risk by effectively converting the interest rate payable on the 2019 Notes from a fixed rate to a floating rate. Under the agreements, Lorillard Tobacco receives interest based on a fixed rate of 8.125% and pays interest based on a floating one-month LIBOR rate plus a spread of 4.625%. The variable rates were 4.864% and 4.896% as of June 30, 2012 and December 31, 2011, respectively. The agreements expire in June 2019. The interest rate swap agreements qualify for hedge accounting and were designated as fair value hedges. Under the swap agreements, Lorillard Tobacco receives a fixed rate settlement and pays a variable rate settlement with the difference recorded in interest expense. That difference reduced interest expense by $6 million and $12 million for the three and six months ended June 30, 2012 and 2011.

For derivatives designated as fair value hedges, which relate entirely to hedges of debt, changes in the fair value of the derivatives are recorded in other assets or other liabilities with an offsetting adjustment to the carrying amount of the hedged debt. At June 30, 2012 and December 31, 2011, the adjusted carrying amounts of the hedged debt outstanding were $860 million and $845 million, respectively and the amounts included in other assets were $110 million and $95 million, respectively.

If our debt rating is downgraded below Ba2 by Moody’s or BB by S&P, the swap agreements will terminate and we will be required to cash settle them before their expiration date. As of June 30, 2012, our debt ratings were Baa2 and BBB- with Moody’s and S&P, respectively, both of which are above the ratings at which settlement of our derivative contracts would be required.

 

13. Earnings Per Share

Basic and diluted earnings per share (“EPS”) were calculated using the following:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  
     (In millions)  

Numerator:

        

Net income, as reported

   $ 284      $ 291      $ 507      $ 539   

Less: Net income attributable to participating securities

     (1     (1     (1     (1
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 283      $ 290      $ 506      $ 538   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Basic EPS- weighted average shares

     130.18        141.79        130.34        143.28   

Effect of dilutive securities:

        

Stock Options and SARS

     0.31        0.17        0.32        0.29   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted EPS- adjusted weighted average shares and assumed conversions

     130.49        141.96        130.66        143.57   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings Per Share:

        

Basic

   $ 2.17      $ 2.05      $ 3.88      $ 3.75   

Diluted

   $ 2.17      $ 2.05      $ 3.87      $ 3.75   

No options to purchase shares of common stock were excluded from the diluted earnings per share calculation because their effect would be anti-dilutive for the three and six months ended June 30, 2012.

 

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14. Retirement Plans

Lorillard has defined benefit pension, postretirement benefits, profit sharing and savings plans for eligible employees.

Net periodic benefit cost components were as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
Pension Benefits        2012             2011             2012             2011      
     (In millions)  

Service cost

   $ 6      $ 5      $ 12      $ 9   

Interest cost

     14        14        28        28   

Expected return on plan assets

     (20     (18     (38     (36

Amortization of net loss

     6        2        11        4   

Amortization of prior service cost

     1        1        2        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 7      $ 4      $ 15      $ 7   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
Other Postretirement Benefits        2012              2011              2012              2011      
     (In millions)  

Service cost

   $ 1       $ 1       $ 2       $ 2   

Interest cost

     3         2         5         5   

Amortization of net loss

     —           —           —           (1
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic benefit cost

   $ 4       $ 3       $ 7       $ 6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Lorillard expects to contribute $31 million to its pension plans and $15 million to its other postretirement benefit plans in 2012, of which $15 million and $6 million had been contributed to the pension and postretirement benefit plans, respectively, as of June 30, 2012.

 

15. Share Repurchase Programs

As of February 24, 2012, the Company completed its $750 million share repurchase program that was announced in August 2011, after repurchasing an additional 1.6 million shares in January and February 2012 for $188 million at an average purchase price of $114.85. The Company repurchased a total of 6.7 million shares at an average price of $111.87 per share under this program.

As of June 30, 2012, total shares repurchased under share repurchase programs authorized by the Board since the Separation were as follows:

 

Program

   Amount
Authorized
     Number of
Shares
Repurchased
 
     (In millions)      (In millions)  

July 2008 — October 2008

   $ 400         5.9   

May 2009 — July 2009

     250         3.7   

July 2009 — January 2010

     750         9.7   

February 2010 — May 2010

     250         3.3   

August 2010 * — August 2011

     1,400         15.0   

August 2011 — February 2012

     750         6.7   
  

 

 

    

 

 

 

Total

   $ 3,800         44.3   
  

 

 

    

 

 

 

 

* As amended on May 19, 2011

 

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16. Consolidating Financial Information

In June 2009, April 2010 and August 2011, Lorillard Tobacco, as primarily obligor, issued Notes, which are unconditionally guaranteed by the Company for the payment and performance of Lorillard Tobacco’s obligation in connection therewith.

The following sets forth the condensed consolidating balance sheets as of June 30, 2012 and December 31, 2011, condensed consolidating statements of income for the three and six months ended June 30, 2012 and 2011, condensed consolidating statements of comprehensive income for the three and six months ended June 30, 2012 and 2011, and condensed consolidating statements of cash flows for the six months ended June 30, 2012 and 2011 for the Company as parent guarantor (herein referred to as “Parent”), Lorillard Tobacco (herein referred to as “Issuer”) and all other non-guarantor subsidiaries of the Company and Lorillard Tobacco. These condensed consolidating financial statements were prepared in accordance with Rule 3-10 of SEC Regulation S-X, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.” Lorillard accounts for investments in these subsidiaries under the equity method of accounting.

 

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Condensed Consolidating Balance Sheets

June 30, 2012

(In millions)

(Unaudited)

 

     Parent     Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Assets:

          

Cash and cash equivalents

   $ 25      $ 640      $ 281      $ —        $ 946   

Accounts receivable, less allowances of $2

     —          14        —          —          14   

Other receivables

       12        2        —          14   

Inventories

     —          344        21        —          365   

Deferred income taxes

     —          535        —          —          535   

Other current assets

     1        100        7        —          108   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

     26        1,645        311        —          1,982   

Investment in subsidiaries

     (1,331     552        —          779        —     

Plant and equipment, net

     —          278        —          —          278   

Goodwill

     —          —          64        —          64   

Intangible assets

     —          —          58        —          58   

Deferred income taxes

     —          45        5        —          50   

Other assets (2)

     125        318        213        (512     144   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ (1,180   $ 2,838      $ 651      $ 267      $ 2,576   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity (Deficit):

          

Accounts and drafts payable

   $ —        $ 28      $ 3      $ —        $ 31   

Accrued liabilities (1)

     —          401        (80     —          321   

Settlement costs

     —          747        —          —          747   

Income taxes

     1        —          1        —          2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     1        1,176        (76     —          1,101   

Long-term debt

     —          2,610        —          —          2,610   

Postretirement pension, medical and life insurance benefits

     —          375        —          —          375   

Other liabilities (2)

     387        43        140        (512     58   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     388        4,204        64        (512     4,144   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shareholders’ Equity (Deficit):

          

Common stock

     2        —          —          —          2   

Additional paid-in capital

     288        77        250        (327     288   

Retained earnings

     2,161        (1,224     337        887        2,161   

Accumulated other comprehensive loss

     (219     (219     —          219        (219

Treasury stock

     (3,800     —          —          —          (3,800
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ equity (deficit)

     (1,568     (1,366     587        779        (1,568
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity (deficit)

   $ (1,180   $ 2,838      $ 651      $ 267      $ 2,576   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.
(2) Other assets of Issuer includes a note receivable from Parent of $174 million due 2016. The note payable is included in other liabilities.

 

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Condensed Consolidating Balance Sheets

December 31, 2011

(In millions)

 

     Parent     Issuer     All
Other
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Assets:

           

Cash and cash equivalents

   $ 235      $ 582      $ 817       $ —        $ 1,634   

Accounts receivable, less allowances of $2

     —          10        —           —          10   

Other receivables

       956        2         (875     83   

Inventories

     —          277        —           —          277   

Deferred income taxes

     —          535        —           —          535   

Other current assets

     —          25        —           —          25   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total current assets

     235        2,385        819         (875     2,564   

Investment in subsidiaries

     (1,347     219        —           1,128        —     

Plant and equipment, net

     —          262        —           —          262   

Deferred income taxes

     —          50        4         —          54   

Other assets (2)

     —          302        213         (387     128   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ (1,112   $ 3,218      $ 1,036       $ (134   $ 3,008   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities and Shareholders’ Equity (Deficit):

           

Accounts and drafts payable

   $ —        $ 32      $ —         $ —        $ 32   

Accrued liabilities (1)

     14        354        803         (875     296   

Settlement costs

     —          1,151        —           —          1,151   

Income taxes

     —          6           —          6   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total current liabilities

     14        1,543        803         (875     1,485   

Long-term debt

     —          2,595        —           —          2,595   

Postretirement pension, medical and life insurance benefits

     —          388        —           —          388   

Other liabilities (2)

     387        39        14         (387     53   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

     401        4,565        817         (1,262     4,521   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Shareholders’ Equity (Deficit):

           

Common stock

     2        —          —           —          2   

Additional paid-in capital

     266        55        214         (269     266   

Retained earnings

     2,059        (1,174     5         1,169        2,059   

Accumulated other comprehensive loss

     (228     (228     —           228        (228

Treasury stock

     (3,612     —          —           —          (3,612
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total shareholders’ equity (deficit)

     (1,513     (1,347     219         1,128        (1,513
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity (deficit)

   $ (1,112   $ 3,218      $ 1,036       $ (134   $ 3,008   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.
(2) Other assets of Issuer includes a note receivable from Parent of $174 million due 2016. The note payable is included in other liabilities.

 

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Condensed Consolidating Statements of Income

For the Three Months Ended June 30, 2012

(In millions)

(Unaudited)

 

     Parent      Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Net sales (including excise taxes of $526)

   $ —         $ 1,723      $ 8      $ —        $ 1,731   

Cost of sales

     —           1,112        7        —          1,119   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     —           611        1        —          612   

Selling, general and administrative (1)

     —           403        (275     —          128   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     —           208        276        —          484   

Investment income

     —           —          —          —          —     

Interest expense

     —           (37     —          —          (37
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     —           171        276        —          447   

Income taxes

     —           63        100        —          163   

Equity in earnings of subsidiaries

     284         177        —          (461     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 284       $ 285      $ 176      $ (461   $ 284   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.

Condensed Consolidating Statements of Income

For the Six Months Ended June 30, 2012

(In millions)

(Unaudited)

 

     Parent     Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Net sales (including excise taxes of $993)

   $ —        $ 3,249      $ 8      $ —        $ 3,257   

Cost of sales

     —          2,115        7        —          2,122   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     —          1,134        1        —          1,135   

Selling, general and administrative (1)

     —          779        (519     —          260   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     —          355        520        —          875   

Investment income

     —          1        1        —          2   

Interest expense

     (1     (75     —          —          (76
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     (1     281        521        —          801   

Income taxes

     (1     106        189        —          294   

Equity in earnings of subsidiaries

     507        333        —          (840     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 507      $ 508      $ 332      $ (840   $ 507   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.

 

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Table of Contents

Condensed Consolidating Statements of Income

For the Three Months Ended June 30, 2011

(In millions)

(Unaudited)

 

     Parent      Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Net sales (including excise taxes of $533)

   $ —         $ 1,692      $ —        $ —        $ 1,692   

Cost of sales

     —           1,093        —          —          1,093   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     —           599        —          —          599   

Selling, general and administrative (1)

     —           380        (268     —          112   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     —           219        268        —          487   

Investment income

     —           1        —          —          1   

Interest expense

     —           (28     —          —          (28
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     —           192        268        —          460   

Income taxes

     —           74        95        —          169   

Equity in earnings of subsidiaries

     291         173        —          (464     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 291       $ 291      $ 173      $ (464   $ 291   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.

Condensed Consolidating Statements of Income

For the Six Months Ended June 30, 2011

(In millions)

(Unaudited)

 

     Parent      Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Net sales (including excise taxes of $1,012)

   $ —         $ 3,227      $ —        $ —        $ 3,227   

Cost of sales

     —           2,085        —          —          2,085   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     —           1,142        —          —          1,142   

Selling, general and administrative (1)

     —           745        (511     —          234   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     —           397        511        —          908   

Investment income

     —           2        —          —          2   

Interest expense

     —           (56     —          —          (56
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     —           343        511        —          854   

Income taxes

     —           133        182        —          315   

Equity in earnings of subsidiaries

     539         329        —          (868     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 539       $ 539      $ 329      $ (868   $ 539   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes intercompany royalties between Issuer and other subsidiaries of a corresponding amount.

 

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Table of Contents

Condensed Consolidating Statements of Comprehensive Income

For the Three Months Ended June 30, 2012

(Unaudited)

 

(In millions)    Parent      Issuer      All
Other
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Net income

   $ 284       $ 285       $ 176       $ (461   $ 284   

Other comprehensive income, net of tax:

             

Defined benefit retirement plan gains, net of tax expense of $3

     —           5         —           —          5   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Other comprehensive income

     —           5         —           —          5   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Comprehensive income

   $ 284       $ 290       $ 176       $ (461   $ 289   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Condensed Consolidating Statements of Comprehensive Income

For the Six Months Ended June 30, 2012

(Unaudited)

 

(In millions)    Parent      Issuer      All
Other
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Net income

   $ 507       $ 508       $ 332       $ (840   $ 507   

Other comprehensive income, net of tax:

             

Defined benefit retirement plan gains, net of tax expense of $5

     —           9         —           —          9   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Other comprehensive income

     —           9         —           —          9   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Comprehensive income

   $ 507       $ 517       $ 332       $ (840   $ 516   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statements of Comprehensive Income

For the Three Months Ended June 30, 2011

(Unaudited)

 

(In millions)    Parent      Issuer     All
Other
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Net income

   $ 291       $ 291      $ 173       $ (464   $ 291   

Other comprehensive income, net of tax:

            

Defined benefit retirement plan loss, net of tax benefit of $3

     —           (4     —           —          (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income

     —           (4     —           —          (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income

   $ 291       $ 287      $ 173       $ (464   $ 287   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Condensed Consolidating Statements of Comprehensive Income

For the Six Months Ended June 30, 2011

(Unaudited)

 

(In millions)    Parent      Issuer     All
Other
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Net income

   $ 539       $ 539      $ 329       $ (868   $ 539   

Other comprehensive income, net of tax:

            

Defined benefit retirement plan loss, net of tax benefit of $2

     —           (3     —           —          (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income

     —           (3     —           —          (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income

   $ 539       $ 536      $ 329       $ (868   $ 536   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statements of Cash Flows

For the Six Months Ended June 30, 2012

(In millions)

(Unaudited)

 

     Parent     Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Cash flows from operating activities:

   $ 507      $ 508      $ 332      $ (840   $ 507   

Net income

          

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

          

Equity income from subsidiaries

     (507     (333     —          840        —     

Depreciation and amortization

     —          20        —          —          20   

Pension, health and life insurance contributions

     —          (20     —          —          (20

Pension, health and life insurance benefits expense

     —          22        —          —          22   

Deferred income taxes

     —          —          (1     —          (1

Share-based compensation

     —          9        —          —          9   

Excess tax benefits from share-based arrangements

     —          (8     —          —          (8

Changes in operating assets and liabilities:

          

Accounts and other receivables

     —          876        2        (875     3   

Inventories

     —          (67     (6     —          (73

Accounts payable and accrued liabilities

     (14     42        (884     875        19   

Settlement costs

     —          (404     —          —          (404

Income taxes

     —          (21     2        —          (19

Other current assets

     —          15        (6     —          9   

Other assets

     (125     (1     —          125        (1

Return on investment in subsidiaries

     557        —          —          (557     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     418        638        (561     (432     63   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Business acquisition

     —          —          (135     —          (135

Additions to plant and equipment

     —          (36     —          —          (36

Investment in subsidiary

     (35     —          —          35        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) investing activities

     (35     (36     (135     35        (171
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Shares repurchased

     (188     —          —          —          (188

Dividends paid

     (405     (557     —          557        (405

Proceeds from issuance of long term debt

     —          —          125        (125     —     

Contributions from Parent

     —          —          35        (35     —     

Proceeds from exercise of stock options

     —          5        —          —          5   

Excess tax benefits from share-based arrangements

     —          8        —          —          8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (593     (544     160        397        (580
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

     (210     58        (536     —          (688

Cash and cash equivalents, beginning of year

     235        582        817        —          1,634   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 25      $ 640      $ 281      $ —        $ 946   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statements of Cash Flows

For the Six Months Ended June 30, 2011

(In millions)

(Unaudited)

 

     Parent     Issuer     All
Other
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Cash flows from operating activities:

          

Net income

   $ 539      $ 539      $ 329      $ (868   $ 539   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

          

Equity income from subsidiaries

     (539     (329     —          868        —     

Depreciation and amortization

     —          19        —          —          19   

Pension, health and life insurance contributions

     —          (18     —          —          (18

Pension, health and life insurance benefits expense

     —          15        —          —          15   

Deferred income taxes

     —          (6     1        —          (5

Share-based compensation

     —          7        —          —          7   

Excess tax benefits from share-based arrangements

     —          (3     —          —          (3

Changes in operating assets and liabilities:

          

Accounts and other receivables

     1        (3     —          —          (2

Inventories

     —          (42     —          —          (42

Accounts payable and accrued liabilities

     23        122        (32     —          113   

Settlement costs

     —          (326     —          —          (326

Income taxes

     —          (38     3        —          (35

Other

     —          1        —          —          1   

Return on investment in subsidiaries

     1,275        549        —          (1,824     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     1,299        487        301        (1,824     263   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Additions to plant and equipment

     —          (26     —          —          (26

Cash flows from financing activities:

          

Shares repurchased

     (783     —          —          —          (783

Dividends paid

     (373     (1,275     (549     1,824        (373

Proceeds from exercise of stock options

     —          7        —          —          7   

Excess tax benefits from share-based arrangements

     —          3        —          —          3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (1,156     (1,265     (549     1,824        (1,146
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

     143        (804     (248     —          (909

Cash and cash equivalents, beginning of year

     163        1,181        719        —          2,063   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 306      $ 377      $ 471      $ —        $ 1,154   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
17. Legal Proceedings

Overview

As of July 23, 2012, 9,488 product liability cases are pending against cigarette manufacturers in the United States. Lorillard Tobacco is a defendant in 8,567 of these cases. Lorillard, Inc. is a co-defendant in 669 pending cases. A total of 5,930 of these lawsuits are Engle Progeny Cases, described below. In addition to the product liability cases, Lorillard Tobacco and, in some instances, Lorillard, Inc., are defendants in Filter Cases and Tobacco-Related Antitrust Cases.

Pending cases against Lorillard are those in which Lorillard Tobacco or Lorillard, Inc. have been joined to the litigation by either receipt of service of process, or execution of a waiver thereof, and a dismissal order has not been entered with respect to Lorillard Tobacco or Lorillard, Inc. Certain Flight Attendant Cases that were dismissed for administrative reasons, but which may be reinstated pursuant to the settlement agreement in Broin v. Philip Morris Companies, Inc., et al. have been included in the count of pending cases. The table below lists the number of certain tobacco-related cases pending against Lorillard as of the dates listed. A description of each type of case follows the table.

 

Type of Case

   Total Number of Cases
Pending against Lorillard as
of July 23, 2012
 

Conventional Product Liability Cases

     22   

Engle Progeny Cases

     5,930   

West Virginia Individual Personal Injury Cases

     38   

Flight Attendant Cases

     2,574   

Class Action Cases

     2   

Reimbursement Cases

     1   

Filter Cases

     42   

Tobacco-Related Antitrust Cases

     1   

Conventional Product Liability Cases. Conventional Product Liability Cases are brought by individuals who allege cancer or other health effects caused by smoking cigarettes, by using smokeless tobacco products, by addiction to tobacco, or by exposure to environmental tobacco smoke. Lorillard Tobacco is a defendant in each of the Conventional Product Liability cases listed in the table above, and Lorillard, Inc. is a co-defendant in four of the Conventional Product Liability Cases.

Engle Progeny Cases. Engle Progeny Cases are brought by individuals who purport to be members of the decertified Engle class. These cases are pending in a number of Florida courts. Lorillard Tobacco is a defendant in each of the Engle Progeny Cases listed in the above table and Lorillard, Inc. is a co-defendant in 665 Engle Progeny Cases. The time period for filing Engle Progeny Cases expired in January 2008 and no additional cases may be filed. Some of the Engle Progeny Cases were filed on behalf of multiple class members. Some of the courts hearing the cases filed by multiple class members have severed these suits into separate individual cases. It is possible the remaining suits filed by multiple class members may also be severed into separate individual cases.

West Virginia Individual Personal Injury Cases. In a 1999 administrative order, the West Virginia Supreme Court of Appeals transferred a group of cases brought by individuals who allege cancer or other health effects caused by smoking cigarettes, by smoking cigars, or by using smokeless tobacco products, to a single West Virginia court (the “West Virginia Individual Personal Injury Cases”). The plaintiffs’ claims alleging injury from smoking cigarettes have been consolidated for trial. The plaintiffs’ claims alleging injury from the use of other tobacco products have been severed from the consolidated cigarette claims and have not been consolidated for trial. Lorillard Tobacco is a defendant in each of the West Virginia Individual Personal Injury Cases listed in the above table. Lorillard, Inc. is not a defendant in any of the West Virginia Individual Personal Injury Cases. The time for filing a case that could be consolidated for trial with the West Virginia Individual Personal Injury Cases expired in 2000.

Flight Attendant Cases. Flight Attendant Cases are brought by non-smoking flight attendants alleging injury from exposure to environmental smoke in the cabins of aircraft. Plaintiffs in these cases may not seek punitive damages for injuries that arose prior to January 15, 1997. Lorillard Tobacco is a defendant in each of the Flight Attendant Cases listed in the above table. Lorillard, Inc. is not a defendant in any of the Flight Attendant Cases. The time for filing Flight Attendant Cases expired in 2000 and no additional cases in this category may be filed.

 

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Table of Contents

Class Action Cases. Class Action Cases are purported to be brought on behalf of large numbers of individuals for damages allegedly caused by smoking. Lorillard Tobacco is a defendant in each of the Class Action Cases listed in the above table. Lorillard, Inc. is not defendant in any of the Class Action Cases. Neither Lorillard Tobacco nor Lorillard, Inc. is a defendant in additional Class Action Cases that are pending against other cigarette manufacturers, including approximately 19 “lights” Class Action Cases and two Class Action Cases that are based primarily on medical monitoring.

Reimbursement Cases. Reimbursement Cases are brought by or on behalf of entities seeking equitable relief and reimbursement of expenses incurred in providing health care to individuals who allegedly were injured by smoking. Plaintiffs in these cases have included the U.S. federal government, U.S. state and local governments, foreign governmental entities, hospitals or hospital districts, American Indian tribes, labor unions, private companies and private citizens. Included in this category is the suit filed by the federal government, United States of America v. Philip Morris USA, Inc. (“Phillip Morris”), et al., that sought to recover profits earned by the defendants and other equitable relief. Lorillard Tobacco is a defendant in the case, and Lorillard, Inc. is not a party to this case. In August 2006, the trial court issued its final judgment and remedial order and granted injunctive and other equitable relief. The final judgment did not award monetary damages. In May 2009, the final judgment was largely affirmed by an appellate court. In June 2010, the U.S. Supreme Court denied review of the case. See “Reimbursement Cases” below.

Filter Cases. Filter Cases are brought by individuals, including former employees of a predecessor of Lorillard Tobacco, who seek damages resulting from their alleged exposure to asbestos fibers that were incorporated into filter material used in one brand of cigarettes manufactured by Lorillard for a limited period of time ending more than 50 years ago. Lorillard Tobacco is a defendant in 38 of the 42 Filter Cases listed in the above table. Lorillard, Inc. is a co-defendant in four of the 42 Filter Cases that are pending against Lorillard Tobacco. Lorillard, Inc. is also a defendant in four additional Filter Cases in which Lorillard Tobacco is not a defendant.

Tobacco-Related Antitrust Cases. Lorillard Tobacco is a defendant in the Tobacco-Related Antitrust Case as set forth in the table above. Lorillard, Inc. is not a defendant in this case. In 2000 and 2001, a number of cases were brought against cigarette manufacturers, including Lorillard Tobacco, alleging that defendants conspired to set the price of cigarettes in violation of federal and state antitrust and unfair business practices statutes. Plaintiffs sought class certification on behalf of persons who purchased cigarettes directly or indirectly from one or more of the defendant cigarette manufacturers. All of the other cases have been either successfully defended or voluntarily dismissed. Another case in this category was brought by a small cigarette manufacturer against a number of states and the cigarette manufacturers, including Lorillard Tobacco, that signed the Master Settlement Agreement (as described herein) with 46 states, the District of Columbia, the Commonwealth of Puerto Rico, Guam, the U.S. Virgin Islands, American Samoa and the Commonwealth of the Northern Mariana Islands. Lorillard, Inc. was not a party to this case. It was alleged that certain provisions of the Master Settlement Agreement violate the antitrust laws. On February 22, 2012, the Court of Appeals for the Sixth Circuit affirmed the judgment of the District Court dismissing the case, and as of July 23, 2012, this case has been successfully dismissed and concluded.

Loss Accrual and Disclosure Policy

Lorillard establishes accruals in accordance with Accounting Standards Codification Topic 450, Contingencies (“ASC 450”), when a material litigation liability is both probable and can be reasonably estimated. There are a number of factors impacting Lorillard’s ability to estimate the possible loss or a range of loss, including the specific facts of each matter; the legal theories proffered by plaintiffs and legal defenses available to Lorillard Tobacco and Lorillard, Inc.; the wide-ranging outcomes reached in similar cases; differing procedural and substantive laws in the various jurisdictions in which lawsuits have been filed, including whether punitive damages may be pursued or are permissible; the degree of specificity in a plaintiff’s complaint; the history of the case and whether discovery has been completed; plaintiffs’ history of use of Lorillard Tobacco’s cigarettes relative to those of the other defendants; the attribution of damages, if any, among multiple defendants; the application of contributory and/or comparative negligence to the allocation of damage awards among plaintiffs and defendants; the likelihood of settlements for de minimus amounts prior to trial; the likelihood of success at trial; the likelihood of success on appeal; and the impact of current and pending state and federal appellate decisions. It has been Lorillard’s experience and is

 

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Table of Contents

its continued expectation that the above complexities and uncertainties will not be clarified until the late stages of litigation. For those reasonably possible loss contingencies for which an estimate of the possible loss or range of loss cannot be made, Lorillard discloses the nature of the litigation and any developments as appropriate.

Lorillard monitors the status of all outstanding litigation on an ongoing basis in order to determine the probability of loss and assess whether an estimate of the possible loss or range of loss can be determined. In evaluating litigation, Lorillard considers, among other things, the nature of the claims; the jurisdiction in which the claims have been filed and the law and case law developed in that jurisdiction; the experience of plaintiffs’ counsel in this type of litigation; the parties’ respective litigation strategies; the stage of the proceedings; the outcome of the matters at trial or on appeal; the type and amount of damages claimed by plaintiffs; the outcomes and damage awards, if any, for similar matters brought against Lorillard and/or the tobacco industry; and the possibility and likelihood of success on appeal. Lorillard’s assessment of a possible loss or range of loss is based on its assessment of the final outcome of the litigation upon the conclusion of all appeals.

Lorillard records provisions in the consolidated financial statements for pending litigation when it determines that it is probable that a loss has been incurred and the amount of loss can be reasonably estimated. Except for the impact of the State Settlement Agreements as described below, while it is reasonably possible that a loss has been incurred, (i) management has concluded that it is not probable that a loss has been incurred in any material pending litigation against Lorillard, (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome in any material pending litigation due to the many variables, uncertainties and complexities described above, and (iii) accordingly, management has not provided any amounts in the consolidated financial statements for possible losses related to material pending litigation. It is possible that Lorillard’s results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially adversely affected by an unfavorable outcome or settlement of certain pending or future litigation or an inability to secure bonds where required to stay the execution of judgments on appeal.

Tobacco-Related Product Liability Litigation

Conventional Product Liability Cases

Since January 1, 2010, verdicts have been returned in eight Conventional Product Liability Cases against cigarette manufacturers. Lorillard Tobacco was the only defendant in one of these eight trials, Evans v. Lorillard Tobacco Company (Superior Court, Suffolk County, Massachusetts). In December 2010, the jury in Evans awarded $50 million in compensatory damages to the estate of a deceased smoker, $21 million in damages to the deceased smoker’s son, and $81 million in punitive damages. In September 2011, the court granted in part Lorillard Tobacco’s motion to reduce the jury’s damages awards and reduced the verdicts to the deceased smoker to $25 million and to the deceased smoker’s son to $10 million. The court did not reduce the punitive damages verdict, and it denied the other motions Lorillard Tobacco filed following trial that contested the jury’s verdict. In September 2011, the court also issued an order that addressed the single claim that was not submitted to the jury. While the court made certain findings that were favorable to the plaintiffs, it did not award additional damages to the plaintiffs on this final claim. The court has denied the various motions filed by Lorillard Tobacco following the entry of the order on the claim that was not submitted to the jury. In September 2011, the court entered a judgment that reflected the jury’s damages awards and the court’s reductions following trial. The judgment awarded plaintiffs interest on each of the three damages awards at the rate of 12% per year from the date the case was filed in 2004. Interest on the three awards will continue to accrue until either the judgment is paid or is vacated on appeal. The judgment permitted plaintiff’s counsel to request an award of attorneys’ fees and costs. In November 2011, the court granted in part plaintiff’s counsel’s application for attorneys’ fees and costs and has awarded approximately $2.4 million in fees and approximately $225,000 in costs. The court entered a final judgment that incorporated the amounts of the verdicts, as reduced by the trial court, the awards of interest, and the awards of attorneys’ fees and costs. Lorillard Tobacco has noticed an appeal from the final judgment to the Massachusetts Appeals Court. In March 2012, plaintiff’s application for direct appellate review was granted, transferring the appeal to the Massachusetts Supreme Judicial Court.

Neither Lorillard Tobacco nor Lorillard, Inc. was a defendant in the seven other trials since January 1, 2010. Juries found in favor of the plaintiffs and awarded compensatory damages in two of these trials. Plaintiff in one of the two cases was awarded $4.0 million in punitive damages. Defendants’ appeals of these verdicts are pending. The plaintiff in another case was awarded $25 million in punitive damages in a retrial ordered by an appellate court in which the jury was permitted to consider only the amount of punitive damages to award. Post-trial motions challenging the verdict were denied in May 2012. Juries found in favor of the defendants in the four other trials.

 

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Two of these four cases have concluded because the plaintiffs did not pursue appeals. Plaintiff in the third case has noticed an appeal, and the plaintiff in the fourth case has filed a post-trial motion for a new trial. As of July 23, 2012 the trial court has not ruled on this motion.

In rulings addressing cases tried in earlier years, some appellate courts have reversed verdicts returned in favor of the plaintiffs while other judgments that awarded damages to smokers have been affirmed on appeal. Manufacturers have exhausted their appeals and have been required to pay damages to plaintiffs in thirteen individual cases since 2001. Punitive damages were paid to the smokers in six of these cases. Neither Lorillard Tobacco nor Lorillard, Inc. was a party to any of these matters.

Some cases are scheduled for trial in 2012. As of July 23, 2012, neither Lorillard Tobacco nor Lorillard Inc. is a defendant in any of the Conventional Product Liability Cases that are scheduled for trial in 2012. Trial dates are subject to change.

Engle Progeny Cases

In 2006, the Florida Supreme Court issued a ruling in Engle v. R.J. Reynolds Tobacco Co., et al., that had been certified as a class action on behalf of Florida residents, and survivors of Florida residents, who were injured or died from medical conditions allegedly caused by addiction to smoking. During a three-phase trial, a Florida jury awarded compensatory damages to three individuals and approximately $145 billion in punitive damages to the certified class. In its 2006 decision, the Florida Supreme Court vacated the punitive damages award, determined that the case could not proceed further as a class action and ordered decertification of the class. The Florida Supreme Court also reinstated the compensatory damages awards to two of the three individuals whose claims were heard during the first phase of the Engle trial. These two awards totaled $7 million, and both verdicts were paid in February 2008. Lorillard Tobacco’s payment to these two individuals, including interest, totaled approximately $3 million.

The Florida Supreme Court’s 2006 ruling also permitted Engle class members to file individual actions, including claims for punitive damages. The court further held that these individuals are entitled to rely on a number of the jury’s findings in favor of the plaintiffs in the first phase of the Engle trial. The time period for filing Engle Progeny Cases expired in January 2008 and no additional cases may be filed. In 2009, the Florida Supreme Court rejected a petition that sought to extend the time for purported class members to file an additional lawsuit.

The pending Engle Progeny Cases are before various Florida state and federal courts. Some of the Engle Progeny Cases were filed on behalf of multiple plaintiffs. Various courts have entered orders severing the cases filed by multiple plaintiffs into separate actions. In 2009, one Florida federal court entered orders that severed the claims of approximately 4,400 Engle Progeny plaintiffs, initially asserted in a small number of multi-plaintiff actions, into separate lawsuits. In some cases, spouses or children of alleged former class members have also brought derivative claims.

Various Engle Progeny Cases have been dismissed. Beginning in 2010 and through July 23, 2012, the United States District Court for the Middle District of Florida entered orders that dismissed approximately 1,228 cases for various reasons. In some instances, the plaintiffs whose cases were dismissed also were pursuing cases pending in other courts. In other instances, the attorneys who represented the plaintiffs asked the court to enter dismissal orders because they were no longer able to contact their clients. In addition, other courts, including state courts, entered orders dismissing additional cases. The United States District Court for the Middle District of Florida also entered other orders in 2011 that addressed approximately 500 cases filed by family members of alleged former class members. These 500 cases were among the 4,400 cases that were severed into separate lawsuits in 2009. In the 2011 orders, the court combined each one of these approximately 500 cases with the cases filed by the smoker from which the family members’ claims purportedly derived.

Various intermediate Florida appellate courts have issued rulings that address whether plaintiffs in the Engle Progeny Cases are entitled to rely on a number of the jury’s findings in favor of the plaintiffs in the first phase of the Engle trial. In December 2010, the Florida First District Court of Appeal ruled that the trial court correctly construed the Florida Supreme Court’s 2006 decision and that it properly instructed the jury on the preclusive effect of certain of the Engle jury’s findings in an appeal from a verdict in which the plaintiff was awarded damages. Since that decision, the Florida First District Court of Appeal has affirmed six other verdicts in which the plaintiff was awarded damages, three in 2011 and three in 2012. Defendants in the first four of these cases were denied review by

 

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the Florida Supreme Court in July 2011 and subsequent petitions for review by the U.S. Supreme Court were denied in March 2012. The Florida Fourth District Court of Appeals has affirmed judgments entered in favor of the plaintiffs in four cases, one in 2011 and three in 2012, but it had a different interpretation of the effect of the 2006 decision on plaintiffs’ claims. Defendants in two of these cases are seeking review by the Florida Supreme Court. As of July 23, 2012, the Florida Supreme Court had not announced whether it would grant review of these cases. In March 2012, the Florida Second District Court of Appeal affirmed the final judgment in another case, however the appeals court certified to the Florida Supreme Court the question of whether reliance on the findings in the first phase of the Engle trial violates the tobacco companies’ due process rights. In May 2012, the Florida Supreme Court announced that it would grant review of this case.

Cigarette manufacturers, including Lorillard Tobacco, asked the U.S. District Court for the Middle District of Florida to certify for appeal to the U.S. Court of Appeals for the Eleventh Circuit an order that addressed the application of the Florida Supreme Court’s Engle ruling on plaintiffs’ claims. The order that prompted defendants’ application addressed whether the Due Process Clause of the United States Constitution permits use of the Engle jury’s Phase I findings to establish the wrongful conduct elements of plaintiffs’ claims. Defendants acknowledged that the district court is bound by two rulings issued by Florida intermediate courts of appeal, but contended that these two decisions are inconsistent with federal due process. In February 2012, the U.S. District Court for the Middle District of Florida denied defendants’ motion to certify the order for appellate review.

Various courts, including appellate courts, have issued rulings that have addressed the conduct of the cases prior to trial. One intermediate state appellate court ruled in 2011 that plaintiffs are permitted to assert a claim against a cigarette manufacturer even if the smoker did not smoke a brand sold by that manufacturer. The defendants are seeking review of this decision by the Florida Supreme court. In March 2012, another intermediate state appellate court agreed with the 2011 ruling and reversed dismissals in a group of cases. Defendants in these cases are also seeking review by the Florida Supreme Court. The Florida Supreme Court has announced that it is deferring decision on whether to accept review of these cases until it decides whether to review the 2011 decision. These rulings may limit the ability of the defendants, including Lorillard Tobacco and Lorillard, Inc., to be dismissed from cases in which smokers did not use a cigarette manufactured by Lorillard Tobacco.

Lorillard Tobacco and Lorillard, Inc. are defendants in Engle Progeny Cases that have been placed on courts’ 2012 trial calendars or in which specific trial dates have been set. Trial schedules are subject to change and it is not possible to predict how many of the cases pending against Lorillard Tobacco or Lorillard, Inc. will be tried in 2012. It also is not possible to predict whether some courts will implement procedures that consolidate multiple Engle Progeny Cases for trial.

As of July 23, 2012, trial was not underway in any Engle Progeny Case in which Lorillard Tobacco is a defendant.

As of July 23, 2012, verdicts had been returned in nine Engle Progeny Cases in which Lorillard Tobacco was a defendant. Lorillard, Inc. was not a defendant in any of these nine cases. Juries awarded compensatory damages to the plaintiffs in seven of these cases. In three of the seven cases in which juries awarded compensatory damages, plaintiffs were awarded punitive damages from Lorillard Tobacco. In one of the cases, the court entered an order following trial that awarded plaintiff compensatory damages. The nine cases are listed below in the order in which the verdicts were returned:

 

   

In Rohr v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Broward County, Florida), a jury returned a verdict in favor of the defendants, including Lorillard Tobacco. Plaintiff in Rohr did not pursue an appeal and the case is concluded.

 

   

In Mrozek v. Lorillard Tobacco Company (Circuit Court, Fourth Judicial Circuit, Duval County, Florida), the jury awarded plaintiffs a total of $6 million in compensatory damages and $11.3 million in punitive damages. The jury apportioned 35% of the fault for the smoker’s injuries to the smoker and 65% to Lorillard Tobacco. The final judgment entered by the trial court reflected the jury’s verdict and awarded plaintiff $3,900,588 in compensatory damages and $11,300,000 in punitive damages plus 6% annual interest. Lorillard Tobacco has noticed an appeal to the Florida First District Court of Appeal. As of July 23, 2012, the trial court had not ruled on plaintiff’s motion for costs and attorneys’ fees.

 

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In Tullo v. R.J. Reynolds, et al. (Circuit Court, Palm Beach County, Florida), the jury awarded plaintiff a total of $4.5 million in compensatory damages. The jury assessed 45% of the fault to the smoker, 5% to Lorillard Tobacco and 50% to other defendants. The jury did not award punitive damages to the plaintiff. The court entered a final judgment that awarded plaintiff $225,000 in compensatory damages from Lorillard Tobacco plus 6% annual interest. Defendants noticed an appeal from the final judgment to the Florida Fourth District Court of Appeal. The trial court has granted plaintiff’s application for costs but, as of July 23, 2012, it had not awarded an amount.

 

   

In Sulcer v. Lorillard Tobacco Company, et al. (Circuit Court, Escambia County, Florida), the jury awarded $225,000 in compensatory damages to the plaintiff and it assessed 95% of the fault for the smoker’s injuries to the smoker with 5% allocated to Lorillard Tobacco. The jury returned a verdict for Lorillard Tobacco as to whether plaintiff is entitled to punitive damages. The court entered a final judgment that incorporated the jury’s determination of the parties’ fault and awarded plaintiff $11,250 in compensatory damages. Lorillard Tobacco paid approximately $246,000 to resolve the verdict, costs and fees, as well as all post-trial motions and any potential appeal by the plaintiff. Following this payment, Sulcer was concluded.

 

   

In Jewett v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Duval County, Florida), the jury awarded the estate of the decedent $692,981 in compensatory damages and awarded the plaintiff $400,000 for loss of companionship. The jury assessed 70% of the responsibility for the decedent’s injuries to the decedent, 20% to R.J. Reynolds and 10% to Lorillard Tobacco. The jury returned a verdict for the defendants regarding whether punitive damages were warranted. The final judgment entered by the trial court reflected the jury’s verdict and awarded plaintiff a total of $109,298 from Lorillard Tobacco plus 6% annual interest. Defendants have noticed an appeal from the final judgment to the Florida First District Court of Appeal. In June 2012, an agreement was reached between the parties as to the amount of costs and attorneys’ fees incurred and plaintiff’s motion for costs and attorneys’ fees was withdrawn.

 

   

In Weingart v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Palm Beach County, Florida), the jury determined that the decedent did not sustain any compensatory damages from the defendants, including Lorillard Tobacco, and it returned a verdict for the defendants that punitive damages were not warranted. The jury assessed 91% of the fault for the decedent’s injuries to the decedent, 3% to Lorillard Tobacco and 3% to each of the other two defendants. Following trial, the court granted in part a motion filed by the plaintiff to award damages and it awarded plaintiff $150,000 in compensatory damages. The court entered a final judgment that applied the jury’s comparative fault determinations to the court’s award of compensatory damages. The final judgment awarded plaintiff $4,500 from Lorillard Tobacco. Defendants have noticed an appeal to the Florida Fourth District Court of Appeal from the order that awarded compensatory damages to the plaintiff and have amended their notice of appeal to address the final judgment. In March 2012, the court entered a judgment against the defendants for costs with Lorillard Tobacco’s share amounting to $43,081 plus 4.75% annual interest. Defendants have noticed an appeal from this cost judgment.

 

   

In Sury v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Duval County, Florida), the jury awarded plaintiff $1,000,000 in compensatory damages and assessed 60% of the responsibility for the decedent’s injuries to the decedent, 20% to Lorillard Tobacco and 20% to R.J. Reynolds. The jury returned a verdict for the defendants regarding whether punitive damages were warranted. In March 2012, the court entered a final judgment against defendants in the amount of $1,000,000 plus 4.75% annual interest, declining to apply the jury’s comparative fault findings to causes of action alleging intentional conduct. Defendants have noticed an appeal to the Florida First District Court of Appeal from the final judgment that awarded compensatory damages to the plaintiff. The trial court granted plaintiff’s application for costs and attorneys’ fees but, as of July 23, 2012, it had not awarded an amount.

 

   

In Alexander v. Lorillard Tobacco Company, et al. (Circuit Court, Eleventh Judicial Circuit, Miami-Dade County, Florida), the jury awarded plaintiff $20,000,000 in compensatory damages and $25,000,000 in punitive damages. Lorillard Tobacco is the only defendant in this case. The jury apportioned 20% of the fault for the smoker’s injuries to the smoker and 80% to Lorillard Tobacco.

 

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In March 2012, the court entered a final judgment that applied the jury’s comparative fault determination to the court’s award of compensatory damages, awarding the plaintiff $16,000,000 in compensatory damages and $25,000,000 in punitive damages from Lorillard Tobacco. In May 2012, the court granted a motion by Lorillard Tobacco to lower the amount of compensatory damages and reduced the amount awarded to $10,000,000 from Lorillard Tobacco. Other post-trial motions challenging the verdict were denied. The court entered an amended final judgment that applied the jury’s comparative fault determination to the court’s award of compensatory damages, awarding the plaintiff $8,000,000 in compensatory damages and $25,000,000 in punitive damages, plus the statutory rate of interest. Lorillard Tobacco has noticed an appeal from the amended final judgment to the Florida Third District Court of Appeal. Plaintiff has filed a motion for attorneys’ fees and costs. As of July 23, 2012, the trial court had not ruled on this motion.

 

   

In Calloway v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Seventeenth Judicial Circuit, Broward County, Florida), the jury awarded plaintiff and a daughter of the decedent a total of $20,500,000 in compensatory damages. The jury apportioned 20.5% of the fault for the smoker’s injuries to the smoker, 27% to R.J. Reynolds, 25% to Philip Morris, 18% to Lorillard Tobacco, and 9.5% to Liggett. The jury returned a verdict for the plaintiff regarding whether punitive damages were warranted and awarded $12,600,000 from Lorillard Tobacco and $42,250,000 from the other defendants, for a total punitive damages award of $54,850,000. Because the jury found in favor of the plaintiff on her claims alleging intentional conduct, the court has ruled that the jury’s finding on the plaintiff’s percentage of comparative fault will not be applied to reduce the compensatory damage award. Defendants have filed a number of post-trial motions challenging the verdict, and plaintiff has filed a motion for attorneys’ fees and costs. As of July 23, 2012, the trial court had not ruled on these motions.

As of July 23, 2012, trial was underway in one Engle Progeny Case involving defendants other than Lorillard Tobacco or Lorillard, Inc.: the case of Hiott v. R. J. Reynolds Tobacco Company, et al. (Circuit Court, Duval County, Florida).

As of July 23, 2012, verdicts have been returned in 57 Engle Progeny Cases since the Florida Supreme Court issued its 2006 ruling that permitted members of the Engle class to bring individual lawsuits in which neither Lorillard Tobacco nor Lorillard, Inc. was a defendant at trial. Juries awarded compensatory damages and punitive damages in 21 of the trials. The 21 punitive damages awards have totaled approximately $620 million and have ranged from $50,000 to $244 million. In 14 of the trials, juries’ awards were limited to compensatory damages. In the 22 remaining trials, juries found in favor of the defendants.

With the exception of the Sulcer case discussed above, defendants had filed, or were expected to file, challenges to each of the verdicts in which plaintiffs were awarded damages as of July 23, 2012. These challenges were pending before various courts and were in various stages as of July 23, 2012. In some of the trials decided in defendants’ favor, plaintiffs have filed motions challenging the verdicts. As of July 23, 2012, none of these motions had resulted in rulings in favor of the plaintiffs.

In a case tried prior to the Florida Supreme Court’s 2006 decision permitting members of the Engle class to bring individual lawsuits, one Florida court allowed the plaintiff to rely at trial on certain of the Engle jury’s findings. That trial resulted in a verdict for the plaintiffs in which they were awarded approximately $25 million in compensatory damages. Neither Lorillard Tobacco nor Lorillard, Inc. was a party to this case. In March 2010, a Florida appellate court affirmed the jury’s verdict. The court denied defendants’ petitions for rehearing in May 2010, and the defendants have satisfied the judgment by paying the damages award.

In June 2009, Florida amended the security requirements for a stay of execution of any judgment during the pendency of appeal in Engle Progeny Cases. The amended statute provides for the amount of security for individual Engle Progeny Cases to vary within prescribed limits based on the number of adverse judgments that are pending on appeal at a given time. The required security decreases as the number of appeals increases to ensure that the total security posted or deposited does not exceed $200 million in the aggregate. This amended statute applies to all judgments entered on or after June 16, 2009. The plaintiffs in some of the cases have challenged the constitutionality of the amended statute. As of July 23, 2012, none of these motions had been granted and courts either denied these challenges or rulings have not been issued. In January 2012, the Florida Supreme Court agreed to review one of the orders denying a challenge to the amended statute.

 

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West Virginia Individual Personal Injury Cases

The West Virginia Individual Personal Injury Cases (the “IPIC Cases”) are brought by individuals who allege cancer or other health effects caused by smoking cigarettes, by smoking cigars, or by using smokeless tobacco products in a single West Virginia court. Approximately 600 IPIC Cases are pending. Most of the pending cases have been consolidated for trial. The order that consolidated the cases for trial, among other things, also limited the consolidation to those cases that were filed by September 2000. No additional IPIC Cases may be consolidated for trial with this group. The court has entered a trial plan for the IPIC Cases that calls for a multi-phase trial. The first phase of trial began in October 2011 but the court ordered a mistrial in November 2011. The first phase of the consolidated trial is scheduled to begin on April 15, 2013.

In September 2000, there were approximately 1,250 IPIC Cases, and Lorillard Tobacco was named in all but a few of them. Plaintiffs in most of the cases alleged injuries from smoking cigarettes, and the claims alleging injury from smoking cigarettes have been consolidated for a multi-phase trial. Approximately 645 IPIC Cases have been dismissed in their entirety. Lorillard Tobacco has been dismissed from approximately 565 additional IPIC Cases because those plaintiffs did not submit evidence that they used a Lorillard Tobacco product. These additional IPIC Cases remain pending against other cigarette manufacturers and some or all of the dismissals of Lorillard Tobacco could be contested in subsequent appeals. As of July 23, 2012, Lorillard Tobacco is a defendant in 31 of the pending IPIC Cases. Lorillard, Inc. was not a defendant in any of the IPIC Cases.

The court has severed from the IPIC Cases those claims alleging injury from the use of tobacco products other than cigarettes, including smokeless tobacco and cigars (the “Severed IPIC Claims”). The Severed IPIC Claims involve 30 plaintiffs. Twenty-eight of these plaintiffs have asserted both claims alleging that their injuries were caused by smoking cigarettes as well as claims alleging that their injuries were caused by using other tobacco products. The former claims will be considered during the consolidated trial of the IPIC Cases, while the latter claims are among the Severed IPIC Claims. Lorillard Tobacco is a defendant in seven of the Severed IPIC Claims. Lorillard, Inc. is not a defendant in any of the Severed IPIC Claims. Two plaintiffs have asserted only claims alleging that injuries were caused by using tobacco products other than cigarettes, and no part of their cases will be considered in the consolidated trial of the IPIC Cases (the “Severed IPIC Cases”). Neither Lorillard Tobacco nor Lorillard, Inc. is a defendant in either of the Severed IPIC Cases.

As of July 23, 2012, the Severed IPIC Claims and the Severed IPIC Cases were not subject to a trial plan. None of the Severed IPIC Claims or the Severed IPIC Cases was scheduled for trial as of July 23, 2012. Trial dates are subject to change.

Flight Attendant Cases

Lorillard Tobacco and three other cigarette manufacturers are the defendants in each of the pending Flight Attendant Cases. Lorillard, Inc. is not a defendant in any of these cases. These suits were filed as a result of a settlement agreement by the parties, including Lorillard Tobacco, in Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Miami-Dade County, Florida, filed October 31, 1991), a class action brought on behalf of flight attendants claiming injury as a result of exposure to environmental tobacco smoke. The settlement agreement, among other things, permitted the plaintiff class members to file these individual suits. These individuals may not seek punitive damages for injuries that arose prior to January 15, 1997. The period for filing Flight Attendant Cases expired in 2000 and no additional cases in this category may be filed.

The judges who have presided over the cases that have been tried have relied upon an order entered in October 2000 by the Circuit Court of Miami-Dade County, Florida. The October 2000 order has been construed by these judges as holding that the flight attendants are not required to prove the substantive liability elements of their claims for negligence, strict liability and breach of implied warranty in order to recover damages. The court further ruled that the trials of these suits are to address whether the plaintiffs’ alleged injuries were caused by their exposure to environmental tobacco smoke and, if so, the amount of damages to be awarded.

Lorillard Tobacco was a defendant in each of the eight Flight Attendant Cases in which verdicts have been returned. Defendants have prevailed in seven of the eight trials. In one of the seven cases in which a defense verdict was returned, the court granted plaintiff’s motion for a new trial and, following appeal, the case has been returned to the trial court for a second trial. The six remaining cases in which defense verdicts were returned are concluded. In

 

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the single trial decided for the plaintiff, French v. Philip Morris Incorporated, et al., the jury awarded $5.5 million in damages. The court, however, reduced this award to $500,000. This verdict, as reduced by the trial court, was affirmed on appeal and the defendants have paid the award. Lorillard Tobacco’s share of the judgment in this matter, including interest, was approximately $60,000.

As of July 23, 2012, none of the Flight Attendant Cases were scheduled for trial. Trial dates are subject to change.

Class Action Cases

Lorillard Tobacco is a defendant in two pending Class Action Cases. Lorillard, Inc. is not a defendant in either of these cases. In these pending cases, plaintiffs seek class certification on behalf of groups of cigarette smokers, or the estates of deceased cigarette smokers, who reside in the state in which the case was filed.

Cigarette manufacturers, including Lorillard Tobacco, have defeated motions for class certification in a number of cases. Motions for class certification have also been ruled upon in some of the “lights” cases or in other class actions to which neither Lorillard Tobacco nor Lorillard, Inc. was a party. In some of these cases, courts have denied class certification to the plaintiffs, while classes have been certified in other matters.

The Scott Case. In one Class Action Case against Lorillard Tobacco, Scott v. The American Tobacco Company, et al. (District Court, Orleans Parish, Louisiana, filed May 24, 1996), a Louisiana jury awarded damages to the certified class in 2004. The jury’s award was reduced on two separate occasions in response to defendants’ appeals, but defendants exhausted their appeals and have paid the final judgment. In August 2011, Lorillard Tobacco paid approximately $69.7 million, or one-fourth of the award, to satisfy its portion of the final judgment and the interest that accrued while appeals were pending.

In 1997, Scott was certified a class action on behalf of certain cigarette smokers resident in the State of Louisiana who desire to participate in medical monitoring or smoking cessation programs and who began smoking prior to September 1, 1988, or who began smoking prior to May 24, 1996 and allege that defendants undermined compliance with the warnings on cigarette packages.

In the fourth quarter of 2007, Lorillard, Inc. recorded a pretax provision of approximately $66 million for this matter which was included in selling, general and administrative expenses on the consolidated statements of income and was reclassified from other liabilities to accrued liabilities in the second quarter of 2010 on the consolidated balance sheets.

Counsel for the certified class has filed a motion for attorneys’ fees, for costs and expenses, and for an award to the class representatives. Plaintiffs’ counsel contends they incurred approximately $59.0 million in attorneys’ fees, and further contend that the value of those fees, given the age of the case, is approximately $92.0 million. Plaintiffs’ counsel request that a multiplier as high as seven be applied to any award ordered by the court. Plaintiffs’ counsel ask the court to order defendants to pay an award in excess of $300.0 million, but request in the alternative that they be awarded, from the fund awarded to the class, 33% to 40% of the amount of that fund. In addition, plaintiffs’ counsel seeks approximately $13.4 million in costs and expenses. Plaintiffs’ counsel further request that the court order a “substantial” award of an unspecified amount to the two class representatives for their services. In May 2012, an agreement was reached among all parties that released all claims against the defendants for attorneys’ fees and costs, and provided that class counsel would seek a fee only from the fund awarded to the class.

Other Class Action Cases. In another Class Action Case pending against Lorillard Tobacco, Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San Diego County, California, filed June 10, 1997), the California Supreme Court in 2009 vacated an order that had previously decertified a class and returned Brown to the trial court for further activity. The class in Brown is composed of residents of California who smoked at least one of defendants’ cigarettes between June 10, 1993 and April 23, 2001 and who were exposed to defendants’ marketing and advertising activities in California. The trial court has permitted plaintiffs to assert claims based on the alleged misrepresentation, concealment and fraudulent marketing of “light” or “ultra-light” cigarettes. In May 2012, the court ruled on separate motions by the defendants to decertify the class and to determine the suitability of currently named plaintiffs to represent the class. The court found that the class action could proceed as to the “light” claims, but that only one of the currently named plaintiffs was suitable to represent the class. Trial is set for April 19, 2013. Lorillard, Inc. is not a defendant in Brown.

 

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“Lights” Class Action Cases. Neither Lorillard Tobacco nor Lorillard, Inc. is a defendant in another approximately 19 Class Action Cases in which plaintiffs’ claims are based on the allegedly fraudulent marketing of “light” or “ultra-light” cigarettes. Classes have been certified in some of these cases. In one of these cases, Craft v. Philip Morris USA (Circuit Court, City of St. Louis, Missouri, filed February 29, 2000), trial began in September 2011. In November 2011, the court ordered a mistrial when the jury was unable to reach a verdict. Retrial has been scheduled for January 2013. In another of the “lights” Class Action Cases, Good v. Altria Group, Inc., et al., the U.S. Supreme Court ruled in December 2008 that neither the Federal Cigarette Labeling and Advertising Act nor the Federal Trade Commission’s regulation of cigarettes’ tar and nicotine disclosures preempts (or bars) some of plaintiffs’ claims. In 2009, the Judicial Panel on Multidistrict Litigation consolidated various federal court “lights” Class Action Cases pending against Philip Morris USA or Altria Group and transferred those cases to the U.S. District Court of Maine (the “MDL cases”). The court denied plaintiffs’ motion for class certification filed in four of the MDL Cases, and a federal appellate court declined to review the class certification order. Following the appellate court’s ruling, plaintiffs dismissed thirteen of the MDL Cases, including Good v. Altria Group, Inc., et al. In April, 2012, the Judicial Panel on Multidistrict Litigation entered an order transferring the four MDL cases that remained pending to the courts in which each originated.

Reimbursement Cases

U.S. Government Case. In August 2006, the U.S. District Court for the District of Columbia issued its final judgment and remedial order in the federal government’s reimbursement suit, United States of America v. Philip Morris USA, Inc., et al., (U.S. District Court, District of Columbia, filed September 22, 1999). The final judgment and remedial order concluded a bench trial that began in September 2004. Lorillard Tobacco, other cigarette manufacturers, two parent companies and two trade associations were defendants in this action during trial. Lorillard, Inc. is not a party to this case.

In its 2006 final judgment and remedial order, the court determined that the defendants, including Lorillard Tobacco, violated certain provisions of the RICO statute, that there was a likelihood of present and future RICO violations, and that equitable relief was warranted. The government was not awarded monetary damages. The equitable relief included permanent injunctions that prohibit the defendants, including Lorillard Tobacco, from engaging in any act of racketeering, as defined under RICO; from making any material false or deceptive statements concerning cigarettes; from making any express or implied statement about health on cigarette packaging or promotional materials (these prohibitions include a ban on using such descriptors as “low tar,” “light,” “ultra-light,” “mild” or “natural”); from making any statements that “low tar,” “light,” “ultra-light,” “mild” or “natural” or low-nicotine cigarettes may result in a reduced risk of disease; and from participating in the management or control of certain entities or their successors. The final judgment and remedial order also requires the defendants, including Lorillard Tobacco, to make corrective statements on their websites, in certain media, in point-of-sale advertisements, and on cigarette package “inserts” concerning: the health effects of smoking; the addictiveness of smoking; that there are no significant health benefits to be gained by smoking “low tar,” “light,” “ultra-light,” “mild” or “natural” cigarettes; that cigarette design has been manipulated to ensure optimum nicotine delivery to smokers; and that there are adverse effects from exposure to secondhand smoke. Lorillard Tobacco could incur costs in excess of $10 million to implement the final judgment and remedial order. The final judgment and remedial order also requires defendants, including Lorillard Tobacco, to make disclosures of disaggregated marketing data to the government, and to make document disclosures on a website and in a physical depository. The final judgment and remedial order prohibits each defendant that manufactures cigarettes, including Lorillard Tobacco, from selling any of its cigarette brands or certain elements of its business unless certain conditions are met.

The final judgment and remedial order has not yet been fully implemented. Following trial, the final judgment and remedial order was stayed because the defendants, the government and several intervenors noticed appeals to the Circuit Court of Appeals for the District of Columbia. In May 2009, a three judge panel upheld substantially all of the District Court’s final judgment and remedial order. In September 2009, the Court of Appeals denied defendants’ rehearing petitions as well as their motion to vacate those statements in the appellate ruling that address defendants’ marketing of “low tar” or “lights” cigarettes, to vacate those parts of the trial court’s judgment on that issue, and to remand the case with instructions to deny as moot the government’s allegations and requested relief regarding “lights” cigarettes. The Court of Appeals stayed its order that formally relinquished jurisdiction of defendants’ appeal pending the disposition of the petitions for writ of certiorari to the U.S. Supreme Court that were noticed by the defendants, the government and the intervenors. In June 2010, the U.S. Supreme Court denied all of the petitions for writ of certiorari. The case has been returned to the trial court for implementation of the Court of Appeals’

 

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directions in its 2009 ruling and for entry of an amended final judgment. As of July 23, 2012, the parties had submitted briefs regarding the issues that were remanded, and the court had not entered an amended final judgment. Following remand, the defendants filed a motion asserting that the 2009 Family Smoking Prevention and Tobacco Control Act had, in whole or in part, extinguished the court’s jurisdiction. In the alternative, defendants urged the court not to order any injunctive remedy in deference to the regulatory authority recently extended to the Food and Drug Administration. The trial court denied this motion in June 2011, and defendants have noticed an appeal to the U.S. Court of Appeals for the District of Columbia Circuit. The government filed a motion following remand requesting clarification of the extent of the defendants’ obligation to make disclosures of disaggregated marketing data and the use the government can make of that data. The trial court granted that motion in April, 2011, holding that the defendants must provide a broad range of data for the ten-year period beginning July 29, 2010, and that the Department of Justice may share that data with other governmental agencies, subject to the confidentiality requirements previously imposed by the trial court. The defendants have noticed an appeal from this order to the U.S. Court of Appeals for the District of Columbia Circuit. As of July 23, 2012, the Court of Appeals had not ruled on defendants’ appeals.

While trial was underway, the Court of Appeals ruled that plaintiff may not seek to recover profits earned by the defendants. Prior to trial, the government had claimed that it was entitled to approximately $280 billion from the defendants for its claim to recover profits earned by the defendants. The U.S. Supreme Court declined to address the decisions dismissing recovery of profits when it denied review of the government’s and the intervenors’ petitions, which effectively disposed of the claim to recover profits in this case.

Settlement of State Reimbursement Litigation. On November 23, 1998, Lorillard Tobacco, Philip Morris Incorporated, Brown & Williamson Tobacco Corporation and R.J. Reynolds Tobacco Company (the “Original Participating Manufacturers”) entered into the Master Settlement Agreement (“MSA”) with 46 states, the District of Columbia, the Commonwealth of Puerto Rico, Guam, the U.S. Virgin Islands, American Samoa and the Commonwealth of the Northern Mariana Islands to settle the asserted and unasserted health care cost recovery and certain other claims of those states. These settling entities are generally referred to as the “Settling States.” The Original Participating Manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota, which together with the MSA are referred to as the “State Settlement Agreements.”

The State Settlement Agreements provide that the agreements are not admissions, concessions or evidence of any liability or wrongdoing on the part of any party, and were entered into by the Original Participating Manufacturers to avoid the further expense, inconvenience, burden and uncertainty of litigation. Lorillard recorded pretax charges for its obligations under the State Settlement Agreements of $364 million and $702 million for the three and six months ended June 30, 2012, respectively, and $353 million and $673 million for the three and six months ended June 30, 2011, respectively. Lorillard’s portion of ongoing adjusted settlement payments and legal fees is based on its share of domestic cigarette shipments in the year preceding that in which the payment is due. Accordingly, Lorillard records its portions of ongoing adjusted settlement payments as part of cost of manufactured products sold as the related sales occur.

The State Settlement Agreements require that the domestic tobacco industry make annual payments of $10.4 billion, subject to adjustment for several factors, including inflation, market share and industry volume. In addition, the domestic tobacco industry is required to pay settling plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million, as well as an additional amount of up to $125 million in each year through 2008. These payment obligations are the several and not joint obligations of each settling defendant. The State Settlement Agreements also include provisions relating to significant advertising and marketing restrictions, public disclosure of certain industry documents, limitations on challenges to tobacco control and underage use laws, and other provisions.

Lorillard Tobacco, the other Original Participating Manufacturers and other subsequent participating manufacturers (collectively, the “Participating Manufacturers”) are seeking from the Settling States an adjustment in the amount of payments made in 2003 and subsequent years pursuant to a provision in the MSA that permits such adjustment if the companies can prove that the MSA was a significant factor in their loss of market share to companies not participating in the MSA and that the Settling States failed to diligently enforce certain statutes passed in connection with the MSA. If the Participating Manufacturers are ultimately successful, any recovery would be in the form of reimbursement of proceeds already paid or as a credit against future payments by the Participating Manufacturers.

 

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From time to time, lawsuits have been brought against Lorillard Tobacco and other participating manufacturers to the MSA, or against one or more of the Settling States, challenging the validity of the MSA on certain grounds, including as a violation of the antitrust laws. See “MSA-Related Antitrust Suit” below.

In addition, in connection with the MSA, the Original Participating Manufacturers entered into an agreement to establish a $5.2 billion trust fund payable between 1999 and 2010 to compensate the tobacco growing communities in 14 states (the “Trust”). Payments to the Trust ended in 2005 as a result of an assessment imposed under a federal law, enacted in 2004, repealing the federal supply management program for tobacco growers. Under the law, tobacco quota holders and growers will be compensated with payments totaling $10.1 billion, funded by an assessment on tobacco manufacturers and importers. Payments under the law to qualifying tobacco quota holders and growers commenced in 2005.

Lorillard believes that the State Settlement Agreements will materially adversely affect its cash flows and operating income in future years. The degree of the adverse impact will depend, among other things, on the rates of decline in domestic cigarette sales in the premium price and discount price segments, Lorillard’s share of the domestic premium price and discount price cigarette segments, and the effect of any resulting cost advantage of manufacturers not subject to significant payment obligations under the State Settlement Agreements.

Filter Cases

In addition to the above, claims have been brought against Lorillard Tobacco and Lorillard, Inc. by individuals who seek damages resulting from their alleged exposure to asbestos fibers that were incorporated into filter material used in one brand of cigarettes manufactured by a predecessor to Lorillard Tobacco for a limited period of time ending more than 50 years ago. As of July 23, 2012, Lorillard Tobacco was a defendant in 38 Filter Cases. Lorillard, Inc. was a defendant in eight Filter Cases, including four that also name Lorillard Tobacco. Since January 1, 2010, Lorillard Tobacco has paid, or has reached agreement to pay, a total of approximately $24.2 million in settlements to finally resolve 102 claims, including the Lenney case, discussed below. The related expense was recorded in selling, general and administrative expenses on the consolidated statements of income. Since January 1, 2010, verdicts have been returned in the following two Filter Cases: Lenney v. Armstrong International, Inc., et al., tried in the Superior Court of California, San Francisco County, and McGuire v. Lorillard Tobacco Company and Hollingsworth & Vose Company, tried in the Circuit Court, Division Four, of Jefferson County, Kentucky. In the Lenney trial, the jury found in favor of the plaintiffs as to their claims for compensatory damages and damages for loss of consortium, but it determined that plaintiffs were not entitled to an award of punitive damages from Lorillard Tobacco or Hollingsworth & Vose. Pursuant to the terms of a 1952 agreement between P. Lorillard Company and H&V Specialties Co., Inc. (the manufacturer of the filter material), Lorillard Tobacco is required to indemnify Hollingsworth & Vose for legal fees, expenses, judgments and resolutions in cases and claims alleging injury from finished products sold by P. Lorillard Company that contained the filter material. The final judgment entered by the trial court awarded plaintiffs a total of approximately $1.1 million in compensatory damages, damages for loss of consortium and costs from Lorillard Tobacco and Hollingsworth & Vose. Lorillard Tobacco and Hollingsworth & Vose noticed an appeal to the California Court of Appeals. In 2012, Lorillard Tobacco reached agreement with the plaintiffs to resolve plaintiffs’ pending claims, and any claims they might assert in the future, for an amount that is included in the above total for settlements reached since January 1, 2010. The jury in the McGuire case returned a verdict for Lorillard Tobacco and Hollingsworth & Vose, and the Court entered final judgment in May 2012. Plaintiff has noticed an appeal to the Kentucky Court of Appeals. As of July 23, 2012, eight Filter Cases were scheduled for trial or have been placed on courts’ trial calendars. Trial dates are subject to change.

Tobacco-Related Antitrust Cases

Indirect Purchaser Suits

Approximately 30 antitrust suits were filed in 2000 and 2001 on behalf of putative classes of consumers in various state courts against cigarette manufacturers. The suits all alleged that the defendants entered into agreements to fix the wholesale prices of cigarettes in violation of state antitrust laws which permit indirect purchasers, such as retailers and consumers, to sue under price fixing or consumer fraud statutes. More than 20 states permit such suits. Lorillard Tobacco was a defendant in all but one of these indirect purchaser cases. Lorillard, Inc. was not named as a defendant in any of these cases. Four indirect purchaser suits, in New York, Florida, New Mexico and Michigan, thereafter were dismissed by courts in those states. The actions in all other states, except for Kansas, were either voluntarily dismissed or dismissed by the courts.

 

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In the Kansas case, the District Court of Seward County certified a class of Kansas indirect purchasers in 2002. In July 2006, the Court issued an order confirming that fact discovery was closed, with the exception of privilege issues that the Court determined, based on a Special Master’s report, justified further fact discovery. In October 2007, the Court denied all of the defendants’ privilege claims, and the Kansas Supreme Court thereafter denied a petition seeking to overturn that ruling. On March 23, 2012, the District Court of Seward County granted the defendants’ motions for summary judgment dismissing the Kansas suit. Plaintiff’s motion for reconsideration was denied. On July 18, 2012, plaintiff filed a notice of appeal to the Court of Appeals for the State of Kansas.

MSA-Related Antitrust Suit

In October 2008, Lorillard Tobacco was named as a defendant in an action filed in the Western District of Kentucky, Vibo Corporation, Inc. d/b/a/ General Tobacco v. Conway, et al. The suit alleges that the named defendants, which include 52 state and territorial attorneys general and 19 tobacco manufacturers, violated the federal Sherman Antitrust Act of 1890 (the “Sherman Act”) by entering into and participating in the MSA. The plaintiff alleges that MSA participants, such as itself, that were not in existence when the MSA was executed in 1998 but subsequently became participants, are unlawfully required to pay significantly more sums to the states than companies that joined the MSA within 90 days after its execution. In addition to the Sherman Act claim, plaintiff has raised a number of constitutional claims against the states. Plaintiff seeks a declaratory judgment in its favor on all claims, an injunction against the continued enforcement of the MSA, treble damages against the tobacco manufacturer defendants, including Lorillard Tobacco, and damages and injunctive relief against the states, including contract recession and restitution. In December 2008, the court dismissed the complaint against all defendants, including Lorillard Tobacco. The court entered its final judgment dismissing the suit in January 2010. Thereafter, the plaintiff appealed to the federal Court of Appeals for the Sixth Circuit. On February 22, 2012, the dismissal of the suit was affirmed by the Court of Appeals for the Sixth Circuit. The time period for the plaintiff to file a petition for certiorari to the U.S. Supreme Court expired prior to July 23, 2012. Accordingly, this suit has been successfully dismissed and concluded.

Defenses

Each of Lorillard Tobacco and Lorillard, Inc. believes that it has valid defenses to the cases pending against it as well as valid bases for appeal should any adverse verdicts be returned against either of them. While Lorillard Tobacco and Lorillard, Inc. intend to defend vigorously all tobacco products liability litigation, it is not possible to predict the outcome of any of this litigation. Litigation is subject to many uncertainties. Plaintiffs have prevailed in several cases, as noted above. It is possible that one or more of the pending actions could be decided unfavorably as to Lorillard Tobacco, Lorillard, Inc. or the other defendants. Lorillard Tobacco and Lorillard, Inc. may enter into discussions in an attempt to settle particular cases if either believe it is appropriate to do so.

Neither Lorillard Tobacco nor Lorillard, Inc. can predict the outcome of pending litigation. Some plaintiffs have been awarded damages from cigarette manufacturers at trial. While some of these awards have been overturned or reduced, other damages awards have been paid after the manufacturers have exhausted their appeals. These awards and other litigation activities against cigarette manufacturers continue to receive media attention. In addition, health issues related to tobacco products also continue to receive media attention. It is possible, for example, that the 2006 verdict in United States of America v. Philip Morris USA, Inc., et al., which made many adverse findings regarding the conduct of the defendants, including Lorillard Tobacco, could form the basis of allegations by other plaintiffs or additional judicial findings against cigarette manufacturers. Any such developments could have an adverse effect on the ability of Lorillard Tobacco or Lorillard, Inc. to prevail in smoking and health litigation and could influence the filing of new suits against Lorillard Tobacco or Lorillard, Inc. Lorillard Tobacco and Lorillard, Inc. also cannot predict the type or extent of litigation that could be brought against either of them, or against other cigarette manufacturers, in the future.

Indemnification Obligations

In connection with the Separation, Lorillard entered into a separation agreement with Loews (the “Separation Agreement”) and agreed to indemnify Loews and its officers, directors, employees and agents against all costs and expenses arising out of third party claims (including, without limitation, attorneys’ fees, interest, penalties and costs of investigation or preparation for defense), judgments, fines, losses, claims, damages, liabilities, taxes, demands, assessments and amounts paid in settlement based on, arising out of or resulting from, among other things, Loews’s ownership of or the operation of Lorillard and its assets and properties, and its operation or conduct of its businesses at any time prior to or following the Separation (including with respect to any product liability claims).

 

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Loews is a defendant in two pending product liability cases, both of which are purported Class Action Cases. Lorillard Tobacco also is a defendant in both of the product liability cases in which Loews is involved. Pursuant to the Separation Agreement, Lorillard is required to indemnify Loews for the amount of any losses and any legal or other fees with respect to such cases.

Other Litigation

Lorillard is also party to other litigation arising in the ordinary course of business. The outcome of this other litigation will not, in the opinion of management, materially affect Lorillard’s results of operations or equity.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our historical consolidated financial statements and the notes related to those financial statements included in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 (the “Form 10-Q”). In addition to historical information, the following discussion contains forward-looking statements based on current expectations that involve risks and uncertainties. Investors are cautioned not to place undue reliance on these forward-looking statements. Statements preceded by, followed by or that otherwise include the words “believe,” “expect,” “anticipate,” “intend,” “project,” “estimate,” “plan,” “may increase,” “may fluctuate” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and are not historical facts. Actual results and the timing of certain events may differ significantly from those projected in such forward-looking statements due to a number of factors, including those risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “Form 10-K”) and those risk factors set forth in “Business Environment” below, in Part II, “Item 1A. Risk Factors” and elsewhere in this Form 10-Q. Except for our ongoing obligations to disclose material information under the federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless required by law. For any forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (“GAAP”).

The terms “Lorillard,” “we,” “our” and “us” refer to Lorillard, Inc., a Delaware corporation, and its subsidiaries. The terms “Lorillard, Inc.” and the “Company” refer solely to the parent company and “Lorillard Tobacco” refers solely to Lorillard Tobacco Company, the principal subsidiary of Lorillard, Inc.

Overview

Lorillard, Inc. (NYSE: LO), through its Lorillard Tobacco Company subsidiary, is the third largest manufacturer of cigarettes in the United States. Founded in 1760, Lorillard is the oldest continuously operating tobacco company in the United States. Newport, our flagship premium cigarette brand, is the top selling menthol and second largest selling cigarette brand overall in the United States based on gross units sold in the first six months of 2012 and in the full year 2011. In addition to the Newport brand, our product line has four additional cigarette brand families marketed under the Kent, True, Maverick and Old Gold brand names. These five cigarette brands include 43 different product offerings which vary in price, taste, flavor, length and packaging. In the United States and certain U.S. possessions and territories, we shipped 20.1 billion cigarettes in the first six months of 2012 and 40.7 billion cigarettes for the full year 2011. Lorillard, through its LOEC, Inc. subsidiary, is also the leading electronic cigarette company in the U.S., marketed under the blu ecigs brand following its acquisition of blu ecigs and other assets used in the manufacture, distribution, development, research, marketing, advertising, sale and service of electronic cigarettes on April 24, 2012. We sold our major trademarks outside of the United States in 1977. We maintain our headquarters and manufacture all of our traditional cigarette products at our Greensboro, North Carolina facilities.

Critical Accounting Policies and Estimates

For a description of the critical accounting policies that require the use of significant judgments and estimates by management, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 21, 2012.

 

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Business Environment -

Participants in the U.S. tobacco industry, including us, face a number of issues that have adversely affected their results of operations and financial condition in the past and will continue to do so, including:

 

   

A substantial volume of litigation seeking compensatory and punitive damages ranging into the billions of dollars, as well as equitable and injunctive relief, arising out of allegations of cancer and other health effects resulting from the use of cigarettes, addiction to smoking or exposure to environmental tobacco smoke, including claims for economic damages relating to alleged misrepresentation concerning the use of descriptors such as “lights,” as well as other alleged damages.

 

   

Substantial annual payments continuing in perpetuity, and significant restrictions on marketing and advertising have been agreed to and are required under the terms of certain settlement agreements, including the Master Settlement Agreement among major tobacco manufacturers and 46 states and various other governments and jurisdictions (the “MSA”) that we entered into in 1998 along with Philip Morris Incorporated, Brown & Williamson Tobacco Corporation and R.J. Reynolds Tobacco Company (the other “Original Participating Manufacturers”) to settle asserted and unasserted health care cost recovery and other claims. We and certain other U.S. tobacco product manufacturers previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (the “Initial State Settlements,” and together with the MSA, the “State Settlement Agreements”). The State Settlement Agreements impose a stream of future payment obligations on us and on the other major U.S. cigarette manufacturers as product is sold and place significant restrictions on our and their ability to market and sell cigarettes.

 

   

The domestic cigarette market, in which we conduct our only significant business, continues to contract. As a result of price increases, restrictions on advertising, promotions and smoking in public and private facilities, increases in regulation and excise taxes, health concerns, a decline in the social acceptability of smoking, increased pressure from anti-tobacco groups and other factors, domestic cigarette shipments have decreased at a compound rate of approximately 3.8% from the twelve months ended June 30, 2002 through the twelve months ended June 30, 2012.

 

   

Increases in cigarette prices since 1998 have led to an increase in the volume of discount and, specifically, deep discount cigarettes. Cigarette price increases have been driven by increases in federal, state and local excise taxes and by manufacturer price increases. Price increases have led, and continue to lead, to high levels of discounting and other promotional activities for premium brands. Deep discount brands have grown from an estimated domestic shipment share in 1998 of less than 2.0% to an estimated share of 13.4% for the three months ended June 30, 2012, and continue to be a significant competitive factor in the domestic cigarette market. We do not have sufficient empirical data to determine whether the increased price of cigarettes has deterred consumers from starting to smoke or encouraged them to quit smoking, but it is likely that increased prices may have had an adverse effect on consumption and may continue to do so.

 

   

The tobacco industry is subject to substantial and increasing regulation. In June 2009, the U.S. Congress passed, and the President signed into law, the Family Smoking Prevention and Tobacco Control Act (the “FSPTCA”) granting the FDA authority to regulate tobacco products. Pursuant to the terms of the FSPTCA, the FDA established the Tobacco Products Scientific Advisory Committee (the “TPSAC”) to evaluate, among other things, the impact of the use of menthol in cigarettes on the public health. In March 2011, the TPSAC issued its report to the FDA stating that “removal of menthol cigarettes from the marketplace would benefit public health.” On July 21, 2011, TPSAC considered revisions to its report, and the voting members unanimously approved the final report for submission to the FDA with no change in its recommendation. The FDA could promulgate regulations that, among other things, could result in a ban on or restrict the use of menthol in cigarettes. The law imposes and will impose new restrictions on the manner in which cigarettes can be advertised and marketed, requires larger and more severe health warnings on cigarette packaging, permits restriction of the level of tar and nicotine contained in or yielded by cigarettes and may alter the way cigarette products are developed and manufactured.

 

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On June 27, 2011, the FDA provided a progress report on its review of the science related to menthol cigarettes. In its Menthol Update, the FDA stated that “[e]xperts within the FDA Center for Tobacco Products are conducting an independent review of the science related to the impact [of menthol] in cigarettes on public health …” The FDA also stated that it will submit its draft independent review of menthol science to an external peer review panel in July 2011, and that following the peer review period (originally announced as three and one-half months), the FDA will make available the results of the peer review and its preliminary scientific assessment for public comment. On January 26, 2012, the FDA stated that its report had been submitted to the peer review panel and comments had been received from the panel on the report. The FDA also indicated that its final report, including the peer review comments, will be released for public comment at a future date.

 

   

In August 2009, we, along with RJR Tobacco, other tobacco manufacturers and a tobacco retailer, filed a lawsuit in the U.S. District Court for the Western District of Kentucky against the FDA challenging the constitutionality of certain restrictions on speech included in the FSPTCA. These restrictions on speech include, among others, bans on the use of color and graphics in certain tobacco product advertising, limits on the right to make truthful statements regarding modified risk tobacco products, a prohibition on making certain statements about the FDA’s regulation of tobacco products, restrictions on the placement of outdoor advertising, a ban on certain promotions offering gifts in consideration for the purchase of tobacco products (e.g., continuity programs), a ban on brand name sponsorship of events and the sale of brand name merchandise, and a ban on the distribution of product samples. The suit also challenges the law’s requirement for extensive graphic warning labels on all packaging and advertising. The complaint seeks a judgment (i) declaring that such provisions of the law violate the First and/or Fifth Amendments of the U.S. Constitution and (ii) enjoining the FDA from enforcing the unconstitutional provisions of the law. On January 4, 2010, the district court issued an order (a) striking down the provisions of the law that (i) banned the use of color and graphics in certain tobacco product advertising and (ii) prohibited tobacco manufacturers from making certain statements about the FDA’s regulation of tobacco products and (b) upholding the remaining challenged advertising provisions. Both sides have appealed the district court’s ruling to the Sixth Circuit Court of Appeals, and the appeal has been fully briefed and argued. On March 19, 2012, the Sixth Circuit issued an opinion (i) affirming the decision of the district court upholding certain of the FSPTCA’s restrictions on marketing tobacco products (but reversing as to the restriction on continuity programs); (ii) affirming the district court’s grant of summary judgment to the tobacco companies concerning the Act’s ban of the use of color and graphics in certain tobacco advertising; and (iii) affirming the lower court’s decision to uphold the constitutionality of the color graphic and non-graphic warning label requirements.

 

   

In February 2011, we, along with RJR Tobacco, filed a lawsuit in the U.S. District Court for the District of Columbia against the FDA challenging the composition of the TPSAC because of the FDA’s appointment of certain voting members with significant financial conflicts of interest. We believe these members are financially biased because they regularly testify as expert witnesses against tobacco-product manufacturers, and because they are paid consultants for pharmaceutical companies that develop and market smoking-cessation products. The suit similarly challenges the presence of certain conflicted individuals on the Constituents Subcommittee of the TPSAC. The complaint seeks a judgment (i) declaring that, among other things, the appointment of the conflicted individuals to the TPSAC (and its Constituents Subcommittee) was arbitrary, capricious, an abuse of discretion, and otherwise not in compliance with the law because it prevented the TPSAC from preparing a report that was unbiased and untainted by conflicts of interest, and (ii) enjoining the FDA from, among other things, relying on the TPSAC’s report. The FDA has filed a motion to dismiss this action, the parties have briefed the issue and a hearing was held on February 14, 2012. As of July 23, 2012, the court has not yet ruled on the motion.

 

   

In August 2011, we, along with RJR Tobacco and several other tobacco manufacturers, filed a lawsuit in the U.S. District Court for the District of Columbia against the FDA challenging the constitutionality of certain regulations requiring specific graphic warning labels on all packaging and advertising. The Complaint seeks a judgment (i) declaring that the regulations violate the First Amendment; (ii) declaring that the regulations violate various provisions of the Administrative Procedure Act; (iii) declaring that the textual and graphic warnings required under the

 

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FSPTCA shall become effective 15 months after the FDA issues regulations that are permissible under the U.S. Constitution and federal law; and (iv) preliminarily and permanently enjoining enforcement of the regulations. Plaintiffs moved for a preliminary injunction, and after full briefing and oral argument, the district court granted plaintiffs’ motion. Plaintiffs also moved in the district court for summary judgment in their favor and after full briefing and oral argument, the district court granted that motion too. The FDA appealed both decisions to the D.C. Circuit Court of Appeals, which consolidated the appeals and heard oral argument on April 10, 2012. As of July 23, 2012, the court has not yet ruled on the consolidated appeal.

 

   

The federal government and many state and local governments and agencies, as well as private businesses, have adopted legislation, regulations or policies which prohibit, restrict or discourage smoking, including legislation, regulations or policies prohibiting or restricting smoking in public buildings and facilities, stores, restaurants and bars, on airline flights and in the workplace. Other similar laws and regulations are under consideration and may be enacted by federal, state and local governments in the future.

 

   

Substantial federal, state and local excise taxes are reflected in the retail price of cigarettes. For the six months ended June 30, 2012, the federal excise tax was $1.0066 per pack and combined state and local excise taxes ranged from $0.17 to $5.85 per pack. For the six months ended June 30, 2012, there was one state excise tax increase implemented in the state of Illinois in the amount of $1.00 per pack. On June 21, 2010, New York state legislature approved a $1.60 per pack state excise tax increase that was implemented on July 1, 2010. The federal excise tax on cigarettes increased by $0.6166 per pack to $1.0066 per pack, effective April 1, 2009, to finance health insurance for children. It is likely that increases in excise and similar taxes have had an adverse impact on sales of cigarettes and that the most recent increase and future increases, the extent of which cannot be predicted, could result in further volume declines for the cigarette industry, including us, and an increased sales shift toward deep discount cigarettes rather than premium brands. In addition, we and other cigarette manufacturers and importers are required to pay an assessment under a federal law designed to fund payments to tobacco quota holders and growers and are required to pay an annual user fee to the FDA.

The domestic market for cigarettes is highly competitive. Competition is primarily based on a brand’s taste; quality; price, including the level of discounting and other promotional activities; positioning; consumer loyalty; and retail display. Our principal competitors are the two other major U.S. cigarette manufacturers, Philip Morris USA and RJR Tobacco. We also compete with numerous other smaller manufacturers and importers of cigarettes, including deep discount cigarette manufacturers. We believe our ability to compete even more effectively has been restrained in some marketing areas as a result of retail merchandising contracts offered by Philip Morris USA and RJR Tobacco which limit the retail shelf space available to our brands. As a result, in some retail locations we are limited in competitively supporting our promotional programs, which may constrain sales.

 

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The following table presents selected Lorillard and industry shipment data for the three and six months ended June 30, 2012 and 2011.

Selected Industry Data (3)

 

     Three Months
Ended
June 30,
    Six Months
Ended
June 30,
 
(Volume in billions)    2012     2011     2012     2011  

Lorillard total domestic unit volume (1)

     10.461        10.598        19.748        20.121   

Industry total domestic unit volume (1)

     76.138        77.425        142.984        147.036   

Lorillard’s premium volume as a percentage of its total volume (2)

     85.3     86.0     85.2     86.3

Newport’s share of Lorillard’s total volume (2)

     84.4     85.0     84.3     85.2

Newport’s share of Lorillard’s net sales (2)

     88.0     88.7     88.0     88.9

 

(1) Source: Management Science Associates, Inc. (“MSAI”), an independent third-party database management organization that collects wholesale shipment data from various cigarette manufacturers. MSAI divides the cigarette market into two price segments, the premium price segment and the discount or reduced price segment. MSAI’s information relating to unit sales volume of certain of the smaller, primarily deep discount, cigarette manufacturers is based on estimates derived by MSAI. Management believes that volume information for deep discount manufacturers may be understated.
(2) Source: Lorillard shipment reports.
(3) Domestic unit volume includes cigarette units sold as well as promotional cigarette units and excludes volumes for Puerto Rico and U.S. Possessions.

The following table presents selected Lorillard and industry retail cigarette market share data for the three and six months ended June 30, 2012 and 2011, based on Lorillard’s proprietary retail shipment data, EXCEL, which reflect shipments from wholesalers to retailers.

Selected Domestic Retail Cigarette Market Share Data (1)

 

     Three Months
Ended
June 30,
    Six Months
Ended
June 30,
 
      2012     2011     2012     2011  

Lorillard’s share of the retail market

     14.3     14.2     14.4     14.1

Lorillard’s share of the premium market

     16.5     16.6     16.7     16.7

Lorillard’s share of the menthol market (2)

     39.3     39.4     39.6     39.2

Newport’s share of the retail market

     12.0     12.0     12.1     12.0

Newport’s share of the premium market

     16.3     16.4     16.5     16.4

Newport’s share of the menthol market (2)

     36.2     36.5     36.5     36.4

Total menthol segment market share for the industry (2)

     30.9     30.3     31.0     30.6

Total discount segment market share for the industry

     26.4     26.9     26.6     27.1

 

(1) Source: Lorillard’s proprietary retail shipment data, EXCEL, which reflect shipments from wholesalers to retailers.
(2) Lorillard has made certain adjustments to its proprietary retail shipment data to reflect management’s judgment as to which brands are included in the menthol segment.

 

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Results of Operations

Three and Six Months Ended June 30, 2012 Compared to the Three and Six Months Ended June 30, 2011

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  
     (in millions)     (in millions)  

Net sales (a)

   $ 1,731      $ 1,692      $ 3,257      $ 3,227   

Cost of sales (a) (b)

     1,119        1,093        2,122        2,085   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     612        599        1,135        1,142   

Selling, general and administrative

     128        112        260        234   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     484        487        875        908   

Investment income

     —          1        2        2   

Interest expense

     (37     (28     (76     (56
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     447        460        801        854   

Income taxes

     163        169        294